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Inheritance and Divorce

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If a beneficiary of a trust is going through a divorce, may the beneficiary’s interest in the trust be taken into account in determining either alimony or a division of marital assets? It depends.

In Pfannenstiehl v. Pfannenstiehl, 475 Mass. 105 (2016), the issue was whether a probate court judge could order a husband to pay his ex-wife $1.4 million based on the husband’s interest in a trust that his father set up for his benefit, even though the husband had no legal right to force the trustee to distribute trust assets to himself.

Curt and Diane were married in 2000. They had two children. Curt filed his complaint for divorce on September 13, 2010. The parties were married for twelve years, but had been separated for nearly two years at the time of trial. Judgment was entered on August 27, 2012. At that time, Curt was forty-two years old and Diane was forty-eight years old; each was in generally good health. Their son was then eleven years old and their daughter was eight years old.

During their marriage, Curt was employed as an assistant bookstore manager for a subsidiary of his father’s corporation, Educor, Inc., earning approximately $170,000 per year. Curt’s annual income was $190,000 at the time judgment was entered, including earnings from some part-time jobs.

Prior to and during the first few years of the marriage, Diane served in the United States Army Reserves, which obligated her to participate in two weeks of training twice per year. In 2004, Diane retired from the Army Reserves, two years short of the twenty years of service that would have entitled her to a pension. The judge found that she made the decision to retire after pressure from Curt and his family following the birth of their daughter, who has Down syndrome. From 2004 through the time of trial, Diane worked one day per week as an ultrasound technician. At the time, Diane was earning a gross annual income of $22,672. She also received $7,428 per year in rental income.

During the marriage, the parties enjoyed an upper middle class lifestyle. They owned a home worth in excess of $700,000, as well as other real estate, took several vacations each year, and belonged to a country club. The income to support this lifestyle was derived largely from Curt’s earnings, augmented by gifts from Curt’s father and distributions to Curt from a 2004 Trust created by Curt’s father for Curt’s benefit. The judge found that Diane made significant contributions as a homemaker and caretaker of the children, while also contributing her earnings and rental income to the marital estate.

The 2004 trust was established by Curt’s father in 2004, four years after Curt and Diane married. The trust benefits an open class of beneficiaries, composed of any one or more of the then living issue of Curt’s father. “Issue” is defined in the trust as the “lawful blood descendants in the first, second, or any other degree of” Curt’s father. The 2004 trust is funded through shares of two for-profit education corporations, several life insurance policies, and a cash account. The trustees are Curt’s brother, who is also a trust beneficiary, and a family attorney who is not a beneficiary.

The 2004 trust provides that distributions to beneficiaries may be made only with the approval of both trustees, who,

“shall pay to, or apply for the benefit of, a class composed of any one or more of the Donor’s then living issue such amounts of income and principal as the Trustee, in its sole discretion, may deem advisable from time to time, whether in equal or unequal shares, to provide for the comfortable support, health, maintenance, welfare and education of each or all members of such class.”

The 2004 trust also contains a spendthrift provision, pursuant to which “[n]either the principal nor income of any trust created hereunder shall be subject to alienation, pledge, assignment or other anticipation by the person for whom the same is intended, nor to attachment, execution, garnishment or other seizure under any legal, equitable or other process.”

The judge found that, at the time of trial, there were eleven living beneficiaries—children and grandchildren of Curt’s father—and no great-grandchildren. The judge determined the value of the trust’s assets to be $24,920,217.37 at that time. Based on her finding that Curt had a one-eleventh interest in the trust, she determined the value of Curt’s interest in the trust to be $2,265,474.31.

At the time of trial, only Curt and his two siblings had received distributions from the 2004 trust; None of his father’s grandchildren had received any distributions. Between 2004 and 2007, there were no distributions from the trust. From April 2008 until August 2010, Curt and his siblings received regular, tax-free distributions from the trust. During that period, Curt received regular monthly distributions for a total of $800,000 in distributions. Since the complaint for divorce was filed in September 2010, Curt had not received any distributions from the 2004 trust. The judge found that the distributions to Curt ceased when he filed the complaint for divorce because the trustees deemed it too risky to distribute funds to Curt at a time when he might be required to share the funds with Diane, a nonbeneficiary. The trustees continued to make distributions to Curt’s two siblings.

The judge determined that distributions from the 2004 trust “augmented” Curt and Diane’s income and lifestyle during the marriage. The judge concluded that Curt’s interest in the 2004 trust should be included as part of the marital estate, and awarded sixty percent of such marital estate to Diane. The judge based the award on her findings concerning Diane’s “past, present and future contributions and her lessened ability to acquire capital assets and work full-time,” which she contrasted with Curt’s “high salary, flexible work hours and beneficiary status in his father’s estate planning.” To effectuate the division of the 2004 trust, the judge ordered Curt to pay Diane the sixty percent of Curt’s interest that she had been awarded in twenty-four monthly installments of $48,699.77, for a total payment of $1,168,794.41 (which included a three per cent interest rate).

As expected, the case proceeded up to the Appellate Division, which affirmed the probate court’s determination that the interest should be part of the estate. The Supreme Judicial Court of Massachusetts (SJC) reversed.

The SJC found that the fact that the trustees have total discretion whether or not to make distributions on Curt’s behalf means that he has an uncertain “expectancy.” Under Massachusetts divorce law, a different standard is applied when dividing assets among former spouses.

In making this decision, the SJC was swayed by the fact that Curt was one of 11 beneficiaries of the trust and that there may be more beneficiaries as additional grandchildren and great-grandchildren come into the picture. It distinguished the case from Comins v. Comins, 33 Mass. App. Ct. 28 (1992), in which the divorcing spouse was the only beneficiary of a discretionary support trust.

One interesting question that remains unanswered is what if the class was closed and the trust was to terminate sometime soon, like in the next few years? In reaching its decision, the SJC relied heavily on the particular facts and circumstances of this case; namely that Curt was one of eleven beneficiaries and the class could expand because of future grandchildren, great-grandchildren, etc.

Attorneys, as well as beneficiaries of trusts who might be involved in divorce proceedings, should have the following takeaways from this case:

  • Use a true, independent trustee, such as a corporate trustee. If counsel serves as trustee consider adding an assuredly independent co-trustee.
  • Form the trust from inception in a trust-friendly jurisdiction that is less likely to undergo a possible transformation in case law, e.g., Nevada. If the trust is in a jurisdiction whose law may be less certain, evaluate whether a change of situs could be completed.
  • Eliminate distributions pursuant to an ascertainable standard in favor of fully discretionary distributions held by an independent trustee. Avoid a pattern of regular distributions to support a beneficiary’s lifestyle and instead make random distributions and not correlated with major life events (e.g., beneficiary buying a house, beneficiary’s child marrying, etc.).
  • Use long term or perpetual trusts instead of using trusts that end when a beneficiary attains a specified age or upon some other triggering event.
  • Have clients sign prenuptial agreements that disclose but exclude family assets, including trusts, when determining either alimony or the division of marital assets.
  • Review existing trusts. If their terms expose them to being considered a marital asset, consider recanting them and making the new trust less vulnerable in case of divorce.

An experienced, estate planning attorney should be able to assist you in the creation of a divorce-proof trust or the recanting of an existing trust that will be less exposed in case of divorce.

About the Author

Christopher R. Mitchell is admitted to the Massachusetts bar and concentrates his practice in the areas of estate planning, trust and estate administration, tax planning, and business succession planning.

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