Colorado Code
Part 9 - Colorado Uniform Trust Decanting Act
§ 15-16-919. Tax-Related Limitations - Definitions

Source: L. 2016: Entire part added, (SB 16-085), ch. 228, p. 885, § 1, effective August 10. L. 2017: (2)(j)(I) amended, (SB 17-124), ch. 88, p. 270, § 1, effective August 9.
COMMENT
Certain tax benefits granted under the Internal Revenue Code (the "Code") or state law are dependent upon a trust containing specific provisions. For example, a qualified terminable interest property ("QTIP") marital trust or general power of appointment marital trust requires that the surviving spouse be entitled for life to all income, and a general power of appointment marital trust also requires that the surviving spouse have a general power of appointment exercisable alone and in all events. If a trustee had the power to decant the trust in a manner that deprived the surviving spouse of the requisite income interest, or in the case of a general power of appointment marital trust, the requisite general power of appointment, then arguably the trust would not qualify for the marital deduction from the inception of the trust. Similarly, it is important to ensure that charitable lead trusts and charitable remainder trusts cannot be modified in a way that arguably would prevent them from qualifying for the charitable deduction or that would reduce the amount of that deduction at their inception.
Grantor Trust . For purposes of this section, a grantor trust means a trust as to which a settlor of the first trust is considered the owner for income tax purposes under the Internal Revenue Code. Section 15-16-919(1)(a). The term does not include a trust over which someone other than the settlor (e.g., a beneficiary) is treated as the owner under Code section 678. A "nongrantor trust" is a trust that is not a grantor trust. Section 15-16-919(1)(c).
Marital Deduction . Subsection (2)(a) protects the marital deduction. For example, for property to qualify as qualified terminable interest property, the surviving spouse must have a qualifying income interest for life and a QTIP election must be made. Code § 2056(b)(7)(B)(i). The surviving spouse has a qualifying income interest for life if the surviving spouse is entitled to all the income from the property payable annually or at more frequent intervals and no person has a power to appoint any part of the property to any person other than the surviving spouse. Code § 2056(b)(7)(B)(ii). If the first trust is a trust with respect to which a QTIP election was made, subsection (2)(a) prohibits decanting the property to a trust that does not give the surviving spouse a qualifying income interest for life. For example, if the trustee had expanded discretion to distribute principal to the surviving spouse, the trustee could not decant to give the surviving spouse a lifetime power of appointment in favor of descendants. In addition, both Section 15-16-911(3)(c) and Section 15-16-919(2)(a) would prohibit the trustee from decanting in a manner that would alter the surviving spouse's income interest.
As another example, assume the first trust qualified for the marital deduction under Code Section 2056(b)(5) because the surviving spouse is entitled for life to all the income, the surviving spouse has a testamentary power of appointment in favor of her estate, and no person has any power to appoint other than to the surviving spouse, and the trustee also has a power to make discretionary distributions to the surviving spouse subject to expanded discretion. Subsection (2)(a) prohibits decanting to a second trust that does not give the surviving spouse a right to all income or that gives any person a power to appoint to anyone other than the surviving spouse. Subsection (2)(a) also requires that the second trust qualify for the marital deduction under the same section of the Code, Section 2056(b)(5). It is not sufficient that the second trust qualify for the marital deduction under another section of the Code. Although Code Section 2056(b)(5) requires that the trust give the surviving spouse a power to appoint to either herself or her estate, the second trust could give the surviving spouse a lifetime power to appoint to herself instead of a testamentary power in favor of her estate, or could expand her testamentary power to include persons other than her estate as potential appointees, because the second trust would still qualify for the marital deduction under Code Section 2056(b)(5). If the first trust, however, gave the surviving spouse a lifetime general power of appointment, the authorized fiduciary could not decant in a manner that eliminated such power of appointment. Section 15-16-911(3)(c).
Charitable Deduction . Section 15-16-919(2)(b) protects the charitable deduction. The act does not apply to wholly charitable trusts. Section 15-16-903(2). While a split interest trust such as a charitable remainder trust or charitable lead trust would not be a wholly charitable trust, in almost all cases the trustee of such a trust would not have discretion to distribute principal to a current beneficiary and therefore there would not be an authorized fiduciary (see Section 15-16-902(3)) who would have authority to exercise the decanting power under Section 15-16-911 or Section 15-16-912. In the rare case in which a split interest charitable trust could be decanted, Section 15-16-919(2)(b) requires that the second trust qualify for the charitable deduction under the same provision of the Internal Revenue Code or state law.
Subject to the provisions of Section 15-16-914, Section 15-16-919(2)(b) does not prohibit the modification or omission of a future gift to a charitable organization even if such gift, if made, would result in a future charitable deduction.
