Cushing And Dolan – Fall Seminar Series Asset Protection
Self-Settled and Third Party Trusts in Divorce Proceedings
Often a divorcing spouse may be the beneficiary of either a self-settled trust or a third party trust. The extent to which the assets in a third party trust are subject to the “marital division of assets” will depend upon whether it is (1) a mandatory distribution trust, (2) a support trust, (3) a discretionary trust, and (4) the extent to which the beneficiary has either a limited power of appointment or a general power of appointment. The extent to which the assets of a self-settled trusts are at risk depends upon the amount of the discretion the trustee has over either income or principal and which state law is to be applied.
1. Mandatory Distribution Trusts
A mandatory distribution trust is a trust in which the trustee has no power to withhold a distribution and the distribution is required by the terms of the trust.
(a) Marital deduction trust: All income must be made payable to the surviving spouse pursuant to I.R.C. § 2056(b)(7).
(b) Grantor retained annuity trust: A fixed annuity must be paid either to the grantor or to the grantor’s spouse pursuant to the terms of the instrument. I.R.C. § 2702.
(c) Charitable Remainder Trust: A fixed annuity or a fixed percentage of the assets must be paid to the grantor every year during the grantor’s life until death, whereupon the remaining assets will be paid over to a designated charity. I.R.C. § 664.
(d) Charitable Lead Trust: Income from the trust assets must be paid to a designated charity for a fixed number of years and, upon the termination of the trust term, the assets will be paid over to the grantor’s family or a trust for the family. See generally I.R.C. §§671-679.
2. Support Trust
A support trust is a trust in which the trustee is directed to make distributions of income and/or principal as is needed for the health, education, support, and maintenance of a beneficiary. Often, this language is used in a so-called by-pass trust and may also be included in a so-called marital share. The term “health, education, support, and maintenance” is derived from I.R.C. § 1041, which excludes such standards from being a general power of appointment.
The consequences of a support trust is that the beneficiary usually can compel the trustee to make distributions by showing that the money is needed for whatever standard was set forth in the instrument. See U.S. v. O’Shaughnessy, 517 N.W. 2d 574 (Minn. 1994); Restatement (Second) of Trusts, § 198. PLANNING NOTE : Consider changing the word “shall” to “may” and adding the words “sole and absolute discretion” to convert the trust from a support trust into a discretionary trust.
3. Discretionary Trust
In a discretionary trust, the trustee is authorized to make distributions of income and principal to or for the benefit of one or more beneficiaries in the trustee’s sole and absolute discretion, whether in equal or unequal portions and on such terms and conditions as the trustee may deem advisable.
In giving the trustee such broad discretion, it appears that a beneficiary can only compel the trustee to make a distribution if the beneficiary can show that the trustee is “abusing its discretion, by acting arbitrarily, capriciously or in bad faith.” Town of Randolph v. Roberts, 195 N.E.2d 72, 346 Mass. 578 (Mass. 1964); See also, Restatement (Second) of Trusts, § 187, Comment E; Lineback v. Stout, 339 S.E.2d 103, (N.C. Ct. App. 1986); and Ridgell v. Ridgell, 960 S.W.2d 144 (Tex. App. 1997).
In the Roberts case, the defendant Roberts had been sued by the town to recover disability payments she had received prior to the death of her aunt. The evidence showed that the aunt had established a testamentary trust, which provided that income was to be paid to her niece Roberts and, with respect to principal:
In the event that the income from said trust fund shall not be sufficient to properly support my said niece . . . I authorize my said trustees to from time to time use such part of the sum of said trust estate as may be necessary for such purpose, and I give my said trustees the sole power of determining whether or not it is necessary to use a part of the principal sum for such purpose, and [if] it is so determined, what part shall be used and when.
Roberts at 73. The court, in denying the claim by the town, found that, as to principal, the trust confided exclusively to the discretion of the trustees, the decision whether any principal should be used for the support of the defendant niece. She had no absolute right to use any part of the principal, and could herself compel principal payment only by showing that the trustees had abused their discretion by “acting arbitrarily, capriciously or in bad faith.” The court also noted that the trust could not take effect before the aunt’s death and, while the record did not disclose the date on which she died, any payments made before the date of death plainly are not to be recovered. Furthermore, it was declared that the parties were correct in not arguing that public policy forbids a beneficiary of a private trust to receive support at public expense and that governmental claims do not receive any special treatment.
