Recent developments in moderntrust law have seen two majortrends that seemingly coincidewith a state’s reconsideration

of its statutory trust code: the enact-ment of a trust decanting statute andthe repeal of the common law ruleagainst perpetuities.A trust decant-ing statute that is coupled with astatutory repeal of the rule againstperpetuities potentially provides apowerful mechanism to extend theterm of irrevocable trusts. Currently,ten states have enacted trust decant-ing statutes:

1. Alaska.1

2. Arizona.2

3. Delaware.3

4. Florida.4

5. Nevada.5

6. New Hampshire. 6

7. New York.7

8. North Carolina.8

9. South Dakota.9

10. Tennessee.10

Four of these states—Tennessee,Florida, New Hampshire, and

North Carolina—have adopted theUniform Trust Code (UTC), andArizona has adopted a modifiedversion of the UTC.

In addition, nearly all of thesestates have either entirely repealedor substantially modified the com-mon law rule against perpetuitiesto allow trusts of a perpetual orextended duration. Arizona,Delaware, New Hampshire, NorthCarolina, and South Dakota haverepealed the common law ruleagainst perpetuities and now per-mit trusts of a perpetual duration.11

Alaska allows trusts to continue for1,000 years, and Florida, Nevada,and Tennessee permit trusts lastingfor a term of 360 or 365 years.12

Therefore, in these states it may bepossible to extend the life of irrev-ocable trusts beyond the term tra-ditionally allowed by the commonlaw rule against perpetuities.

Trust decant ing overviewTrust decanting generally refers tothe distribution of property fromone trust to another trust pursuantto a trustee’s discretionary powerto distribute property to or for thebenefit of the trust’s beneficiaries.The rationale behind decantingis that if a trustee has the discre-tionary power to distribute prop-erty to or for the benefit of oneor more beneficiaries, then thetrustee has, in effect, a specialpower of appointment that shouldenable the trustee to distributeproperty to a second trust for thebenefit of one or more of such ben-eficiaries.

In general, the holder of a spe-cial power of appointment maytransfer any beneficial interest inproperty to objects of the power tothe same extent as if the holderactually owned the beneficialinterest in property.13 A power ofappointment is characterized by theability to transfer a beneficial inter-est in property the holder of the

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Us e of Trus t De canting toExtend the Term ofIrrevocable Trus ts

GST and gift tax consequences arise from us ing state statutes that permit trust decantingand a relaxed rule against perpetuities to extend the duration of irrevocable trusts.

WILLIAM R. CULP, JR. AND BRIANI L. BENNETT, ATTORNEYS

WILLIAM R. CULP, JR. is a partner and BRIANI L. BEN-NETT is an associate at Culp Elliott & Carpenter, PLLC,in Charlotte, North Carolina.

power does not otherwise possess,and thus a trustee’s discretion todistribute trust property to oramong a class of beneficiaries maybe characterized as a special powerof appointment.14

A trustee with discretionarypower to distribute property to orfor the benefit of one or more ben-eficiaries, moreover, should be ableto give the current beneficiaries aspecial or general power of appoint-ment under the terms of the secondtrust that would be the functionalequivalent of distributing the prop-erty outright to the beneficiaries.15

Of course, unlike the run-of-the-mill power of appointment, thetrustee’s ability to decant trustproperty to another trust is subjectto the trustee’s fiduciary duties totrust beneficiaries.16

Although the extent of a trustee’sauthority to decant trust propertyunder common law may be unclear,an increasing number of statestatutes have been enacted toexpressly authorize a trustee’s powerto decant trust property to anothertrust.17 In addition, the terms ofthe trust instrument itself mayexpressly authorize a decanting.

In 1992, New York was the firststate to enact a state “decanting”statute that allowed a trustee toappoint trust property in favor ofanother trust.18 New York’s decant-ing statute was enacted with an eyetowards extending the generation-skipping transfer (GST) tax exemptstatus of “grandfathered trusts,”trusts that are exempt from applica-tionof theGST tax because theywereirrevocable on 9/25/1985, or other-wisequalify for exemptionunder cer-tain transition rules.19 Most com-mentators, however, take the viewthat the ability to extend the term ofa grandfathered trust pursuant to theregulatory “safe harbors” is of lim-ited utility.20 An unresolved issueremains as to whether a post-effec-tive date trust that is exempt fromGST tax because sufficient GST taxexemptionwas allocated to cause thetrust to have a zero-inclusion ratio (a“ZIR trust”)may be extended indef-initely without adverse GST or gifttax consequences.21

Extending the term ofgrandfathered trustsThe decanting issue has special impli-cations for grandfathered trusts.

Exercise of a power of appoint-ment. The GST tax regulations donot treat the exercise of a specialpower of appointment contained ina grandfathered trust as a contri-bution of additional property thatwould taint grandfathered trust sta-tus so long as the power is not exer-cised in a manner that violates thepermissible perpetuities period. Thisperiod generally is limited to livesin being plus 21 years or 90 yearsmeasured from the date of the grand-fathered trust’s creation (the “fed-eral perpetuities period”).22

For example, the exercise of aspecia l power of appo intmentby appointing property furtherin trust would not subject trans-fers of grandfathered trust prop-erty to GST tax if the term of thecontinuing trust does not extendbeyond the federal perpetuitiesperiod.23 However, if the exerciseof the special power causes grand-fathered trust property to con-tinue in trust for a period that vio-lates the federa l perpetu it iesperiod, grandfathered trust prop-erty appointed in further trustwould be treated as an addition to

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E S T A T E P L A N N I N G J U N E 2 0 1 0 V O L 3 7 / N O 6

1 A l a s k a S t a t . § 1 3 . 3 6 . 1 57 .2 A ri z . R e v. S t a t . § 1 4-1 08 1 9 .3 D e l . C o d e A n n . T it . 1 2 , § 3 5 2 8 .4 F l a . S t a t . A n n . § 7 3 6 . 0 4 1 1 7(1)( a ).5 2009 N e v. St a t. c h. 215, § 37 (S. B . 287) (e n a c t-

in g trus t d e c a n t in g p ro v is io n in C h a p t e r 1 6 3o f th e N e v a d a R e v is e d S t a tu t e s).

6 N . H . R e v. S t a t . A n n . § 5 6 4- B :4-4 1 8 .7 N .Y. E s t . P o w e rs & Tru s ts L a w § 1 0-6 . 6 .8 N . C . G e n . S t a t . § 3 6 C -8-8 1 6 . 1 .9 S . D . C o d if i e d L a w § 5 5-2-1 5 .10 Te n n . C o d e A n n . § 3 5-1 5-8 1 6(2 7).11 A ri z . R e v. S t a t . § 1 4-2 9 0 1; D e l . C o d e A n n . T it .

2 5 , § 5 0 3 ; N . H . R e v. S t a t . A n n . § 5 6 4 : 2 4 ;N . C . G e n . S t a t . § 4 1-2 3; S . D . C o d if i e d L a w s§ § 4 3-5-1 , 4 3-5-4 , a n d 4 3-5-8 . T h e c o n s t itu-t io n a l ity o f N . C . G e n . S t . § 4 1-2 3 w a s u p h e l di n a l o w e r a p p e l l a t e c o ur t d e c i s i o n . B ro w nB ro s . H a rrim a n Tru s t C o . , N . A . v. B e n so n , 6 8 8S . E . 2 d 7 5 2 (2 0 1 0) . T h i s d e c i s i o n h a s b e e na p p e a le d to th e N orth C arolin a Su pre m e C ourt.

12 A l a sk a St a t. § § 34 .27 .051 a n d 34 .27 .100; F l a .S t a t . § 6 8 9 . 2 2 5 (3 60 y e a rs); N e v. R e v. S t a t . §1 1 1 . 1 0 3 1 (3 6 5 y e a rs); Te n n C o d e A n n . § 6 6-1-2 0 2(f) (3 60 y e a rs).

13 R e s t a t e m e n t ( S e c o n d ) o f P ro p . : D o n a t i v eTr a n s f e rs § 1 9 . 3 (1 9 8 6).

14 R e s t a t e m e n t ( S e c o n d ) o f P ro p . : D o n a t i v eTr a n s f e rs § 1 1 . 1 c m ts . a , d (1 9 8 6).

