Tax Issues for Changing Trusts After a Divorce

Planning is all about being ready for circumstances we expect, those we don’t and those we hope never do. Kind of like a prenuptial agreement, when planning our finances, sometimes we have to consider the possibility of divorce.

The intention of an irrevocable trust obviously is that it will not be changed, but there are some circumstances in which these can be modified. First you will want to look at your document to see what provisions are included that allow for modification.

It may be that you no longer want the current beneficiary to benefit from the trust; perhaps you don’t want to be responsible for paying tax on income generated by a trust.

· Judicial modification can be expensive and can cause private family information to become part of the court record. However, it might be required to be binding to IRS and third parties.

· UTC does have standards to allow parties to consent to modification or for termination of the trust if all beneficiaries agree.

· Some states allow some modification through a nonjudicial settlement agreement to preserve privacy and lessen cost.

· Decanting is a method that allows the trustee to use its discretionary distribution authority to place the assets in another new irrevocable trust with more appropriate terms. This often can be less expensive, preserve privacy, allows for additional tax planning, and doesn’t require approval by the beneficiaries.

· The trust may have provisions related to the power of appointment or to an independent trustee that could be used to modify the trust agreement.

Any time you are considering one of these options, you will want to obtain some professional advice about how these will affect all parties and the potential gift, income, and estate tax implications. If you are on the other end of this and drafting these documents, you may want to make sure that your trust instrument has some tool for modification while still being a valid irrevocable trust.

This article is an overview of legal considerations and does not cover every legal right or obligation, consideration, exception, or restriction. Every business decision should be well researched and discussed with a professional before being made.

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