The income of $30 per month was properly paid out to the niece and therefore reduced the town’s financial burden to provide disability assistance by $30 per month. (It is important to note that in the case of a mandatory distribution right, the creditor will be seeking to attach the mandatory distribution stream rather than the trust’s underlying assets. Restatement (Third) of Trusts, § 56, Comment A; Uniform Trust Code Section 501.
In a discretionary interest trust, the beneficiary has no contractual or enforceable right to any income or principal from the trust and therefore the beneficiary cannot force any action by the trustee. In Re: Marriage of Jones, 812 P.2d 1152 (Colo. 1991). It has been held that this interest is a “mere expectancy” in the nondistributed income and not a property interest and therefore the creditor may not force a distribution. U.S. v. O’Shaughnessy, 517 N.W. 2d 574, 577 (Minn. 1994) (United States’ claim against trust assets denied as trust was totally discretionary and the beneficiary’s testamentary limited power of appointment was not a property interest.)
4. Does the Beneficiary have a “Property Right” in the Remainder of a Third-Party Trust ?
If the beneficiary does not have a property interest, then a creditor cannot recover against the debtor’s beneficial interest. Magavern v. U.S., 550 F.2d 797 (2 nd Cir. 1977). Unfortunately, spouses are given more leeway and some states, including Massachusetts, have held that a beneficiary of a pure discretionary trust may have a property interest in the remainder of the trust at least for the purpose of the domestic relations statutes. Therefore, a value may be ascertainable and thus the remainder interest can be included for purposes of asset division. While a beneficiary may have no right to receive distributions except in a trustee’s discretion, the beneficiary, nevertheless, may have a remainder interest in the property. Such an interest has been construed to be a “property interest” in the context of a divorce. Davidson v. Davidson, 474 N.E.2d 1137, 19 Mass. App. Ct. 364 (Mass. App. Ct. 1985) (Husband’s remainder interest in a trust, subject to a spendthrift clause and the condition of survivorship was divisible.); Balanson v. Balanson, 25 P.3d 28 (Colo. 2001); and Trowbridge v. Trowbridge, 114 N.W.2d 129 (Wis. 1962). (Spendthrift provision was not sufficient to protect trust assets and 30% of trust assets were awarded to spouse.)
In Davidson v. Davidson, an ex-wife decided to seek a modification of her divorce decree that had been entered five years earlier. The trial court found a material change in circumstances and awarded the wife, among other things, $125 per week for the support of the minor children and a lump sum alimony of $15,000. Additionally, the ex-husband was ordered to pay his ex-wife $45,000 “as a division of marital property” and $13,500 as counsel fees.
The husband appealed, arguing that the trial court judge improperly made an award of “after acquired property,” meaning property acquired by the husband after the date of the divorce decree. Davidson at 1142. The ex-wife argued that Massachusetts law, as applied, would ” give the trial judge discretion to assign to one spouse property of the other spouse whenever and however acquired .” Id.
Citing Rice v. Rice, 361 N.E.2d 1305, 372 Mass. 398 (Mass. 1977), the Massachusetts Appeals Court noted that the term “‘whenever and however acquired,’ in context referred to separate property acquired by the husband before the marriage and as gifts during the marriage. To hold that property interests acquired after the dissolution of the marriage are subject to division under [Massachusetts law] would be contrary to the marital partnership concept on which [the asset division statute] is founded.” Davidson at 1143. Only property that existed as of the date of the termination of the marriage can be considered in asset division.
The Court then found that, at the time of divorce proceedings, the husband did have an irrevocable remainder interest under a testamentary trust of his deceased father. Although the value of the interest was uncertain in a proceeding under Mass. Gen. Laws ch. 208, §34 for division of marital property, it was within the discretion of the Judge to conclude that the husband’s interest under the trust from which he had received distributions after the divorce, constituted a sufficient property interest to make it part of his estate for purposes of Mass. Gen. Laws ch. 208, §34. Davidson at 1144.