15 S e e R e st a t e m e n t (S e c on d) of Pro p .: D on a t iv eTra nsf ers § 19 .4 (in d i c a tin g th a t ho l d er of s p e-c i a l p o w e r o f a p p o i n t m e n t m a y g r a n t n e wp o w e r o f a p p o in tm e n t to o b j e c ts o f th e p ow e rb e c a u s e th e c re a t ion o f a t e s t a m e n t a ry g e n-e r a l p ow e r in th e p e rm is s i b l e a p p o in t e e is , ins u b s t a n c e , t h e e q u i v a l e n t o f a n o u t r i g h ta p p o intm e nt of trust pro p erty, e s p e c i a lly if th ep erm iss i b l e a p p o int e e h a s a lif e in c om e int er-e s t in th e a p p o in t iv e a s s e ts).

16 S e e R e s t a t e m e n t (T h ird ) o f Pro p e rty: W i l ls &O th e r D o n a t iv e Tr a n s f e rs § 1 7 . 1 c m t . g (Te n-t a t i v e D r a f t N o . 5 , 2 0 0 6) ( d e f i n i n g p o w e r o fa p p o in tm e n t a s p ow e r h e l d in a n o n f i d u c i a ryc a p a c i t y b u t re c o g n i z in g t h a t f i d u c i a r y d is-tri b u t iv e p o w ers m a y b e s u b j e c t to th e s a m eg e n e r a l ru l e s g o v e r n i n g s p e c i a l p o w e rs o fa p p o in tm e n t).

17 C a s e s in a t l e a st thre e st a t e s h a v e b e e n re c-o g n i z e d a s s u p p or t i n g a tru s t e e ’s p o w e r t od e c a nt pro p erty to a noth er trust. S e e H a l p erina n d O ’ D onn e ll, “Mo d ify in g Irre vo c a b l e Trusts:S t a t e L a w a n d Ta x C o n s i d e r a t i o n s i n Tr u s tD e c a ntin g ,” 42 H e c k erlin g Inst. O n E st. P l a n-ning ¶ 1302.3 (2008) (d iscussing Phip ps v. Pa lmB e a c h Tru s t C o . , 1 4 2 F l a . 7 8 2 , 1 9 6 S o . 2 9 9(1940); a n d Wie d e nm a y er v. Johnson , 106 N .J .Su p er. 161 , 254 A .2 d 534 (1969)); F ox , “Trust

D e c a nt in g U n d er C ommon L a w a n d A lt ern a-tiv e s to D e c a ntin g ,” re print e d in N .Y C ity B arC L E m a t eri a ls for “Th e C a n ’s & C a n ’ts of TrustD e c a ntin g ” (10/21/08) (d is c uss in g In re E st a t eo f S p e n c e r, 2 3 2 N . W. 2 d 4 9 1 (I o w a , 1 9 7 5 );Phip p s, 142 F la . 782, 196 So. 299; a n d Wie d e n-m a y er, 106 N .J . Su p er. 161 , 254 A .2 d 534).

18 S e e N .Y. E st. Pow ers & Trust L a w. § 10-6 .6(b).19 S e c tion 2601; Ta x R e form A c t of 1986 , Pu b . L .

No. 99–514 se c tion 1433(a); R e g . 26.2601-1(a).20 S e e H a l p e rin a n d O ’ D o n n e l l , supra n o t e 1 7;

H a l p e r i n a n d W a n d l e r, “ D e c a n t i n g D i s c r e -t io n a ry Tru s ts: S t a t e L a w a n d Ta x C o n s i d e r a -t io n s ,” 2 9 Ta x M g m ’t E s t a t e s G ifts & Tru s ts J .N o . 5 (9/9/2004); N e nno , “Terrors of th e D e e p :Ta x D a n g e rs W h e n E x e rc is in g P o w e rs O v e rTr u s t s — T h e G S T R e g u l a t i o n s a n d t h eD e l a w a r e Ta x Tr a p , ” 3 4 Ta x M g m ’t E s t a t e s ,G ifts & Tru s ts J . N o . 1 (1/1/2 0 0 9).

21 T h i s a r t i c l e d o e s n o t a d d r e s s t h e e s t a t e orin c o m e t a x is s u e s r a is e d b y a tru s t d e c a n t i-n g . F o r a d i s c u s s i o n o f p o t e n t i a l e s t a t e o rin c om e t a x c o n s e q u e n c e s from tru s t d e c a n t-i n g , s e e g e n e r a l ly C u l p a n d B e n n e t t , “ Tru s tD e c a n t in g : A n O v e rv i e w a n d In tro d u c t io n toC r e a t i v e P l a n n i n g O p p o r t u n i t i e s , ” 4 5 R e a lPro p . Pro b a te & Trust J. (S prin g 2010); H a lp erina n d O ’ D o n n e ll , supra n o t e 1 7 .

22 R e g . 2 6 . 2 60 1-1( b )(1)(v)( B)(2).23 S e e R e g . 2 6 . 2 6 01-1( b )(1)(v)( D), E x a m p l e 4 .

trusts would cause a loss of GSTexempt status.

Regulatory “safe harbors.” Despitethe fact that the regulations containno general rule providing whatactions or modifications wouldresult in a loss of a grandfatheredtrust’s exempt status, the regulationsnevertheless provide certain safe har-bors that apply to a decanting ofproperty from grandfatheredtrusts.26 For purposes of this article,the safe harbors that governtrust decantings will be referredto as “Safe Harbor #1” and “SafeHarbor #2.”

Safe Harbor #1. The first safeharbor governs discretionary dis-tributions from grandfatheredtrusts taken pursuant to trusteeaction (Safe Harbor #1).27 Atrustee’s discretionary distributionof property from a grandfathered

trust to a new trust, or retention ofcorpus in a continuing trust, doesnot cause the new or continuingtrust to lose the grandfatheredtrust’s exempt status if the fol-lowing three requirements are met:

1. Either the terms of the grand-fathered trust or state lawauthorized the trustee’s actionon the date the grandfatheredtrust became irrevocable.

2. The trustee’s action can betaken without beneficiary con-sent or court approval.

3. The new or continuing trustdoes not postpone or suspendthe vesting, absolute ownership,or power of alienation of aninterest in property beyond thefederal perpetuities period.28

SafeHarbor #1 may be availableto extend a trust if the terms ofthe trust or state common law

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24 S e e R e g . 2 6 . 2 6 0 1-1( b )(1)(v)(D ), E x a m p l e 5 .25 S e e , e . g . , N .Y. E st. Pow ers & Trusts L a w § 10-

6 .6(f); A l a sk a St a t. § 13 .36 .157(c); D e l. C o d eA n n . T i t . 1 2 , § 3 5 2 8 ( c ) ; F l a . S t a t . A n n . §7 3 6 . 0 4 1 1 7 ( 3 ) ; N . C . G e n . S t a t . § 3 6 C - 8 -8 1 6 . 1( d).

26 R e g s . 2 6 . 2 6 0 1 - 1 ( b )( 4 )( i)( A ) a n d 2 6 . 2 6 0 1 -1(b )(4)(i)( D ).

27 R e g . 2 6 . 2 6 0 1-1( b )(4)(i)( A).28 Id.

a trust that is no longer exemptfrom GST tax.24

Although state decanting sta-tutes are premised on the under-lying principle that a trustee’s dis-cretionary authority to distributeproperty is equivalent to a specialpower of appointment, the regu-lations do not treat decantingsfrom grandfathered trusts as theexercise of a special power ofappointment for GST tax purpos-es.25 Instead, the regulations pro-vide various “safe harbors” thatgovern whether distributions fromor modifications of grandfathered

authorized a trustee’s distributionof property further in trust on thedate the trust became irrevocable.However, use of a state decantingstatute to extend a grandfatheredtrust’s term would not satisfy thefirst requirement of SafeHarbor #1because the first decanting statutewas not enacted until 1992. Evenassuming that a given state’s com-mon law authorized a trust decant-ing on the date the trust becameirrevocable, the term of the grand-fathered trust cannot be extendedindefinitely without violating thefederal perpetuities period. It maybe possible, however, to extend theterm of a grandfathered trust to thelimits of the federal perpetuitiesperiod under the terms of the trust29

or in states with favorable commonlaw on trust decanting.30

Safe Harbor #2. The second safeharbor applies to modificationsof grandfathered trusts, a catch-allprovision covering any changes tograndfathered trusts by trustdecanting, court action, or other-wise (Safe Harbor #2).31 Anychange to a grandfathered trustcaused by a trust decanting mustsatisfy two requirements to meetSafe Harbor #2:

1. The modification must notshift a beneficial interest in thetrust to any generation lowerthan that of the persons hold-ing beneficial interests prior tothe modification.

