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When to Pursue a Trust Reformation Action, Thoughts in a UTC State

Oct 4, 2022 | General Estate Planning, IRS / Tax Guidance, Podcasts, T&E Administration, Uniform Law, Multi-State Issues & Laws

“When to Pursue a Trust Reformation Action, Thoughts in a UTC State,” that’s the subject of today’s ACTEC Trust and Estate Talk.

This is Lois Ann Stanton, an ACTEC Fellow from Austin, Texas. There are multiple ways to amend an irrevocable trust under the Uniform Trust Code (UTC), including a decanting transaction. The action that can be most impactful, however, for achieving a desired tax result or to resolve a trust dispute is a trust reformation court action. ACTEC Fellow Doug Stanley from St. Louis, Missouri will tell us more. Welcome Doug.

Thank you, Lois Ann. I’ll be talking about trust reformations in a UTC state, and when to pursue such an action instead of the other trust reformation techniques that Lois Ann mentioned for you.

Alternatives to UTC Reformations

To review those briefly, I’ll mention that we often use in our practice what’s called a non-judicial settlement agreement, and that wouldn’t be something that we would want for the reasons I’m going to describe here because you can’t have a material purpose change in one of those. Another type would be a modification if the settlor and all the beneficiaries agree. A court modification if beneficiaries agree and the court indicates that there’s not an inconsistent purpose with the change. And then, other court unanticipated circumstances might be a reason. The court might say they’ll allow a modification to achieve tax objectives or we might even get into the decanting transactions by the trustees.

Trust Reformation

All of those types of modifications are very different from a trust reformation and we can’t use those when we are looking for changes retroactive to the date of the agreement, which is what you’re going to do with a trust reformation. You’re honing in on the issue of having a trust instrument that was the same when it was actually created as it is today. That’s the key with the trust reformation and all those other modification methods I just recited, you can’t do that. Those take place whenever the action is complete and when the modification occurs. This is different.

So why make such a big deal about that? Why is it different? Well, one is, we may be wanting a desired tax result. We may need to add or remove language to qualify for, let’s say, the marital deduction or the charitable estate tax deduction. It might be that we have a trust instrument that doesn’t allow for all income to be distributed to the spouse or there (is) more than one beneficiary of the trust that would preclude the marital deduction because the spouse is not the only beneficiary. So, changing the document to either add or remove language to achieve that desired tax purpose would be what we would want to do.

Another might be to add language that was intended, like a residuary clause that was mistakenly left out of a trust. Or maybe there’s a wrong person identified as a recipient of a gift. Or you’ve omitted a class or other clauses that pertain to beneficiaries. All of this hinges on whether you can prove that there was a mistake made by the settlor of the trust. That the settlor was mistaken about a particular fact or mistaken about the law or, more commonly, if there was a mistake made by the attorney who was drafting the document.

That’s the kind of reformations I’ve seen more often, where the attorney who drafted made a mistake. We often see this referred to as a scrivener’s error, but that’s often the reason for the trust reformation, is to correct such a mistake. You have to prove this by extrinsic evidence. Information outside the four corners of the document. This might be through testimony, affidavit, or documents and, that standard, the standard that you have to prove to the court that the reformation is necessary, is a high one. It’s a clear and convincing evidence standard.

Requirements of Reformation

When you’re doing a trust reformation, all the beneficiaries who are affected by the action have to join into the proceeding – it could be a lot of people, including appointed guardian ad litems, GALs, who are also part of the matter if you have minor beneficiaries. And, the best-case scenario is you have the cooperation of the drafting attorney to make an admission of a mistake. That’s hard to find actually, because for an attorney to make such a statement in open court, may be concerning from a malpractice standpoint. They may be advised by their own counsel not to talk and may require some sort of full release of liability before they would enter into such an action. It can be a challenge.

So, sometimes it might be easier to get it through the testimony of others, documents that would prove that this was the intent of the settlor is to have this information included or excluded from the trust instrument. I’ve gotten there that way too. Sometimes you’re drafting attorney may not be living, or you can’t contact them. When you are going through this, it can be a challenge. But it also has its rewards because you can get your tax results that you might have. That’s where I use them more often because often with a trust dispute, you might get the same result through a regular modification– those that I mentioned in the earlier part of the podcast.

Court Preparation for a Trust Reformation

I would like to leave you with one fact that you might want to think about when you’re going through this action, if you’re the one bringing the action in court, is if you get to the point where you have, a court that says they’re willing to grant the action, it might be helpful if you had the ability to prepare a proposed order for the court. And the reason for that is, often when you’re doing a trust reformation action, you may have already reached some sort of accord with the family and so everyone will consent to the action.

You submit those consents with your petition, and the court sees that and says, “Okay, everyone’s in agreement,” and treats it like a regular modification. And then they would issue an order that says it’s modified to say this. But what’s key to the fact of a trust modification- particularly with a tax issue- is that it relates back. It’s retroactive to the beginning of the trust. So, if you’re the one that’s handling the case that would be a good step to take, is to see if you can draft a proposed order.

Thank you, Doug, for sharing your experiences and also your expertise relating to trust reformation in a UTC state.

 

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