In addressing these issues, the Court stated:
While property concepts have not become immaterial, implicit in our appellate decisions is the rejection of the notion that the content of the estates of divorcing parties ought to be determined by the wooden application of technical rules of the law of property. We think an expansive approach, within the limits of the marital partnership concept, is appropriate. The purpose of § 34 is to empower the courts to deal broadly with property and its equitable division incident to a divorce proceeding. Such broad discretion is necessary in order that the courts can handle the myriad of different fact situations that surround divorces and arrive at a fair financial settlement in each case. (Citations omitted.)
Id . The Court then concluded that the husband’s remainder interest under his father’s testamentary trust, while it may have been at the outer limits of what could be considered a property interest, constituted a sufficient property interest to make it part of his estate for consideration in connection with the property division under Massachusetts law. Id. The court noted that the husband’s right to the remainder interest was fixed at the time of the couple’s divorce, subject only to the conditions of survivorship. Id. “T he uncertainty of value or the inalienability of the interest, in themselves, are [not] sufficient to preclude consideration of the interest as subject to division.” Id.
The facts showed that at the time of the divorce, the husband’s remainder interest would be distributed free of trust when his mother died and when he reached age 35. The husband was 33 years old and his mother was alive. The trust provided that the trustees could “in their uncontrolled discretion” invade principal for the benefit of the husband’s mother.” The fact that the value of the remainder interest was uncertain, actuarial calculations would be to no avail, and the remainder was subject to a valid spendthrift clause and could not have then been reached by the wife in satisfaction of any judgment or claim was not determinative. Davidson at 1144.
The court avoided the sticky question of valuation by simply saying, “The [trial] judge was correct in valuing [the husband’s] remainder interest under his father’s testamentary trust on the basis of the distributions from the trust which [the husband] had received at the time of trial.” Davidson at 1147.
PLANNING NOTE : Following the Davidson decision, the result probably would have been different if the father of the ex-husband had given his wife, the mother of the ex-spouse, a limited power of appointment to disinherit the ex-husband.
More recent cases have continued to hold that a vested remainder interest in a discretionary trust will be considered marital property for domestic relations purposes. Lauricella v. Lauricella, 565 N.E.2d 436, 409 Mass. 211 (Mass. 1991); Henderson v. Collins, 267 S.E.2d 202 (Georgia 1980); Burrell v. Burrell, 537 P.2d 1 (Alaska 1975); Moyars v. Moyars, 717 N.E.2d 976 (Ind. Ct. App. 1999); and In re Marriage of Bentson, 656 P.2d 395 (Or. Ct. App. 1 999).
In Lauricella, the Court expanded on the holding in Davidson, saying: The determination whether to include a particular interest in the property to be divided lies within the sound discretion of the judge after consideration of all of the § 34 factors . . . the [ Davidson] court decided as a matter of law that a remainder interest in a spendthrift trust could be divisible. Whether to divide the interest, however, was left to the judge’s discretion.
Lauricella at 438 . In Lauricella, the facts showed that the husband and wife were married in 1983 and the husband’s father died in 1986 with the father’s wife dying shortly thereafter. The husband’s father had created a trust, which had as its sole asset, a two-family house. The Trust provided that the Trust was to last for 21 years from the death of the husband’s father, during which the beneficiaries have equitable interests with no power to require partition or distribution. The interests of the beneficiaries were restricted by a spendthrift clause, that provided, in part, that their interests were inalienable and not subject to any legal or equitable proceeding by creditors or others. The Trust was subject to amendment upon unanimous vote of the trustee or trustees and beneficiaries. The Trust was subject to termination by the trustees if they sold the property and turned the proceeds over to the beneficiaries.
Through the marriage, the husband and his sister were the sole beneficiaries of the trust. In 1988, the wife filed for divorce requesting an equitable division of the marital property, specifically suggesting that “the trust is the only asset of any value in the marriage and that she needed it financially.” Lauricella at 437.