2. The modification must notextend the time for vesting ofany beneficial interests beyondthe period provided for underthe terms of the grandfatheredtrust.32 Because the secondrequirement of Safe Harbor #2prohibits the extension of timefor vesting of any beneficialinterest in a grandfatheredtrust, Safe Harbor #2 isunavailable to extend the termof a grandfathered trust.

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The trus te e ’sability to de canttrus t property toanother trus t issubje ct to thetrus te e ’s fiduc iarydutie s to trus tbenefic iarie s .

The regulations provide that forpurposes of SafeHarbor #2, a mod-ification of a grandfathered trustresults in a shift in beneficial inter-ests to a lower-generation benefi-ciary if the modification can resultin either (1) an increase in the GSTtransfer, or (2) the creation of a newGST transfer.33 Although the term“GST transfer” is not defined in theregulation, an example to the reg-ulation illustrates that a modifica-tion of a grandfathered trust for thebenefit of the settlor’s three grand-children that increases the incomepayable to one of the grandchildrenresults in a shift in beneficial inter-ests within generations, but doesnot impermissibly shift a beneficialinterest to a lower generation.34

The examples illustrating SafeHarbor #2, however, do not includethe effect of a trust modification thatalters or eliminates a general powerof appointment contained in agrandfathered trust. As such, it isunclearwhether SafeHarbor #2 pro-tects GST tax-exempt status whenproperty is decanted from a grand-fathered trust containing a generalpower of appointment to a trust con-taining only special powers.

The Code and regulations aresilent as to the treatment of a gen-eral power of appointment as a ben-eficial interest in trust property forGST purposes, but under the grantortrust rules contained in Sections 671through 679, a person having a gen-eral power of appointment over trustproperty is deemed to have a bene-

ficial interest in the trust for pur-poses of the definition of an “adverseparty.”35 The definition of a bene-ficial interest in property for pur-poses of Section 2013 also includesa general power of appointment.36

Consequences of losing grandfa-thered status. The IRS has not defin-itively resolved the treatment of agrandfathered trust after a modifi-cation or extension of the trust’sterm that violates the regulatory safeharbors and results in the trust’s lossof its GST tax-exempt status. Ini-tially the IRS informally indicatedthat on the loss of a grandfatheredtrust’s exempt status, the currentbeneficiaries would be deemed tocreate a new trust in a transactionsubject to the gift tax.37 The IRS laterreconsidered its position and con-cluded that the settlor of a grand-fathered trust would be treated asthe transferor for GST tax purpos-es if the grandfathered trust lost itsexempt status.38

Although whether and to whatextent the settlor’s GST tax exemp-tion would be applied to a trust los-ing grandfathered status remainsunclear, most commentators feelthat the loss of exempt status doesnot subject all future distributionsfrom the trust to GST tax.39 It is

29 S e e R e g . 2 6 . 2 6 0 1-1( b )(4)( i)( E ) , E x a m p l e 1(provid in g a n e x a m p le of wh e n a d is cre tion arytru s t for a c h i l d a n d c h i l d ’s is s u e th a t t e rm i-n a t e s on th e d e a th of th e c h il d wou l d not los egra n d f a th ere d st a tus if, p ursu a nt to th e t ermso f th e g o v ern in g in s tru m e n t , p ro p e rty is d is-tri b u t e d to a n o th e r tru s t th a t c o n t in u e s d ur-in g th e l if e o f th e c h i l d ’s is s u e ).

30 F or c a s e s g e n e r a l ly v i e w e d a s s u p p ort in g atrust e e ’s c ommon l a w a uthority to d e c a nt, s e en o t e 1 7 , supra.

31 R e g . 2 6 . 2 6 01-1(b )(4)(i)( D).32 Id.33 R e g . 2 6 . 2 6 01-1(b )(4)(i)( D)(2).34 R e g . 2 6 . 2 6 0 1-1( b )(4)(i)( E ), E x a m p l e 7 ( p ro-

v i d in g e x a m p l e o f m o d if i c a t io n th a t d o e s n o ts h ift a n in t e re s t to a lo w e r g e n e r a t io n).

35 S e c t io n 6 7 2( a ).36 S e c t io n 2 0 1 3( e).37 L tr. R u ls . 9 4 2 1 0 4 8 a n d 9 4 4 8 0 2 4 .38 L tr. R u l . 9 5 2 2 0 3 2 .39 S e e , e . g . , H a rri n g t o n , P l a i n e , a n d Z a ri t s k y,

Generation-Skipping Transfer Tax: AnalysisWith Forms ( 2 d e d . ) ¶ 7 . 0 6 [ 3 ] ( T h o m s o nR e u t e rs/W G &L , 2 0 0 1).

been allocated sufficient GST taxexemption to cause the trust to havea zero-inclusion ratio. Private let-ter rulings, however, have extend-ed the application of safe harborsto ZIR trusts by analogy. In the pri-vate letter rulings, the IRS acknowl-edges that no guidance has beenissued on changes to trusts that mayaffect the exempt status of a ZIRtrust, but concedes that, at a min-imum, a modification that satisfiesthe grandfathered trust safe har-bors would not affect the inclusionratio of a ZIR trust.41 Therefore,it should be possible to extend theterm of a ZIR trust pursuant to SafeHarbor #1, within the limits of thefederal rule against perpetuities,if the terms of the trust or state lawauthorized the decanting at the timethe trust became irrevocable.

Extending ZIR trust terms outsideof the safe harbors. Additionally,it may be possible to extend theterm of a ZIR trust beyond the fed-eral rule against perpetuities appli-cable to grandfathered trusts bydecanting trust property to a validperpetual or dynasty trust underapplicable state law, even if the per-

petual extension of the trust’s termwould violate Safe Harbor #1.42 Asmentioned above, the regulatory“safe harbors” expressly apply onlyto grandfathered trusts, and do notextend to ZIR trusts.

AZIR trust differs from a grand-fathered trust in that a ZIR trust isexempt from GST tax because suf-ficient GST tax exemption was allo-cated to the trust to produce a zeroinclusion ratio, whereas a grand-fathered trust is exempt from GSTtax pursuant to the effective daterules set forth in the regulations.In the absence of statutory or reg-ulatory guidance on the GST taxconsequences of extending ZIRtrusts, a trust decanting thatextends the term of a ZIR trustcould be analyzed under the rulesgoverning the exercise of specialpowers of appointment.

Prior to the regulatory amend-ments issued on 5/20/1997, theregulations provided that the exer-cise of a special power of appoint-ment in a non-grandfathered trustthat extended a trust’s term beyondthe federal perpetuities periodwould be treated as a transfer sub-ject to federal gift and estate tax,

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likely that distributions of grand-fathered trust property would notbe subject to the GST tax if the dis-tributions would not qualify asgeneration-skipping transfers hadthe trust’s exempt status beenignored. However, distributions tobeneficiaries who could not havereceived distributions free of GSTtax from the grandfathered trusthad the GST tax rules applied like-ly would be subject to GST tax.40

Extending the term ofzero-inclus ion rat io trustsThe discussion that follows focus-es on issues that arise from extend-ing the term of zero-inclusion ratio(ZIR) trusts.

Regulatory safe harbors. The reg-ulatory safe harbors relating tograndfathered trusts, by their terms,do not apply to ZIR trusts that have

40 H a l p e r i n a n d O ’ D o n n e l l , supra n o t e 1 7 , a t¶ 1 3 0 4 . 5 (2 0 0 8).

41 L tr. R u l . 2 0 0 7 4 3 0 2 8 ( c o n c e d in g t h a t “[ a ]t am in im u m , a c h a n g e th a t w o u l d n o t a ff e c t th eG S T s t a t u s o f a g r a n d f a t h e re d tru s t s h o u l dsimilarly not a ff e c t th e e x e m p t st a tus of [a z eroi n c l u s i o n r a t i o] tru s t ; ” L tr. R u l . 2 0 0 9 1 9 0 0 8(s a m e ).

