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Family Law

Divorce: Trust Fund Feuds

Divorce: Trust Fund Feuds
Marlene M. Browne, Forbes Magazine

'Tis the time of presents and charity, and in the spirit of the holidays and the joy of the season, I thought you’d be interested to learn that in some areas of the country, a financial gift or trust fund established for a child or relative (or even yourself) may--despite the best laid intentions of professional wealth managers and estate planners--become part of a battle over property distribution in a divorce case. As you’ll see, it all boils down to where you live.

Here’s why: In most other developed countries, domestic relations law is uniformly applied across the land. But in the U.S. there are different ways of handling the division of assets (and liabilities) upon divorce or legal separation. Basically, in the West and Southwest (i.e., Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin or Alaska--with a community property agreement) you have so-called "community property" laws that look upon each spouse as having an equal, undivided, one half interest in every "marital" asset or income (regardless of title). Meanwhile, the rest of the U.S. follows the "equitable distribution" method derived from English common law. These equitable distribution laws view marriage as an economic enterprise or partnership and demand that "marital property" be distributed fairly (but not necessarily equally) between the spouses upon divorce.

So far, so good for trust-funders, and trust-founders, because most community property and equitable distribution states limit the concept of marital property to that which was accumulated by the parties during their marriage; specifically excluding from distribution "separate property," typically defined as anything that was acquired before the marriage, or during the marriage individually by gift, bequest, devise or descent (i.e., inheritance). But here’s where things get complicated.

For a select number of states, the normal marital property/separate property distinction doesn’t exist. Instead, everything any spouse owns is subject to distribution upon divorce. Last I checked, Connecticut, Indiana, Kansas, Massachusetts, Michigan, Montana, New Hampshire, North Dakota, Oregon, South Dakota and Vermont allow basically all forms of property in the "marital pot," regardless of how, from whom or when the property was acquired by either spouse. Similarly, Alabama, Alaska, Arkansas, Hawaii, Iowa, Minnesota, Ohio, Wisconsin and Wyoming will distribute separate property, provided there's a special show of need by the nontitled spouse or the kids. (Consult with a lawyer to confirm your state's current status.)

Consider the Vermont statute on the issue: "All property owned by either or both of the parties, however and whenever acquired, shall be subject to the jurisdiction of the court," i.e., available to either spouse in a divorce case. Compare it to California’s code or even New York’s statute, which specifically immunize separate property (i.e., that which was acquired before marriage; or property individually acquired by bequest, devise or descent; or gift from a party other than the spouse) from distribution upon divorce or legal separation.

Due to strikingly diverse ways of addressing the concept of "property," trust fund issues play out differently depending on where you divorce. So long as you don’t reside in a "kitchen-sink" (aka "all-property") state, any trust that was settled and continues to be controlled by a third party--say, a parent or relative--will continue to be the separate property of the beneficiary spouse, unavailable for distribution to the other spouse upon divorce. The same will hold true for gifted property. In fact, the only way to change the character of separate property, like a family trust or gift funds, would be to commingle them with "marital" accounts with the explicit intent to share ownership or control with the other spouse. Short of this kind of transmutation, what belongs to one spouse, individually, will continue to be his or hers alone--as long it's maintained separately during the marriage.

If, however, you live in Connecticut, Michigan or Massachusetts (or any of the other all-property states) the result could be very different. Not only could an interest in a family trust fund be considered marital property, but theoretically the court could transfer the ownership interest in the trust or gifted property to the other spouse, individually, after the divorce. (Of course, if you live in one of these all-property states, having a legally enforceable prenuptial agreement is crucial to maintaining the integrity of family wealth that might have accumulated over generations.) Without the protection of a valid prenuptial agreement (i.e., entered into voluntarily--with full financial disclosure and opportunity for effective legal counsel and conscionable when enforced) you could be leaving your marriage with a whole lot less than your spouse.

According to a leading case from Massachusetts, D.L. vs. G.L. (AC 01-P-1253) 61 Mass. App. Ct. 488 (2004), the court can (depending on the facts as applied to the governing factors--i.e., duration of marriage, lifestyle and typical usage of funds, age and health of the parties, their respective contributions to the marital estate, their opportunities for future income and investment, their ability to earn money and general equity concerns) award even a remainder interest to the "other spouse," so long as the likelihood to benefit from the trust in question is not "too remote or speculative." In other words, the interest in a trust must be more than a "mere expectancy" to be considered property available for distribution. (The Massachusetts court cited the possibility of receiving a future inheritance as an example of a "mere expectancy" too speculative to be a factor in a divorce case.) But remember, what's good for the goose is good for the gander. The court will also consider your spouse's access to family trust funds and gifts when performing the calculus of property distribution.

But no matter where you live, whether an all-property or marital only state, all sources of income, whether from separate or marital trust funds, will be included when support obligations are set. Same goes for gifts: If you regularly received $22,000 a year from your parents, this money will be deemed available when deciding how much you can pay (or need) for support. For instance, alimony (also called spousal support or maintenance) will be set according to your ability to meet your own needs--or pay for those of your spouse--after the court distributes whatever property you have between you. So, even if you are fortunate enough to live in a state that will not distribute family trust funds as property, per se, you can be sure that the income those trusts generate will be included when fixing final spousal and child support amounts.

What's more, while a spouse will be supported to the extent required to maintain the marital lifestyle (or marital standard of living--MSOL), kids will be entitled to receive support commensurate with a parent's ever-increasing ability to pay. In other words, their standard of living will always be tied to their wealthiest parent's current lifestyle, long after the divorce is a distant memory, pending their eventual emancipation (ranging from high school graduation to age 21, or beyond, depending on where you live). It's like they say, you can divorce your spouse, but you can't divorce your kids. (And why would you want to?)

Finally, to make sure your own gifts or trusts remain in the correct hands, draft your documents carefully and retain control of the funds. If your beneficiaries happen to live in an inconvenient "kitchen-sink" forum, beseech them to gain the protection of a prenuptial agreement before they wed, or consider withholding your beneficence till you’re sure about their spouses' respective intentions about your money. If the natural objects of your bounty are already wed and living in an all-property state, make all distributions or gifts a "mere expectancy"--or less. Ho, Ho, Ho.

From San Francisco Family Law Blog posted 2006-12-28.

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