|Estate planners have a love-hate relationship with irrevocable trusts.
They are loved because they can do many things for clients: Clients are happy to make
permanent transfers (during lifetime or at death) over which the client may nevertheless
continue to exert ongoing control through the terms of the trust; clients are happy to be
able to take advantage of tax-savings strategies often available only through such trusts.
the other hand, irrevocable trusts are hated because they are so . . . well, irrevocable.
They have fixed provisions, while the personal circumstances of most clients and their
loved ones, not to mention the tax and other laws which govern trusts, are in a constant
state of flux.
Clients (or their successors) are often unhappy, frustrated, disappointed. This
inability to deal with change is frequently true no matter how cleverly documents are
drafted and no matter how flexible the terms are made.
Fortunately, California law allows for the amendment, modification or termination of an
otherwise irrevocable trust--under the proper circumstances and using the proper
procedures. This article will discuss those Probate Code sections that accommodate the
seemingly contradictory goal of changing an irrevocable trust.
This article will not address the estate, gift or income tax consequences of such
actions. However, two tax-related questions must be answered whenever a change to an
irrevocable trust is contemplated.
First, for a tax-motivated change to the terms of a trust, consider whether the change
will be given effect by the Internal Revenue Service. That is, amendments may be
accomplished under California law, but nevertheless not be recognized for federal tax
The Internal Revenue Service honors some amendments because they are authorized by the
Internal Reve-nue Code or the regulations thereunder; for example, amending the terms of a
trust to qualify it as a "qualified domestic trust" (QDOT) under Treas-ury
On the other hand, the Internal Revenue Service takes the position (upheld by reviewing
courts) that it is not required to honor all trust modifications, even when the
modification is authorized under California law and is made pursuant to an order of the
Probate Court. See, Commissioner v. Estate of Bosch, 387 U.S. 456 (1967), and the recent
Ninth Circuit decision in Estate of Bert B. Rapp v. Commissioner, 140 F.3d 1211 (1998).
Second, even if a
change to the terms of a trust is not tax-motivated, consider whether there will be
unintended tax consequences. For example, will a change in the rights of a beneficiary
result in a gift by that beneficiary?
To understand the scope of the opportunity afforded by California's statutory scheme
for modifying or terminating an otherwise irrevocable trust, consider the following
situations, which should be familiar to almost every attorney who handles trust and estate
matters, and which have the potential to be remedied under applicable Probate Code
We want to make a distribution to a beneficiary
which is not clearly within the "health, support, maintenance or education"
standard otherwise required by the trust (e.g., to make a gift, help defray the college
costs of the beneficiary's child, invest in life insurance on the beneficiary's life).
We want to hold S corporation stock in a trust,
but the trust has multiple beneficiaries (and therefore will not qualify as a Qualified
Subchapter S Trust).
We want to divide one trust in order to separate
property which is exempt from the generation-skipping transfer tax from property which is
not exempt from the generation-skipping transfer tax.
We want to authorize the trustees to engage in
transactions not authorized by the trust agreement (e.g., to guarantee obligations of
related entities, to have enhanced investment powers).
We want an individual trustee in a trust requiring
a corporate trustee.
We want a beneficiary to serve as sole or
co-trustee where the trust instrument does not allow it.
We want to divide one trust with multiple
beneficiaries into two or more trusts because there are beneficiaries who wish to pursue
separate investment policies.
We want to try to achieve an estate and/or gift
tax goal: for example, to qualify a trust for the marital deduction or to try to obtain a
charitable deduction by transforming defective charitable trusts into outright charitable
We want to make changes to restrictions on the
disposition of property in light of the maturity of children beneficiaries.
We want to benefit new, unanticipated
We want to change the dispositive terms so that a
series of nearly identical trusts for the benefit of a beneficiary can be consolidated for
ease of administration.
We want to terminate or not create a trust which
will be uneconomical to administer because of a smaller-than-anticipated corpus.
We want a marital trust to be modified to meet the
QDOT requirements where a surviving spouse is not a United States citizen.
We want a trust created to qualify as a particular
tax-savings vehicle (GRAT, GRUT, QPRT, CRT, etc.) to continue to qualify where the
applicable requirements have been changed by statute or regulation.
Finally, a word of caution: Always consider whether a no-contest clause might be
triggered by seeking to amend an irrevocable trust.