42 C are should b e t a k e n to e nsure th a t th e e xt e n-s io n d o e s n o t v io l a t e th e D e l a w a re Ta x Tr a p ,d is c u s s e d infra.

and the powerholder would be thedeemed transferor of the trust afterexercise of the special power.43 Theintent of the regulation was to sub-ject the extension of a ZIR trust pur-suant to a special power of appoint-ment to the GST tax, although taxwould not have applied otherwise.44

However, a regulatory amendmentdeleted the section after it was per-ceived as an abuse to extend theterm of trust with an inclusion ratioof one beyond the applicable per-petuities period and shift the iden-tity of the transferor to the power-holder’s generation tax-free.45

Because this provision has beendeleted from the regulations, itshould be possible to extend theterm of a ZIR trust through theexercise of a special power ofappointment without adverse GSTtax consequences.46 Care must betaken, however, to ensure that theextension does not violate Sections2041(a)(3) and 2041(d), commonlyknown as the “Delaware tax trap”(discussed below). The Delawaretax trap could be avoided by pro-viding that the second trust can-not be extended for a period deter-mined without reference to thecreation of the first power in theoriginal trust.

Consequently, it also should bepossible to extend the term of a ZIRtrust indefinitely through trustdecanting by analogizing thetrustee’s power to distribute to aspecial power of appointment.Although it is currently unclearwhether the treatment of a trustee’sdiscretionary distribution power asa special power of appointment forGST tax purposes would be deter-mined under state law or as-of-yet-delineated federal common law,nearly every state decanting statutespecifically treats the trustee’spower to decant as the exercise ofa special power of appointment.47

Unlike the GST tax regulationsgoverning grandfathered trusts,

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Most commentatorsfe e l that thelos s of exempts tatus doe s notsubje ct a ll futuredis tributionsfrom the trus tto GST tax.

which treat a trustee’s discretionarypower to distribute differently fromthe exercise of a special power ofappointment, the definition of a“power of appointment” under theestate and gift tax regulations isbroad enough to include a trustee’sfiduciary power to distribute trustproperty. The gift and estate taxregulations define a power ofappointment as “all powers whichare in substance and effect pow-ers of appointment regardless ofthe nomenclature used in creatingthe power and regardless of localproperty law connotations.”48 Afiduciary power over the manage-ment or administration of trustassets is not considered a power ofappointment if the holder has nopower “to enlarge or shift any ofthe beneficial interests” in trust,excepting those powers that inci-dentally affect beneficial interestsas a consequence of discharging thetrustee’s fiduciary duties.49

This definition implies that afiduciary power that would enablethe holder to enlarge or shift anyof the beneficial interests in a trust,such as a discretionary power todistribute trust income or princi-pal to some, none, or all of a trust’sbeneficiaries, would satisfy the def-inition of a power of appointment.Because the defining feature of apower of appointment for gift andestate tax purposes appears to bethe ability to affect substantiallythe enjoyment of beneficial inter-ests in trust property, by analogya trustee’s power to decant trust

property should be treated as apower of appointment for GST taxpurposes. In the absence of statu-tory or regulatory guidance thatexplicitly provide special rules gov-erning decantings of property fromnongrandfathered trusts, it shouldbe possible to extend the term ofa ZIR trust to the fullest extent ofthe perpetuities period allowedunder applicable state law.

Inclusion ratio resulting from adecanting. The qualified severancestatute, Section 2642(a)(3), andcorresponding regulations provideguidance on when multiple trustsresulting from the division of a sin-gle trust would be treated asseparate trusts for GST tax pur-poses.50 The qualified severancestatute was temporarily added bythe Economic Growth and TaxRelief Reconciliation Act of 2001and currently is set to sunset after2010. A “qualified severance”occurs if:

1. A single trust is divided on afractional basis.

2. The terms of the trusts resultingfrom the division provide, in theaggregate, for the same succes-sion of beneficial interests asprovided in the original trust.51

A qualified severance of a ZIRtrust results in each separate trusthaving an inclusion ratio equalto zero.52

If a trust authorizes discretionarydistributions to beneficiaries on anon-pro rata basis, then separate

43 S e e R e g . 2 6 . 2 6 5 2-1( a )(4) , p r i or t o a m e n d -m e n t b y T D 8 7 2 0 , 5/2 0/1 9 9 7 .

44 T D 8 7 2 0 , 5/2 0/1 9 9 7 .45 Id.46 S e e H a rrin g to n , P l a in e , a n d Z a rits k y, supra

n o t e 3 9 , a t ¶ 2 . 0 2[1].47 S e e , e . g . , A l a s k a S t a t . § 1 3 . 3 6 . 1 5 7( c ); D e l .

C o d e A n n . T it . 1 2 , § 3 5 2 8( c ); F l a . S t a t . A n n .§ 736.04117(3); N .Y. E st. Pow ers & Trusts L a w§ 1 0-6 . 6(f); N . C . G e n . S t . § 3 6 C -8-8 16 . 1( b).

48 R e g s . 2 0 . 2 0 41-1( b )(1) a n d 2 5 . 2 5 14-1(b )(1).49 Id.50 S e c t io n 2 6 4 2( a)(3); R e g . 2 6 . 2 6 4 2-6 .51 S e c t io n 2 6 4 2( a)(3)( b )(i).52 R e g . 2 6 . 2 6 42-6(d )(6).

is deemed a transfer of property bythe powerholder if:

(1) The power of appointment wascreated after October 21, 1942;and

(2) The power is exercised by cre-ating another power of appoint-ment which, under applicable statelaw, could be validly exercised to:

(a) postpone the vesting of anyestate or interest in the propertysubject to the first power for a peri-od ascertainable without regard tothe date of creation of the firstpower; or

(b) suspend the absolute owner-ship or power of alienation of prop-erty subject to the first power fora period ascertainable withoutregard to the date of creation ofthe first power.57

If Section 2514(d) is violated,the powerholder is deemed to trans-fer the property subject to thepower of appointment created bythe exercise of the first power.58 Theregulations suggest that the deter-mination of whether an invalidpostponement or suspension occursdepends on whether the rule againstperpetuities under applicable locallaw is stated in terms of vesting orthe power of alienation.59 There-fore, the postponement-of-vest-ing branch applies if the applica-ble rule against perpetuities is basedon a rule against remoteness of vest-ing, and the suspension-of-ab-solute-ownership or power-of-alienation branch applies where theapplicable perpetuities period isstated in terms of suspension ofownership or power of alienation.60

The definition of a power ofappointment contained in the gifttax regulations appears broadenough to include an independenttrustee’s discretionary power to dis-tribute property if the trustee couldexercise the power in a manner thatwould substantially shift beneficialinterests in the trust.All of the statedecanting statutes premise atrustee’s ability to distribute prop-erty further in trust on the trustee’s

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53 R e g s . 2 6 . 2 6 4 2-6( d )(5)(i) thro u g h (iv).54 S e e , e . g . , L tr. R u l . 2 0 0 8 3 2 0 2 0 (m o d if i c a t io n

b y tru s t e e s to d iv i d e a n d c h a n g e a d m in is tr a -t iv e p ro v is io n s o f tru s t a u th ori z e d u n d er s t a t el a w w a s tre a t e d a s a c o n t in u a t io n o f th e tru s tf o r f e d e r a l i n c o m e t a x p u r p o s e s ); L tr. R u l .9 3 3 0 0 0 8 ( e x t e n s io n o f a tru s t re s u lt in g fro mt h e e x e rc i s e o f a s p e c i a l p o w e r o f a p p o i n t-m e n t g r a n t e d in th e g r a n d f a th e re d tru s t w a stre a t e d a s a c ontinu a tion of th e gra n d f a th ere dtru s t).

