Reducing estate taxes and helping to ensure your assets are distributed as you wish are some of the estate planning benefits of using an irrevocable trust. However, estate planning isn’t just a “set it and forget it” process as families, tax laws, and financial circumstances can change at any moment. Irrevocable trusts do have a major downside that you need to know: Once they’ve been signed and funded, they’re difficult to update. Decanting an irrevocable trust can help with this.
What Does It Mean To “Decant” A Trust?
The term decanting comes from pouring wine from one bottle to another. In estate planning, it means transferring assets from an existing trust to a new trust that can better achieve your goals.
Depending on the trust’s language and the provisions of applicable state law, decanting may allow a trustee to:
- Correct errors or clarify trust language,
- Move the trust to a state with more favorable tax or asset protection laws,
- Take advantage of new tax laws,
- Remove beneficiaries,
- Change the number of trustees or alter their powers,
- Add or enhance spendthrift language to protect the trust assets from creditors’ claims, or
- Move funds to a special needs trust for a disabled beneficiary.
Unlike assets transferred at death, assets that are transferred to a trust don’t receive a step-up in basis. As a result, they can subject the beneficiaries to capital gains tax on any appreciation in value. One potential solution is to use decanting.
Decanting can authorize the trustee to confer a general power of appointment over the assets to the trust’s grantor. This would cause the assets to be included in the grantor’s estate and, therefore, to be eligible for a step-up in basis. Depending on the size of the estate, this might make sense given today’s high gift and estate tax exemption ($15 million in 2026).
Beware Of Your State’s Laws
Many states have decanting statutes, and in some states, decanting is authorized by common law. Either way, it’s critical to understand your state’s requirements. For example, in certain states, the trustee must notify the beneficiaries or even obtain their consent to decant.
Even if decanting an irrevocable trust is permitted, there may be limitations on its uses. Some states, for example, prohibit the use of decanting to eliminate beneficiaries or add a power of appointment. And most states won’t allow the addition of a new beneficiary. If your state doesn’t authorize decanting, or if its decanting laws don’t allow you to accomplish your objectives, it may be possible to move the trust to a state whose laws meet your needs.
Don’t Forget About Potential Tax Implications
One of the risks associated with decanting is uncertainty over its tax implications. For example, let’s say a beneficiary’s interest is reduced. Have they made a taxable gift? Does it depend on whether the beneficiary has consented to the decanting? If the trust’s language authorizes decanting, must it be treated as a grantor trust? Does such language jeopardize the trust’s eligibility for the marital deduction? Does distribution of assets from one trust to another trigger capital gains or other income tax consequences to the trust or its beneficiaries?
If you have tax-related questions, please contact us. We’d be happy to help you better understand the financial pros and cons of decanting a trust.