Gift Tax Annual Exclusion . Code Section 2503(b) grants a gift tax annual exclusion for gifts of a "present interest." Present interests are often created in trusts by granting the beneficiary a Crummey right of withdrawal over contributions to the trust. If a trustee could decant in a manner that prematurely terminated a beneficiary's existing Crummey right of withdrawal over a prior contribution to the trust, then arguably the contribution would not qualify for the gift tax annual exclusion. The restriction in Section 15-16-911(3)(c) prohibiting the modification or elimination of a presently exercisable power of appointment also protects the annual exclusion for a prior gift to a Crummey trust.
Code Section 2503(c) provides another method for qualifying gifts to a trust for the gift tax annual exclusion. Code Section 2503(c) permits a gift tax annual exclusion for a gift to a trust for an individual under age 21 provided that the property and its income may be expended for the benefit of the donee before attaining age 21, to the extent not so expended passes to the donee upon attaining age 21, and, in the event of the donee's death, is payable to the estate of the donee or pursuant to a general power of appointment.
Assume, for example that the first trust permitted distributions of income and principal subject to expanded discretion to A, provided that the trust property should be distributed to A at age 21 and directed that the trust be distributed to A's estate if A died prior to age 21. A is age 19. The authorized fiduciary could decant to a second trust that, instead of distributing the property to A at age 21, provided A a right to withdraw the trust property for 60 days and that, instead of distributing the property to A's estate, gave A a general testamentary power of appointment. Such a decanting is permitted because the second trust would still qualify under Code Section 2503(c). The authorized fiduciary could not decant to a trust that did not permit A to withdraw the assets until age 30 or that neither gave A a testamentary general power of appointment nor directed distribution of the property to A's estate.
S Corporation Stock . Under Code Section 1361, only certain types of trusts are permitted to own S corporation stock. If the first trust owns S corporation stock, the second trust must also qualify to own S corporation stock under Code Section 1361(c)(2). If the first trust qualifies because it is an electing small business trust (an "ESBT"), the second trust may either be an ESBT or qualify to hold S corporation stock because it is a grantor trust or a qualified subchapter S trust (a "QSST"). Similarly, if the first trust owns S corporation stock and is a grantor trust, the second trust may qualify to hold S corporation stock by being a grantor trust, an ESBT or a QSST.
Subsection (2)(d) imposes a more stringent rule if the first trust is a QSST. In order for a trust to qualify as a QSST, (a) the terms of the trust must require that during the life of the current income beneficiary there shall be only one income beneficiary and (b) all of the income must be distributed to such beneficiary. Code § 1361(d)(3). Thus it may be important that a trust intended to qualify as a QSST not be permitted to be decanted into a trust that would not qualify as a QSST. If the first trust owns S corporation stock and qualifies as an S corporation shareholder because it is a QSST, subsection (2)(d) requires that the second trust also be a QSST. If the first trust is a QSST, it is not sufficient that the second trust qualify to hold S corporation stock under another provision of the Code. If the authorized fiduciary had the power to modify a trust intended to qualify as a QSST to a trust that did not so qualify, the trust would not be a QSST from its inception.
GST "Annual Exclusion" Gifts . Code Section 2642(c) grants a zero inclusion ratio, essentially a "GST annual exclusion," to gifts that qualify for the gift tax annual exclusion but imposes two additional requirements for gifts to trusts. First, the trust must be only for a single individual and second, if the individual dies before the termination of the trust, the property of the trust must be included in the gross estate of such individual. Thus while gifts to trusts for multiple beneficiaries could qualify for the gift tax annual exclusion through the use of Crummey withdrawal rights, such gifts generally would not qualify for the GST annual exclusion. The Code Section 2642(c) restriction requiring a trust be for a single individual for such individual's life could be violated through decanting if the decanting permitted a remainder beneficiary to receive distributions prior to the individual's death. Section 15-16-919(2)(e) prohibits such a modification. The requirement that the trust be included in the gross estate of the individual could perhaps be violated by decanting to a trust that was not includible in the beneficiary's gross estate. Section 15-16-919(2)(e) prohibits such a decanting.
Qualified Benefits . Complicated rules determine when the life expectancy of a trust beneficiary can be considered in determining the required minimum distribution rules when a trust is the beneficiary of a qualified retirement plan or IRA. These rules are found in Code Section 401(a)(9) and the corresponding regulations, and in other Code sections that refer to Section 401(a)(9). For example, with IRAs, Code Section 408(a)(6) states: "Under regulations prescribed by the Secretary, rules similar to the rules of section 401(a)(9) and the incidental death benefit requirements of section 401(a) shall apply to the distribution of the entire interest of an individual for whose benefit the trust is maintained."
Under the rules in Code Section 401(a)(9), only trusts with certain provisions and restrictions permit the life expectancy of the beneficiary to be used to determine required minimum distributions. If a trustee could decant to a trust that would not meet these requirements, then arguably the old trust would not qualify from the inception to use the life expectancy of the beneficiary.