55 R e g . 2 6 . 2 6 4 2-6(h).

56 F or a g e n e r a l d is c u s s io n o f th e D e l a w a re t a xtr a p , s e e C l in e , Estates, Gifts & Trusts, 8 2 5—3rd Ta x M g m t . P or t f o l io ( B N A ) a t III . E , A -2 0(2 0 0 7); L i s c h e r, Gifts , 8 4 5—2 n d Ta x M g m t .P ortfo lio ( B N A ) a t VI. C . 4 , A -55 (2 0 0 5).

57 S e c t io n 2 5 1 4( d ).58 Id.59 R e g . 2 5 . 2 51 4-3(d ).60 Id.; s e e a lso a lso E s t a t e o f Murp hy, 71 T C 671

(1979) (d is c ussin g int e nt of S e c tion 2041(a)(3)a n d d e v e lo p m e n t o f s t a t e p e rp e tu it i e s l a w int e rm s o f v e s t in g or a li e n a t ion).

trusts will not provide for the samesuccession of beneficial interestswithin the meaning of Section2642(a)(3) unless:

1. The terms of the trusts are thesame as the original trust(although the beneficiaries ofthe original trust do not haveto be beneficiaries of all result-ing trusts).

2. Each beneficiary’s interest inthe resulting trusts collectivelyequals the beneficiary’s interesteither under the terms of theoriginal trust or, if not provid-ed for in the original trust, ona per capita basis.

3. The severance does not shift abeneficial interest in the trustto any beneficiary in a lowergeneration.

4. The severance does not extendthe time for vesting of any ben-eficial interest beyond the peri-od provided for in, or applica-ble to, the original trust.53

It is therefore unlikely that anextension of a ZIR trust’s term pur-suant to a trust decanting wouldsatisfy the qualified severancerequirements where the decantingresulted in a single trust that extend-ed beyond the terms of the originaltrust. A decanting that validlyextends the term of a ZIR trustunder applicable state law, how-ever, arguably would retain thezero-inclusion ratio of the origi-nal trust and be treated as a con-tinuance of the original trust.54 Withrespect to a ZIR trust that is divid-ed into multiple trusts, the regula-tions provide that if a nongrand-

fathered trust is divided into one ormore multiple trusts pursuant to anonqualified severance, the result-ing trust would have the same inclu-sion ratio as the original trust andbe recognized as a separate trust forGST tax purposes if the division isrecognized under state law.55 There-fore, a valid division of a ZIR trustinto more than one separate trustunder state law should cause eachtrust resulting from the divisionto have a zero-inclusion ratio, evenif the terms of the separate trustsextend beyond that provided in theoriginal trust.

Delaware tax trapIn addition to changes to a trust’sinclusion ratio, an additional con-sideration iswhether a trust decant-ing that extends the term of a ZIRtrust could result in taxable gift byviolating Section 2514(d), alsoknown in conjunction with Sec-tion 2041(a)(3) as the “Delawaretax trap.”56 Section 2014(d) is anarcane statute that, as a practicalmatter, easily may be avoided bycareful drafting or by state legisla-tion.As further discussed below, thevast majority of the states withdecanting statutes in force haveenacted legislation that generallymakes application of Section2514(d) a non-issue. Section2514(d), however, may pose a trapfor the unwary estate planning prac-titioner when a trust decanting isperformed pursuant to the terms ofthe trust instrument or inartfullydrafted decanting legislation.

Section 2514(d) provides that theexercise of a power of appointment

discretionary power to distributeproperty under the trust instru-ment.61 The overwhelming majori-ty of these decanting statutes, more-over, expressly characterize adecanting by the trustee as the exer-cise of a special power of appoint-ment. Therefore, a decanting oftrust property pursuant to statestatute, common law, or the trustinstrument that validly extends theterm of a trust under state lawpotentially could violate the provi-sions of Section 2514(d) and resultin a transfer of property by thetrustee for gift tax purposes. It maybe possible, however, for a decant-ing by an independent trustee thatvalidly extends the term of atrust to avoid application of Sec-t ion 2514(d) for either of tworeasons:

1. The decanting does not create apower that may be exercised soas to postpone the vesting orsuspend the absolute owner-ship or power of alienation ofan interest in trust property fora period ascertainable withoutregard to the date of the cre-ation of the trustee’s discre-tionary distribution power.

2. A decanting by an independenttrustee does not result in a “gift”for purposes of the gift tax.

Suspension or postponement ofvesting or alienation. If a trustee’sdiscretionary power to make dis-tributions is viewed as a power ofappointment, a trust decanting couldcreate a power that may be exer-cised to postpone or suspend thevesting of interests in, or power ofalienation over, trust propertywherethe new trust authorizes discre-tionary distributions to beneficiar-ies for a period beyond that author-ized in the original trust. A trustdecanting could also postpone orsuspend the vesting or alienation ofproperty if the new trust creates new

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A qua lifieds everanc e ofa ZIR trus t re sult sin each s eparatetrus t having aninc lus ion ratioequa l to zero.

powers of appointment that can beexercised to extend the duration ofthe trust. To violate Section 2514(d),however, the potential to postponeor suspend the vesting or alienationof property in the second trust mustbe made without regard to the dateof creation of the trustee’s discre-tionary power in the first trust.

To help protect against a poten-tial violation of Section 2514(d),nearly all of the state decantingstatutes have been drafted torequire that the permissible periodfor the postponement of vesting ofinterests in trust property or, ifthe state’s perpetuities rule is stat-ed in terms of alienation, the sus-pension of power of alienation overtrust property pursuant to atrustee’s decanting power, mustbe determined by reference to thedate of creation of the originalpower of appointment.62 The TaxCourt examined this issue in Estateof Murphy,63 and ultimately heldthat property subject to a power ofappointment was not included inthe power holder’s estate under Sec-tion 2041(a)(3), the estate tax coun-terpart to Section 2514(d), where,under applicable local law, the per-missible perpetuities period of apower of appointment createdthrough the exercise of a specialpower is computed from the spe-cial’s power’s creation, and not itssubsequent exercise.

The facts of Murphywere as fol-lows: Under a trust established byher father, the decedent was givena special testamentary power of

appointment over trust property ifthe decedent died before termina-tion of the trust. In her will, thedecedent exercised the power byappointing trust property to a fam-ily trust established for the bene-fit of the decedent’s spouse andissue under the terms of the will.The family trust gave the decedent’sspouse a special testamentarypower to appoint the trust prop-erty “as he may see fit.”

Under Wisconsin law, the lawgoverning the decedent’s exercise ofthe special power of appointment,the permissible perpetuities periodgoverning the exercise of a specialpower of appointment to create anew power ran from the creation ofthe first power, and not its exercise.As a result, Section 2041(a)(3) didnot apply to include property sub-ject to the decedent’s special powerof appointment in her estate,because under applicable local lawthe perpetuities period of the newlycreated power could not be com-puted without regard to the dateof the creation of the first power.

Wisconsin’s statutory rule againstperpetuities, however, stated the per-missible perpetuities period solelyin terms of the power of alienation,and provided that an interest in

61 A l a s k a S t a t . § 1 3 . 3 6 . 1 5 7( a ); A ri z . R e v. S t a t .§ 1 4 - 1 0 8 1 9 ( A ) ; D e l . C o d e A n n . T i t . 1 2 ,§ 3 5 2 8( a ); F l a . S t a t . A n n . § 7 3 6 . 0 4 1 1 7(1)( a );2009 N e v. St a t . c h . 215 , § 37 (S . B . 287); N . H .R e v. S t a t . A n n . § 5 6 4- B : 4-4 1 8( a ); N . Y. E s t .Pow ers & Trusts L a w § 10-6.6(b)(1); N . C . G e n.S t a t . § 3 6 C -8-8 1 6 . 1( b ); S . D . C o d i f i e d L a w§ 55-2-15; Te nn . C o d e A nn . § 35-15-816(27).

