2021 – A Vintage Year for Estate Planning and Asset Protection

Although California produces stellar wine vintages year after year, there has been relatively little production of anything new or positive for California trusts. But the 2021 landscape has changed significantly, the conditions are ideal, and the time is ripe. A recent crop of legislation and cases, including California’s new Uniform Trust Decanting Act and the Paula Trust case, as well as the potential for significant tax changes at both the state and federal level, might make 2021 a vintage year for reviewing (or creating) your estate/asset protection plans with the attorneys at Johnson Fistel.

CA Decanting

The California Uniform Trust Decanting Act (“CUTDA”), which took effect January 1, 2019, has significantly eased restrictions and limitations on trust fiduciaries when it comes to “updating” irrevocable trusts in California. “Decanting” an old trust, similar to decanting an old wine, is literally the act of pouring the assets and provisions from an outdated irrevocable trust into a brand-new irrevocable trust. The crucial difference is that wine decanting involves pouring the same wine into a different container. Trust decanting, on the other hand, allows fiduciaries the ability to modify the trust’s terms and provisions, resulting in a substantially different and improved container.

Before passage of the CUTDA, a fiduciary’s ability to modify the terms and provisions of an irrevocable trust in California, with certain exceptions, was limited, time consuming and expensive. In most cases, the fiduciary was required to obtain the consent of all the trust’s beneficiaries, and a court hearing was needed to make any proposed changes. And even if the fiduciary was able to overcome these obstacles, their power to make substantive modifications to the original trust instrument was severely restricted.

Under the CUTDA, a fiduciary now has the power to decant and modify an irrevocable trust without the consent of the settlor, beneficiaries, or the court.  The fiduciary must still provide notice to all of the interested parties above (as well as the California Attorney General if the trust has charitable components), but their approval and consent is no longer required.

Fiduciaries can use decanting to make administrative changes and, depending upon the authority granted to them by the original trust, they may also have the power to make significant substantive changes. Fiduciaries with “expanded distributive discretion” can alter both administrative and dispositive provisions, including modifications to distributions, beneficiaries, appointments and trust duration.  Decanting power does not mean unlimited power and unfettered discretion – the decanted trust’s “juice” can be modified and fortified, but it can’t be replaced with an entirely different product. Fiduciaries are still restricted when it comes to modifying their own powers, liabilities and compensation. In addition, they are barred from making any changes that alter the trust’s charitable components and/or negatively affect its tax status.

Fiduciaries are free, however, to make changes that positively affect the trust’s tax status. The Paula Trust case, coupled with the new decanting powers under CUTDA, could very well provide trustees with a perfect window to make that happen.

The Paula Trust Case

In general, the income of a non-grantor trust is subject to taxation in California if that trust’s fiduciary or beneficiary is a resident of California.[1] The California Franchise Tax Board (“FTB”) has generally taken the position that all California-source income is subject to taxation and all other trust income is eligible for apportionment according to a formula involving the trust’s fiduciaries and beneficiaries.[2]

The Paula Trust v. FTB [3] decision rejected the FTB’s historic position and held that all of the Paula Trust’s income, including all of its California-source income, was eligible for apportionment. A 2007 sale of the Paula Trust’s property resulted in a $2.8M capital gain in California, and the Paula Trust successfully argued that the same tax structure should be applicable to both California-source and non-California-source income. By applying the apportionment formula, the Paula Trust was able to defer California taxes on roughly $1.4M of the gain. The Paula Trust decision is being appealed by the FTB, but it’s currently the law of California.

Dust Off Your California Estate Plan and Pop the Cork

There are additional compelling factors making 2021 an opportune time to evaluate and overhaul your existing estate planning strategies, including the potential sunsetting of the high federal basic exclusion amount at the end of 2025, CA Senate Bill 378 which could establish a separate and punitive estate tax regime in California, the availability of new insurance products that can help mitigate tax exposure, and the need to review/update your existing plan due to COVID-19 and the 2020 federal elections and ensuing transfer of power.

Effective Estate and Asset Protection Plans, like vintage Napa cabernets or First Growth Bordeaux, are precious and enduring gifts that need to be preserved and protected for future generations to enjoy and cherish.  If you are a trustee or fiduciary of a non-grantor California trust that is past its prime, the Decanting Statute and Paula Trust decision may empower you to make substantive changes that better serve the evolving needs of the trust’s beneficiaries while significantly reducing (and possibly eliminating altogether) California tax exposure.

The Estate Planning and Asset Protection Groups at Johnson Fistel can help guide you through all the complex options and find the right fit that integrates your business and personal goals, mitigates risk and uncertainty, and maximizes potential benefits for your family and loved ones regardless of what the future may hold. Contact us for a free consultation.

[1] Cal. Rev. & Tax Code §17742(a)

[2] Cal. Code Regs. tit. 18, §17743

[3] Paula Trust v. Cal. Franchise Tax Bd., 2018 Cal. Super. LEXIS 644 (currently under appeal by FTB)


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