April 21, 2016

Modifying an Irrevocable Trust

A revocable trust can naturally be changed. The relevant probate code section provides "unless the trust instrument provides otherwise, if a trust is revocable by the settlor, the settlor may modify the trust by the procedure for revocation." Prob C § 15402. Interestingly, an irrevocable trust can also be changed. Although it is not as easy to modify an irrevocable trust. 

The probate code provides various methods in which an irrevocable trust can be modified. One method that has become increasingly popular is modification on the grounds of "changed circumstances." This law is found in Prob C § 15409. It provides:

(a) On petition by a trustee or beneficiary, the court may modify the administrative or dispositive provisions of the trust or terminate the trust if, owing to circumstances not known to the settlor and not anticipated by the settlor, the continuation of the trust under its terms would defeat or substantially impair the accomplishment of the purposes of the trust. In this case, if necessary to carry out the purposes of the trust, the court may order the trustee to do acts that are not authorized or are forbidden by the trust instrument.

(b) The court shall consider a trust provision restraining transfer of the beneficiary’s interest as a factor in making its decision whether to modify or terminate the trust, but the court is not precluded from exercising its discretion to modify or terminate the trust solely because of a restraint on transfer.

The principal reason why the "changed circumstances" avenue is more available now is because of the immense growth in the estate tax exclusion amount. The chart below displays the exclusion amount from 2001 - 2015. 

Year                   Amount Excluded        Maximum Tax Rate

2001                   $675,000                      55%

2002                   $1M                             50%

2003                   $1M                             49%

2004                   $1M                             48%

2005                   $1M                             47%

2006                   $2M                             46%

2007                   $2M                             45%

2008                   $2M                             45%

2009                   $3.5M                          45%

2010                   Repealed                      0%

2011                   $5M                             35%

2012                   $5.12M                        35%

2013                   $5.25M                        40%

2014                   $5.34M                        40%

2015                   $5.43M                        40%

Many people in the 1990s and 2000s were (rightly) under the belief that their estate would be subject to the estate tax. Thus they would execute what is commonly referred to as an A/B Trust to maximize the amount that could be shielded from the estate tax. However, since the estate tax exclusion amount has risen substantially, many couples do not need an A/B Trust.

The problem is that in a A/B Trust situation, upon the death of the first spouse to pass away, the split of the marital estate into two separate trusts, an A Trust and B Trust, is mandatory. Thus, there is the creation of an irrevocable trust when one spouse passes away, the B Trust. However, the B Trust's main purpose is to minimize the estate tax. If the estate tax is not an issue, then the B Trust loses much of its importance. Therein lies where a petition under Prob C § 15409 to eliminate the B Trust comes into play. Typically, the surviving spouse will ask a probate court to order that the B Trust be terminated because of the changed circumstances. Although in a case I had both parents were deceased and the successor trustees sought to eliminate the B Trust.