62 S e e A l a sk a St a t. § 13 .36 .157(a)(3); D e l. C o d eA n n . T it . 1 2 , § 3 5 2 8( c ), D e l . C o d e A n n . T it .2 5 , § 5 0 4 , b u t cf. D e l . C o d e A n n . T i t . 2 5 , §5 0 1 ( p ro v i d in g th a t e s t a t e or in t e re s t in p ro p -e r t y c r e a t e d t h ro u g h e x e r c i s e o f p o w e r o fa p p o i n t m e n t s h a l l b e d e e m e d c r e a t e d a tth e t im e o f th e e x e rc is e o f th e p o w e r for p ur-p os e s of a ny rule a g a inst p erp e tuitie s, re mote-n e s s o f v e s t i n g , r e s t r a i n t o n p o w e r o fa l i e n a t i o n , o r a c c u m u l a t i o n s ); F l a . S t a t . §7 3 6 . 0 41 1 7(3); N . Y. E s t . P ow e rs & Tru s ts L a w§ 1 0 - 6 . 6 ( f ) ; N . C . G e n . S t a t . § § 3 6 C - 8 -8 1 6 . 1(c )(8), ( d ), a n d 4 1-2 3( c ); S . D . C o d if i e dL a w § § 43-5-5 a n d 55-2-20; Te nn . C o d e A nn .§ 3 5-1 5-8 1 6(2 7)( C ); s e e a ls o E s t a t e o f M ur-p h y, supra n o t e 6 0 ( c re a t io n o f n e w s p e c i a lp ow er of a p p ointm e nt d id not viola te D e la w aret a x tra p b e c a us e W is c ons in l a w re q u ire s th a tth e p erm iss i b l e p erp e tu iti e s p erio d b e m e a s-ure d from th e d a t e th e f irst p ow er is cre a t e d).

63 N o t e 6 0 supra.

suspension of the power of alien-ation. The prohibition againstremoteness of vesting has become themore commonly viewed form of therule, which generally provides thata future interest is void unless it mustvest or fail within lives in being plus21 years. The more historic versionof the rule against perpetuities, how-ever, prohibits the suspension ofthe power of alienation, which existswhen there are no persons in beingwho can collectively transfer com-plete ownership of property.

The court concluded that thestatutory requirements concerningthe postponement of vesting or thesuspension of absolute ownershipor power of alienation of proper-ty depended on the nature of therule against perpetuities applied ina particular jurisdiction, whetherstated in terms of vesting, alien-ation, or absolute ownership ofproperty. The court noted that,although a literal reading of Sec-tion 2041(a)(3) required that allthree conditions be met, the appli-cable regulations and legislativehistory indicated that Congressintended for the statute to cover therule against perpetuities as for-mulated under the law of the var-ious states. In rejecting the IRS’sargument that all three require-ments apply to every exercise of apower of appointment regardlessof its validity under the perpetu-ities law of the applicable juris-diction, the court stated that “[t]hisinterpretation of section 2041(a)(3)would ignore the evolution of theRule throughout the various Statesand extend its reach well beyondthat intended by Congress.”

Extension of the court’s analy-sis in Murphy indicates that, to avoidapplication of Section 2514(d), thepermissible perpetuities period, asexpressed under applicable state law,of a new power created by the exer-cise of a special power of appoint-ment must be measured from the

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date of creation of the first power.Although it might not be necessaryfor a given trust decanting to satis-fy all three statutory conditions asto vesting, alienation, or absoluteownership of property, it may beadvisable to include a provision thataddresses all three situations giventhe increased mobility of trusts. Thesimplest way to avoid applicationof Section 2514(d) may be to trackthe language of the statute in theterms of the governing instrument.Nevertheless, practitioners shouldbe advised to research the validityof the provision in light of the lawof a particular jurisdiction.

As a result, it may be possible todistribute property to another trustof perpetual duration in Delaware,64

property is void only if it suspendsthe power of alienation for longerthan lives in being, plus 30 years.The statute additionally providedthat the power of alienation overtrust property is not suspended ifthe trustee has the power to sellthe property. Wisconsin law did notprohibit remoteness of vesting solong as the statutory prohibitionagainst suspension of the power ofalienation was not violated.

The IRS took the position thatSection 2041(a)(3) required thatproperty subject to a power ofappointment be included in thepower holder’s estate if the exer-cise of the power violated any ofthree statutory conditions:

1. Postponement of vesting.2. Suspension of absolute owner-

ship of property.3. Suspension of the power of

alienation.

Considering that Wisconsin’sperpetuities law referred to onlythe suspension of the power ofalienation, the IRS argued thatthe decedent’s exercise of the spe-cial power of appointment violat-ed Section 2041(a)(3) because itcould be validly exercised to post-pone indefinitely the vesting of anyinterest in the property.

In determiningwhether the dece-dent’s exercise of the testamentaryspecial power of appointment vio-lated Section 2041(a)(3), the TaxCourt analyzed the common lawtreatment of the rule against perpe-tuities that was “so inextricably apart of section 2041(a)(3).” Thecourt noted that the common lawrule against perpetuities could be stat-ed in two ways, either in terms ofremoteness of vesting, or in terms of

64 S e e D e l . C o d e A n n . T it . 1 2 , § 3 5 2 8( c ), D e l .C o d e A nn . T it. 25 , § § 503 , 504 , a n d 254 D e l.L a ws 2008 . It shou l d b e not e d , how e v er, th a tD e l a w are l a w prov i d e s th a t “[t]h e d ura tion ofa trust a n d t im e of v e stin g of int ere sts in th etrust prop erty sha ll not cha ng e mere ly b e c auset h e p l a c e o f a d m i n i s tr a t i o n o f t h e tr u s t i sc h a n g e d from som e oth er juris d i c tion to th isSt a t e .” D e l. C o d e A nn . T it. 12 , § 3332(a).

permissible perpetuities period.

Decanting as a transfer by gift.Assuming that a trust decanting isperformed in a manner that vio-lates Section 2514(d), it would notnecessarily follow that the trusteehas made a taxable gift. As a gen-eral matter, the gift tax is imposedon: (1) the transfer; (2) of proper-ty; (3) by gift.69 Under a plain read-ing of the statute, a decanting bya trustee that violates Section2514(d) is deemed to be “a trans-fer of property,” thus satisfying thefirst two elements required for theimposition of the gift tax. Section2514(d), however, does not explic-itly provide that the deemed trans-fer of property is also a deemed gift.

No cases construe or interpretSection 2514(d), but it is arguable

that a trust decanting that otherwiseviolates Section 2514(d) would notresult in a taxable gift where thetrustee possesses no beneficial inter-est in the property subject to thedecanting. (Court decisions andinformal rulings by the IRS haveonly considered the inclusion ofproperty in a power holder’s estateunder Section 2041(a)(3)where thepower holder had a beneficial inter-est in the property subject to a tes-tamentary power of appointment.70)The regulations provide that a giftsubject to tax results from “anytransaction in which an interest inproperty is gratuitously passed orconferred upon another, regardlessof themeans or device employed.”71

Although donative intent is notan essential element for a transferto be subject to gift tax, the regu-

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Planning TipThe view has been expressed that the Delaware tax trap would be violated if a newpower of appointment were created in a state with a perpetual perpetuities period,because there would be no finite period of time within which the property interestmust vest or become fully alienable. See, e.g., Greer, The Alaska Dynasty Trust, 18 Alas-ka L. Rev. 253, 277 (2001). However, the states that allow trusts of a perpetual dura-tion also limit the duration of trusts if certain requirements are not met and, there-fore, provide multiple perpetuities periods: one that is indefinite, and another that islimited to a finite period. For example, Delaware allows trusts to hold personal prop-erty indefinitely, but a 110-year limitation is placed on real property. Del. Code Ann.Tit. 25, § 503(a), (b). North Carolina repealed the common law rule against perpetu-ities based on vesting in favor of an alienation rule that voids a trust that suspendsthe power of alienation over trust property for longer than 21 years plus lives inbeing, but permits a perpetual trust under certain circumstances, for example, if thetrustee has the power to sell the property. N.C. Gen. St. § 41-23(a), (e).

North Carolina,65 and South Dako-ta66 pursuant to a trust decantingwithout violating Section 2514(d),so long as the terms of the trustotherwise satisfy the statutoryrequirements relating to valid per-petual trusts. In these three states,the repeal of the traditional commonlaw rule against perpetuities basedon remoteness of vesting appliesretroactively to trusts created beforethe repeal’s enactment.67 Therefore,it may be possible to extend indefi-nitely the termof a trust created priorto the repeal that originallywas lim-ited to the traditional common lawrule against perpetuities, even ifthe new perpetuities period ismeas-ured from the time of the trust’s cre-ation.