When and how to amend
In general, various Probate Code sections (discussed in detail later in this article)
allow for amendment, modification or termination of a trust, generally upon petition to
the Probate Court by the appropriate parties. Before a petition is instituted or the
amendment is done non-judicially, however, determine if other alternatives are available
to accomplish the same goal.
DISCLAIMER. Can a timely disclaimer (within nine months of transfer)
solve the problem? Thus, if a "QTIP" (qualified terminable interest property)
election for a marital trust is desirable, but the terms of the trust provide for income
distributions to the surviving spouse and a child, will the child disclaim his or her
income interest? If so, that is much easier than amending the terms of the trust (and more
likely to obtain the desired tax result).
INTERPRETATION. Can the document be read to allow what is desired? In
particular, consider the impact of the "savings clauses" in the Probate Code:
Probate Code §16081 (general powers of
Probate Code §§16100 et seq (charitable
Probate Code §21503 (formula marital deduction
Probate Code §21522 (marital deduction);
Probate Code §21524 (marital deduction trusts);
Probate Code §§21540 and 21541 (charitable
INTERNAL AMENDMENT PROVISIONS. Is there a mechanism for amending the
terms of the trust contained in the document itself? It is becoming more common,
particularly in tax-oriented trusts (GRATs, GRUTs, QPRTs, CRTs), to find provisions
allowing certain amendments.
CONSENT, INDEMNIFICATION. Is there someone who will indemnify the
trustee with respect to the proposed action? (Caveat: The tax
consequences of an indemnification should be considered.)
California's statutory scheme
Probate Code §§15400-15414 describe several methods for amending trusts under various
circumstances and Probate Code §§17200-17211 describe the procedure for petitioning the
court in the event court approval is required. These sections are summarized below along
with practical considerations for using them.
METHODS FOR AMENDING. Division 9, Part 2, Chapter 3 of the Probate
Code, commencing with §15400, is entitled "Modification and Termination of
Trusts" and sets forth the various methods of modifying, terminating, consolidating
and dividing trusts.
CONSENT OF ALL BENEFICIARIES. Section 15403 provides that, if all
beneficiaries of an irrevocable trust consent, they may compel modification or termination
of the trust upon petition to the court. Some important considerations are:
A guardian ad litem is frequently necessary
because of the "all beneficiaries" requirement and the existence of minor,
unborn or unascertained beneficiaries. Note, however, that Probate Code §15405 permits
the guardian ad litem to "rely on general family benefit accruing to living members
of the beneficiary's family as a basis for approving a modification or termination of the
Under this section, a trust with a spendthrift
clause cannot be terminated (compare this with methods under other Probate Code sections
discussed later where the existence of a spendthrift clause is irrelevant).
The court must consider whether the continuance of
the trust as created is necessary to carry out a material purpose of the trust, and the
court must further determine whether the reason for the change outweighs the interest in
accomplishing that material purpose. If so, the court may allow the modification or
termination of the trust as requested. The important point is that the petitioning
beneficiaries must demonstrate good reason for the change.
Consent of settlor and all beneficiaries. Under
Probate Code §15404, if the settlor and all beneficiaries of a trust consent, they may
compel the modification or termination of a trust. Some considerations:
Note that, in contrast to Probate Code §15403
(consent of all beneficiaries, discussed above), no petition to the court is required.
Because of the "all beneficiaries"
requirement, a guardian ad litem may be necessary (see discussion above with respect to
Probate Code §15403). Note, however, that under Probate Code §15404(c), the court may
limit the class of beneficiaries whose consent is needed under certain circumstances.
A spendthrift clause will not preclude
modification or termination.
No reason is required for the requested
modification or termination.
CONSENT OF SETTLOR AND SOME BENEFICIARIES. Probate Code §15404 also
governs the situation where the settlor and only some beneficiaries consent. In that
event, however, a petition to the Court for an order compelling modification or partial
termination is required and it will be granted on a showing that the interests of the
non-consenting beneficiaries are not substantially impaired.
Uneconomically low principal. Probate Code §15408
provides an "out" when a trust becomes too small to administer efficiently:
A trust is presumptively too small if trust
principal is no greater than $20,000, in which case the trustee may terminate the trust
without further direction from the court.
