Tag Archives: Tax Planning

‘Decant’ an Irrevocable Trust

Trust DecantIrrevocable may not mean what you think it means when it comes to trust planning.  Thanks to a process known as “trust decanting,” a trustee can change irrevocable trust terms. The decanting process occurs by figuratively pouring the trust assets from an old trust to a new trust agreement.  Just as one decants wine by pouring from an old bottle to a new one, a trustee can move trust assets to a new, more favorable trust. Nevada, along with 20 other states, has very favorable decanting laws in place.

There are limits as to what can be accomplished with decanting.  Trustees cannot alter a beneficiary’s already-vested interests in a trust.  However, a trustee can push back the age at which the beneficiary receives a payout.  Importantly, the trustee can change the governing law of the trust by moving the situs of the trust.  Nevada is the premier domestic self-settled spendthrift trust state so many trustees look to move their assets to Nevada.  In addition, if there is no successor trustee named, decanting can make it possible to name a proper successor trustee.

Nevada law is very favorable because there is no statutory requirement to notify beneficiaries of the decanting.  The trustee does not need to provide beneficiaries copies of the existing or new trust documents.  These privacy protections greatly favor the use of Nevada trust laws.  The trustee has discretion to seek court approval for the decanting process but is not required to do so.  In reality, the vast majority of trustees seek beneficiary approval before starting the procedure to decant the trust assets.

There are uncertain implications for gift, income, and generation-skipping transfers taxes. The Internal Revenue Service has not issued guidelines related to the federal tax issues presented by decanting.  However, the IRS has solicited comments for several years now and guidance should be forthcoming.  Even without federal income tax guidance, there are state income tax savings to be achieved by moving trust assets to a state like Nevada without income tax.

Deductibility of Legal Fees for Estate Planning

**UPDATE: Tax Cuts and Jobs Act (TCJA) enacted on December 22, 2017, provided, “[n]otwithstanding subsection (a) [subjecting certain miscellaneous itemized deductions to the 2 percent floor], no miscellaneous itemized deductions shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026.”**

Section 212 of the Internal Revenue Code (the “Code”) provides that a deduction is available for all the ordinary and necessary expenses paid or incurred during the taxable year:

1. for the production or collection of income;

2. for the management, conservation, or maintenance of property held for the production of income; or

3. in connection with the determination, collection, or refund of any tax.

Section 212 is limited by the two percent (2%) floor under § 67 of the Code. Section 67 provides an individual’s “miscellaneous itemized deductions” may only be deducted to the extent that the aggregate of the deductions exceed two (2%) percent of adjusted gross income. IRC §67(a).  Because of the itemized deductions floor, most clients will not benefit from a deduction for legal expenses incurred in estate planning.

The Tax Court has considered numerous cases to determine whether legal fees incurred in estate planning are deductible.  One of the first cases to allow a deduction for estate planning fees, Bagley v. Commissioner, found that the law firm provided deductible legal services under §212(2).  The law firm consulted the clients with regard to tax-favorable investments, loans to the corporation owned by the client family, and the review and creation of estate plans for the family members.

In Merians v. Commissioner, the court allowed a §212(3) deduction for legal fees allocated to tax advice.  The court narrowly construed their decision to a deduction for only the portion of services which it considered tax advice.  The attorney did not maintain accurate time entry or billing records reflecting the amount of time spent on tax-related aspects of his representation.

The Tax Court has disallowed deductions for legal fees paid for estate planning and general business guidance when the taxpayer does not have any evidence of how the fees relate to the §212 categories.  The mere preparation of a will or testamentary trust will not be deductible.  However, an argument can be made that the creation of a revocable living trust is a tax-motivated transaction for the management and conservation of property.  Similarly, the taxpayer could argue the fees were incurred in connection with the determination (minimization) of the taxpayer’s future tax liability. Therefore, the fees should be deductible under §§212(2) and 212(3).