Similarly, it may be possible toextend trusts created in Alaska for1,000 years through a trust decant-ing, or in Florida for a term of 360years, measured as of the date of theoriginal trust’s creation.68 Despitethe protection built into the statedecanting statutes, it would be advis-able to include a clause in the decant-ing resolution or the extended trustthat provides that postponementof vesting of beneficial interests in,or suspension of absolute ownershipor power of alienation over, trustproperty cannot be extended throughthe trustee’s discretionary distribu-tion power or the exercise of a spe-cial power of appointment for a peri-od in excess of the governing

65 N . C . G e n. St a t. § § 36 C -8-816.1(c)(8), (d), a n d41-23(c). Th e c onstitution a lity of N . C . G e n . St.§ 41-23 w a s u p h e l d in a low er a p p e ll a t e c ourtd e c ision. Brown Bros . H arrim a n Trust C o., N . A .v. B e n s o n , supra n o t e 1 1 . T h e d e c is io n h a sb e e n a p p e a l e d to th e N orth C aro lin a Su pre m eC o urt .

66 S e e S . D . C o d if i e d L a w § § 43-5-1 , 43-5-4 , 43-5-5 , a n d 43-5-8 . Th e a b ility to e x t e n d th e t ermof a trust b y m e a ns of th e South D a kota d e c a nt-in g st a tut e m a y b e lim it e d b e c a us e th e st a tut eprov i d e s th a t th e d e c a ntin g m a y not “sus p e n dth e p o w e r to a l i e n a t e tru s t p ro p erty or extendthe first trust beyond any applicable termina-tion date under the terms of the instrument ofthe first trust or th e p e rm is s i b l e p e rio d o f a n yru l e a g a inst p erp e tu iti e s a p p li c a b l e to th e firsttru s t .” S . D . C o d if i e d L a w § 5 5-2-2 0 ( e m p h a -s is a d d e d ).

67 D e l . C o d e A n n . T it . 2 5 , § § 5 0 3 , 5 0 4 , a n d 2 5 4

D e l . L a ws 2008; S . D . C o d if i e d L a ws § § 43-5-1 , 4 3-5-4 , 4 3-5-8 , a n d 4 3-5-9; N . C . G e n . S t a t .§ 41-23 . N e w H a m p shire h a s re p e a le d th e rulea g a inst p erp e tu iti e s w ith re s p e c t to trusts , b utonly for trusts cre a t e d a ft er 1/1/2004. N . H . R e v.S t a t . A n n . § 5 6 4:2 4 . A ri z o n a a l lo w s p e r p e tu-a l tru s t s , b u t a s o f t h e d a t e o f t h i s a r t i c l e i ta p p e a rs t h a t a n o n v e s t e d p ro p e r t y i n t e re s tor a p ow er of a p p ointm e nt cre a te d b y th e e x er-c i s e o f a p o w e r o f a p p o i n t m e n t w o u l d b ed e e m e d c re a t e d w h e n th e p o w er is irre v o c a-b ly e x e rc is e d . A ri z . R e v. S t a t . § 1 4-2 9 0 5( C ).A s s u c h , a d e c a n t i n g p urs u a n t t o A ri z o n a ’sd e c a n t i n g s t a t u t e m a y c a u s e t h e tru s t e e t oi n a d v e r t e n t l y s p r i n g t h e D e l a w a r e t a x tr a p .S e e A r i z . R e v. S t a t . § § 1 4-1 0 8 1 9 (tru s t e e ’sp o w e r to d e c a n t), 1 4-2 9 0 1 (ru l e s g o v e rn in gp e r m i s s i b l e p e r p e t u i t i e s p e r i o d s f o r n o n -v e st e d pro p erty int ere sts), a n d 14-2905 (non-v e st e d pro p erty int ere st or a p ow er of a p p o int-m e n t c re a t e d b y t h e e x e rc i s e o f a p o w e r o f

a p p o intm e nt d e e m e d cre a t e d wh e n th e p ow eris irre v o c a b ly e x e rc is e d ).

68 A la sk a Sta t. § § 13.36.157(a)(3) a n d 34.27.051,2 0 0 0 A l a s k a S e s s . L a w s 1 7 ; F l a . S t a t . § §7 3 6 . 0 4 1 1 7(3) a n d 6 8 9 . 2 2 5 . Te n n e s s e a l lo w sa 3 6 0-y e a r t e r m , b u t o n l y f or tru s t s c re a t e dor b e c omin g irre vo c a b le a fter 6/20/2007. Te nn.C o d e A n n . § 6 6-1-20 2(f).

69 S e c tion 2501(a)(1); s e e a lso S e c tion 2511(a)( p ro v i d i n g t h a t t h e g i f t t a x a p p l i e s w h e t h e r(1) “th e tra nsfer is in trust or oth erwis e;” (2) “th eg ift is d ire c t or in d ire c t;” a n d (3) “th e pro p er-ty is re a l or p erson a l, t a n g i b l e or int a n g i b l e ”).

70 S e e , e . g . , E s t a t e o f M ur p h y, supra n o t e 6 0(e x erc is e o f a t e s t a m e n t ary p ow er o f a p p o in t-m e nt b y b e n e fic iary); Ltr. Rul. 200928013 (e x er-c is e o f t e s t a m e n t a ry g e n e ra l p o w e r b y b e n e -f i c i a ry-tru s t e e ); L tr. R u l . 2 0 0 8 2 1 0 1 3 (s a m e );L tr. R u l . 8 9 2 4 0 1 1 (s a m e ).

71 R e g . 2 5 . 2 51 1-1( c )(1).

lations clarify that the gift tax isinapplicable to certain types oftransfers and that “[a] transfer bya trustee of property in which hehas no beneficial interest does notconstitute a gift by the trustee.”72

Therefore, a decanting by an inde-pendent trustee with no beneficialinterest in the trust property shouldnot result in a taxable gift. Forexample, no gift would result froma trustee’s discretionary distribu-tion of property to beneficiarieswhere the trustee had no beneficialinterest in the distributed proper-ty. Similarly, the distribution oftrust property to another trust pur-suant to a trustee’s power to decantshould not result in a taxable giftif the trustee had no beneficial inter-est in the property and the decant-ing is undertaken in furtherance ofthe trustee’s fiduciary duties to thetrust and its beneficiaries.

In contrast, the regulations pro-vide that a gift may occur if atrustee with a beneficial interest intrust property makes a discre-tionary distribution, unless distri-butions by the trustee are limitedby an ascertainable standard underthe governing instrument.73 How-ever, if a beneficiary-trustee par-ticipates in a decanting of proper-ty to a trust with an extended term,a taxable gift may result under Sec-tion 2511(a), without regard to Sec-tion 2514(d), if the decanting elim-inates or otherwise reduces thetrustee’s beneficial interest in the

trust. For example, if a beneficiary-trustee participates in a trustdecanting that extends the termof a trust or eliminates the trustee’sdiscretionary life income interestin the property, then the decantingmay result in a taxable gift by thetrustee.74

Similarly, if the trustee is a con-tingent remainder beneficiary oftrust property, a taxable gift couldresult under Section 2511(a) if thetrustee decants property to anoth-er trust with an extended term thateliminates or decreases the trustee’scontingent remainder interest in theproperty.75 The value of the giftunder Section 2511(a), however,would be limited to the value ofthe interested beneficiary-trustee’sinterest that was eliminated orreduced by the decanting.