If a trust is larger than $20,000, a beneficiary
or trustee may petition for a court determination that continued administration will
"defeat or substantially impair the accomplishment" of the trust's purposes. If
the court so finds, it may, in its discretion, order any of the following (attempting to
conform as nearly as possible to the intention of the settlor): termination of the trust,
modification of the trust or appointment of a new trustee.
The court may order termination even where the
trust includes a spendthrift clause.
CHANGED CIRCUMSTANCES. Probate Code §15409 permits a trustee or
beneficiary to petition to have the administrative or dispositive provisions of a trust
modified, or to have the trust terminated. The court has discretion to make such orders on
a showing that "circumstances not known to the settlor and not anticipated by the
settlor" will defeat or substantially impair the accomplishment of the purposes of
the trust. Some considerations:
The court has wide latitude and may even modify
the trust terms so as to include provisions which are not authorized or are forbidden
under the original trust instrument.
A spendthrift clause will be considered along with
all other factors (i.e., its existence is not dispositive of whether or not the trust will
be modified or terminated in the face of changed circumstances).
This provision may be a good alternative when the
consent of the beneficiaries and/or settlor cannot be obtained, or when doing so is
considered risky for tax purposes.
COMBINATION OF SIMILAR TRUSTS. Under Probate Code §15411, a Court
may, on a showing of good cause, order the combination of trusts if administration as a
single trust will not defeat or substantially impair the accomplishment of the trust
purposes or the interests of the beneficiaries. Important considerations include:
A petition by a trustee or beneficiary is
required. It is often helpful to the court, in making its determination, to have the
consent of the beneficiaries.
Because Probate Code §15411 allows the
consolidation of similar (not necessarily identical) trusts, it may be possible to obtain
a variation in terms of a trust by combining it with a similar trust.
DIVISION OF TRUSTS. Under Probate Code §15412, a Court may, on a
showing of good cause, order the division of a trust into two or more separate trusts if
this will not defeat or substantially impair the accomplishment of the trust purposes or
the interests of the beneficiaries. A petition by a trustee or beneficiary is required.
While not required, it is often helpful to the Court, in making its determination, to have
the consent of the beneficiaries.
PROCEDURE. Division 9, Part 5, Chapter 3 of the Probate Code,
commencing with §17200, is entitled "Judicial Proceedings Concerning Trusts"
and sets forth the various court procedures for petitioning the Court with respect to
The principal authorizing statute is Probate Code §17200(b), which provides that
proceedings concerning the internal affairs of a trust include, inter alia, proceedings
for approving or directing the modification or termination of a trust (Probate Code
§17200(b)(13)) and approving or directing the combination or division of trusts (Probate
Under Probate Code §17201, a proceeding is commenced with the filing of a petition
which states: (1) the facts showing that the petition is authorized under the Probate
Code; (2) the grounds of the petition; and (3) the names and addresses of each person
entitled to notice.
There are no Judicial Council forms for these petitions at this time--each must be
individually created, based on the particular facts and circumstances.
Notice of the hearing must be given for at least 30 days before the hearing date, and
the Judicial Council Notice of Hearing form is sufficient for this purpose.
Notice of the hearing must be given to all trustees and all beneficiaries.
A copy of the petition need not be served on trustees or beneficiaries unless the
trustee or beneficiary has served and filed either a notice of appearance or a written
request for a copy of the petition, in which case a copy of the petition must be mailed
within five days after service of the notice of appearance or receipt of the request.
The requirement of service on all beneficiaries is subject to the "virtual
representation" limitations set forth in Probate Code §15804.
Notice and a copy of the petition must also be served on any other person whose right,
title or interest is affected by the petition. Special provisions, included at Probate
Code §17203(c), apply if a person otherwise entitled to notice is deceased. If the
petition relates to a charitable trust, notice must also be given to the attorney general.
The proliferation of irrevocable trusts for both tax planning and "control"
purposes, coupled with the fact that lives (and law) are not always predictable, suggest
that the ability to amend, modify and terminate trusts is an important feature of
California's Probate Code.
Estate planners should not "just say no" when confronted with a client's wish
to change an irrevocable trust, but, rather, should consider what can be accomplished
through use of the statutory scheme described above.
Sandra Price of Cooley Godward LLP's San
Francisco office is certified as a specialist in estate planning, trust and probate law.
She is a member of the executive committee of the State Bar's Estate Planning, Trust &
Probate Law Section.