Subsection (2)(f) applies not only to any trust that is currently the beneficiary of an individual retirement account ("IRA") or qualified benefit, but also to any successor trust. The need to apply subsection (2)(f) to successor trusts is demonstrated by the following example. Assume Trust A is the beneficiary of Parent's $100,000 IRA. Child is the current beneficiary of Trust A and upon Child's death the assets of Trust A will be distributed to Trusts X and Y for Child's children. Trust A is not a "conduit trust," but qualified to take IRA distributions over Child's life expectancy because Trust A, and Trusts X and Y, have only individuals as beneficiaries and all future beneficiaries must be younger than Child. If Trusts X and Y permitted the exercise of a decanting power in any way that could result in the addition of charities or individuals older than Child as beneficiaries or permissible appointees, Trust A would not have qualified to take IRA distributions over Child C's life expectancy. Therefore, the restrictions on decanting must apply to Trusts X and Y, as well as to Trust A. Trusts X and Y are indirect beneficiaries of the qualified benefit property.
If an attempted decanting violates subsection (2)(f), the qualified benefit property is deemed to be held as a separate share as of the date of the exercise of the decanting power. Holding the qualified benefit property as a separate share permits the remedial rules of Section 15-16-922 to apply only with respect to the qualified benefit property and its proceeds.
Foreign Grantor Trusts . Generally, the grantor trust rules apply only to a "grantor" who is a citizen or resident of the United States or a domestic corporation. An exception to this rule applies if (a) the foreign grantor has the power to revest title to the trust property in the grantor and such power is exercisable (1) solely by the grantor without the approval or consent of any other person or (2) with the consent of a related or subordinate party who is subservient to the grantor, or (b) distributions may be made only to the grantor and the grantor's spouse during the life of the grantor. If a foreign trust qualifies as a grantor trust because of Code Section 672(f)(2)(A), subsection (2)(g) provides that the decanting power cannot be exercised to a second trust that does not meet the requirements of Code Section 672(f)(2)(A).
Catch-all . Subsection (2)(h) is a catch-all provision intended to preserve any tax benefits not specifically listed in Section 19 for which the first trust qualified if the first-trust instrument expressly indicates an intent to qualify for the tax benefit or is clearly designed to qualify for the tax benefit. Note that subsection (2)(h) does not address any tax benefits for which the trust may qualify in the future. For example, assume that the first trust was a credit shelter trust that was not subject to federal estate tax at the death of the first to die of a married couple because of the decedent's federal exclusion. Assume that an independent person may make discretionary distributions to the surviving spouse and descendants pursuant to expanded discretion. Also assume that the credit shelter trust was designed so that it would not be included in the surviving spouse's estate. The authorized fiduciary could decant and the second trust could grant the surviving spouse a general power of appointment that would cause inclusion in the surviving spouse's estate. Although the credit shelter trust was designed to be excluded from the surviving spouse's estate, such tax benefit is one that would occur, if at all, in the future at the surviving spouse's death; it is not a tax benefit claimed in the past. Therefore subsection (2)(h) does not prohibit such a modification. If the settlor's purposes include saving taxes, and causing inclusion in the spouse's estate may save more taxes by causing a basis adjustment at the surviving spouse's death even though the trust assets would then be included in the surviving spouse's estate, then such a decanting may be appropriate and is not prohibited by subsection (2)(h).
Grantor Trusts . Subsection (2)(i) expressly permits an exercise of the decanting power to change the income tax status of the trust from a grantor trust to a nongrantor trust or vice versa. Although, absent subsection (2)(i), grantor trust status generally might be viewed as a tax benefit of the first trust, grantor trust status is treated differently under the act because the grantor does not necessarily intend that the grantor trust status be maintained until the grantor's death and because other desirable modifications of the trust may result in a loss of grantor trust status.
An exercise of the decanting power may cause a nongrantor trust to become a grantor trust either as a primary purpose of the exercise of the decanting power or as an incidental consequence of other changes made by the decanting. Subsection (2)(i)(II). It would be fundamentally unfair, however, to permit a decanting to impose on the settlor liability for the second trust's income taxes if the settlor objected to such liability. Therefore subsection (2)(j)(II) permits the settlor to block the decanting by objection during the notice period unless the settlor has the power to cause the second trust to cease to be a grantor trust. The settlor receives prior notice of the exercise of the decanting power under Section 15-16-907(3)(a).
Where the first trust is a grantor trust, often the settlor or another person has the power to cause the trust to cease to be a grantor trust. This power permits the settlor or someone acting on the settlor's behalf to relieve the settlor of the income tax liability for the trust. If the second trust is a grantor trust and does not contain the same provisions permitting the grantor trust treatment to be "turned off," the settlor may block the proposed decanting by objecting during the notice period. Subsection (2)(j)(I).
If a portion of a trust is a grantor trust and the remaining portion is a nongrantor trust, subsection (2)(j) applies to the portion that is a grantor trust.