In the absence of an eliminationor reduction in a trustee’s benefi-cial interest, for example, where abeneficiary-trustee’s interest in atrust remains the same before andafter the decanting, it would appearthat a decanting would not resultin a taxable gift under Section2511(a), but a taxable gift mayoccur if the transfer falls within theterms of Section 2514(d) and themere fact of the trustee’s beneficialinterest is enough to subject thetransfer to gift taxation. It is pos-sible that the IRS would take thisposition and argue that where abeneficiary-trustee decants prop-erty to another trust, the trustee

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is treated as making a gift of theentire value of property subject toa new power of appointment cre-ated under the terms of the sec-ond trust in violation of Section2514(d).76

Conflict of lawsgoverning trust decant ingsPractitioners should be aware ofany conflict of law principlesinvolved with a decanting thatextends the term of a trust.77 Boththe Restatement (Second) of Con-flict of Laws (the “Restatement 2dConflicts”) and the U.T.C. supportthe general proposition that theterms of a trust may designate thelaw of a jurisdiction to govern mat-ters concerning the trust or thetrust’s administration so long as thejurisdiction has some connection ofparticular significance to the trust.78

The Restatement 2d Conflictsand the U.T.C., however, recognizethat the law designated in the termsof a trust may not be respectedwhere the law is contrary to thestrong public policy of the statehaving the most significant rela-tionship to the trust matter atissue.79 Property decanted to a trustwhose governing law permits anextended perpetuities period poten-tially could raise the issue ofwhether application of the new per-

72 R e g . 2 5 . 2 5 1 1-1( g )(1).73 R e g . 2 5 . 2 5 1 1-1( g )(2).74 S e e , e . g . , E s t a t e o f R e g e s t e r, 8 3 T C 1 (1 9 8 4)

(th e e x e rc is e o f a s p e c i a l p o w e r o f a p p o in t-m e n t b y a lif e in c om e b e n e f i c i ary tra ns f errin ga l l tru s t a s s e ts t o a n o t h e r tru s t o f w h i c h t h ep ow e rh o l d e r is n o t a b e n e f i c i a ry is a t a x a b l eg ift w h e re th e p o w e rh o l d e r re c e iv e d n o c o n-s i d e r a t i o n f o r t h e e x e r c i s e ); R e v. R u l . 7 9 -327 , 1979-2 C B 342 (t a x a b l e g ift re su lts wh eret h e p o w e rh o l d e r r e l i n q u i s h e s a l i f e i n c o m ei n t e r e s t i n t r u s t p ro p e r t y b y e x e r c i s e o f as p e c i a l p ow e r). S e e a ls o L tr. R u l . 2 0 0 2 43 0 2 6( i n t e r v i v o s e x e r c i s e o f s p e c i a l p o w e r o fa p p o in t m e n t t o tru s t s f or t h e s o l e b e n e f it o fd e s c e n d a nts re su lts in a t a x a b l e g ift b e c a us eth e p ow e rho l d e r re lin q u is h e d a d is c re t io n a ryi n t e re s t in tru s t in c o m e a n d p ri n c i p a l i n t h eori g in a l tru s t a s a re s u lt o f th e e x e rc is e).

75 Cf. TA M 9419007 (e x erc is e of a s p e c i a l p ow ero f a p p o in tm e n t in f a v or o f b e n e f i c i a ri e s th a td i d n o t in c lu d e t h e p o w e rh o l d e r re s u lt e d int a x a b l e g ift o f th e p ow e rh o l d e r’s in c o m e a n dc o n t i n g e n t r e m a i n d e r i n t e r e s t s i n t h e tr u s tu n d e r S e c t ion 2 5 1 1(a )).

76 S e c t io n 2 5 1 4( d ); R e g . 2 5 . 25 1 4-3( d ).77 F o r a g e n e r a l d i s c u s s i o n o f c o n f l i c t o f l a w

issu e s involvin g trusts, s e e B o g ert a n d B o g ert,The Law of Tr. & Trustees, 2 d e d ., § 301 (Thom-s o n R e u t ers/W e s t , 1 9 9 2).

78 S e e , e . g . , R e s t a t e m e n t (S e c o n d ) o f C o n f l i c to f L a w s : Tr u s t s § § 2 6 8 ( 1 ) , 2 7 0 ( a ) , 2 7 2 ( a )(1 9 7 1); U n if . Tru s t C o d e § 1 0 7(1) (2 00 0).

79 S e e , e . g . , R e s t a t e m e n t (S e c o n d ) o f C o n f l i c to f L a w s : Tru s t s § 2 7 0( a ) (1 9 7 1); U n i f . Tru s tC o d e § 1 0 7(1) (2 0 0 0).

missible perpetuities period wouldviolate the strong public policy ofthe state with the most significantrelationship to the trust.

As such, practitioners wouldbe well advised to determine thepolicy of the state having the mostsignificant relationship to the trustwith respect to any perpetuitiesissue. TheRestatement 2d Conflictslists several factors indicating thata state has a substantial relation toa trust, such as:

• Whether the state was desig-nated as the trust’s place ofadministration by the settlor.

• Whether the state was theplace of business or domicil ofthe trustee, the state of domicilof the settlor, or the locationof trust assets, at the time ofthe trust’s creation.

• Whether the state was thedomicil of the beneficiaries.80

TheRestatement 2d Conflicts fur-ther recognizes that “there may beother contacts or groupings of con-tacts which will likewise suffice.”81

Practitioners should considernot only the public policy of thestate with the most significant rela-tionship to the trust, but also thelaw of the state governing the per-missible perpetuities period aftera trust decanting. For example,South Dakota’s decanting statuteprovides that the decanting maynot “suspend the power to alien-ate trust property or extend thefirst trust beyond any applicabletermination date under the termsof the instrument of the first trustor the permissible period of anyrule against perpetuities applica-ble to the first trust.”82 It is unclear,however, whether this limitationapplies only to a trust decantingtaken pursuant to South Dakota’sdecanting statute. Also, Delawarelaw provides that “[t]he duration

of a trust and time of vesting ofinterests in trust property shall notchange merely because the placeof administration of the trust ischanged from some other juris-d ict ion to th is State ,”83 wh ichimplies that a trust will not be gov-erned by Delaware’s perpetuitieslaw unless the trust’s connectionto the state involves somethingmore than a mere change to itsplace of administration.

The effective date and appli-cability of a state’s repeal of thecommon law rule against perpe-tuities also should be thoroughlyinvestigated before property isdecanted to a trust intended tobe governed by the perpetuitieslaw of that jurisdiction. Similarly,practitioners should consider thepermissible perpetuities periodapplicable to particular types ofproperty decanted to another trust.For example, the Restatement 2dConflicts takes the position thatbeneficial interests in real prop-erty held in trust are governed bythe law of the property’s situs.84

Therefore , a lthough persona lproperty potent ia l ly cou ld bedecanted to a trust of perpetualduration, real property decantedto such a trust may remain subjectto the permissible perpetuities peri-od of the jurisdiction in which theproperty is located. It should bepossible to avoid a more restric-tive perpetuities period applicableto real property held in trust byholding equitable interests in cor-porations or limited liability com-pan ies that own rea l property,where the equitable interests aretreated as personal property understate law.

Conclus ionAlthough the consequences ofextending the duration of an irrev-ocable trust by means of trust

decanting are as of yet unresolved,in the absence of statutory or reg-ulatory guidance to the contrary,a good argument can be made thatthe term of a trust may be validlyextended without adverse GST andgift tax consequences. The unre-solved issues regarding the change,if any, to a ZIR trust’s inclusionratio as a result of extending thetrust’s term beyond that original-ly provided for in the trust instru-ment raises a host of questions,including:

1. The method to determine theZIR trust’s new inclusion ratio.

2. The identity of the persontreated as the transferor forGST tax purposes.

3. The manner and extent towhich the initial deemed trans-feror’s GST tax exemptionwould apply.

Until further guidance on theseissues has been provided, itis arguab le that the extensionof a ZIR trust’s term by means ofa trust decant ing shou ld notalter the zero-inclusion ratio of atrust validly extended under theterms of the trust instrument orstate law.

As a practical matter, gift taxa-tion of trust decantings that extendthe duration of an irrevocable trustin violation of Section 2514(d)would raise various challengingissues. In light of the dearth of guid-ance on the reach and effect of Sec-tion 2514(d), it is important that atrustee be satisfied that a decanti-ng avoids application of the sectionbefore exercising the trustee’spower to decant. ■

80 R e s t a t e m e n t (S e c o n d ) o f C o n f l i c t o f L a w s :Tru s ts § 2 7 0 c m t . b (1 97 1).

81 Id.82 S . D . C o d if i e d L a w § 5 5-2-20 .83 D e l . C o d e A n n . T it . 1 2 , § 3 3 3 2( a ).84 S e e , e . g . , R e s t a t e m e n t (S e c on d ) o f C o n f l i c t

o f L a ws: Tru s ts § 2 7 8 (1 9 71).

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