The trial court held that the husband’s interest was not a marital asset subject to distribution. On appeal, the Supreme Judicial Court reiterated that it was not bound by traditional concepts of title or property. Lauricella at 438. As examples, the Court cited the treatment of: non-vested pension rights in Dewan v. Dewan, 506 N.E.2d 879, 399 Mass. 754 (Mass. 1987); rights in pending lawsuits in Hanify v. Hanify, 526 N.E.2d 1056, 403 Mass. 184 (Mass. 1988); rights under a contingent fee agreement in Lyons v. Lyons, 526 N.E.2d 1063, 403 Mass. 1003 (Mass. 1988); and self-settled trust proceeds in Wolfe v. Wolfe, 486 N.E.2d 747, 21 Mass. App. Ct. 254 (Mass. App. Ct. 1985).
The Lauricella Court found that the husband’s interest in the trust was a property interest, at least for domestic relations purposes. The Court noted:
In this case, the husband has a present, enforceable, equitable right to use the trust property for his benefit. He exercised this right during the marriage by using one of the dwelling units in the property as the marital domicile. He can continue to use the property as a residence (as apparently he is doing), or he can generate income by renting his unit. The husband also has a vested right to the future receipt of a share of the legal title to the trust property. This interest is subject to divestment only if he does not survive until the trust terminates according to its terms. As the husband is only about twenty-six years old, the likelihood is that he will survive to receive his share of the title. The spendthrift clause is not a bar.
Lauricella at 439. The Court found that, even though the husband could be individually removed as a beneficiary if all beneficiaries (including himself) and the trustees assented, this fact would not detract from the conclusion that the husband’s interest was part of his divisible estate. Id. Since as of the date of the decision, the husband was in fact still a beneficiary, the court would not concern itself with the uncertain possibility that his interest would be forfeited in the future. Id. Furthermore, of great import was the court’s statement that ” Were he to attempt to eliminate himself, the court would be free to consider whether his actions constituted an improper effort to frustrate the wife’s right to an assignment of property.” Id.
It should be noted that days after the wife filed her Complaint for divorce, the successor trustees and the beneficiaries voted to amend the declaration of trust by naming the minor children of the husband and children of the husband’s deceased children as beneficiaries and providing that the interest of any deceased beneficiary shall be distributed pursuant to their respective wills or by the intestacy statutes. Since the husband and sister each had two children, the effect of the amendment was to reduce the husband’s beneficial interest from a one-half interest to a one-sixth interest. The Court specifically noted that, “on remand, it will be necessary for the judge to consider the propriety of this amendment .” Lauricella at 439.
As to valuation, the Supreme Judicial Court decided that they would leave it to the judge’s broad discretion, subject to general observations, as follows: ” to valuation, the trust res is improved real estate subject to an income-producing use and of a readily quantifiable value. It obviously will not be difficult to attach a value to the husband’s interest. ” Id.
In Lauricella, the Massachusetts Supreme Judicial Court reviewed the opinions of other states that had considered similar questions and determined that there was no national consensus on the issue of whether the vested beneficial interest in a trust was includable in property division matters. Massachusetts followed the courts of several states that have held vested beneficial interests in trust assets are divisible. Alaska, Burrell v. Burre ll , 537 P.2d 1, 2-3, 6 (Alaska, 1975); Montana, Buxbaum v. Buxbaum , 692 P.2d 411 (Mont. 1984); Oregon: In re Marriage of Bentson, 656 P.2d 395 (Or. Ct. App. 1983) (holding that contingent interests are divisible.) To the contrary, Connecticut, Rubin v. Rubin, 527 A.2d 1184 (Conn. 1987) (involving a residual interest in trust); Indiana, Loeb v. Loeb, 301 N.E.2d 349 (Ind. 1973) (a discretionary trust); Wyoming, Storm v. Storm, 470 P.2d 367 (Wyo. 1970); Colorado: Balanson v. Balanson, 25 P.3d 28 (Colo. 2001), 107 P.3d 1037 (Colo. App. 2004).
The case of Balanson is fairly illustrative since it involves a typical estate planning mechanism whereby the wife’s parents had established revocable trusts prior to death. When the wife’s mother died, her trust became irrevocable. At that time, the trust was to be divided into two trusts, “Trust A” (the marital trust) and “Trust B” (the by-pass trust). Under the terms of the trust instrument, wife’s father, as trustee, had to pay the entire net income from both trusts to himself during his lifetime and had the discretion to invade corpus for his own support, care and maintenance. When wife’s father died, the corpus of Trust A was to be distributed as designated in his will and any undesignated portion was payable to Trust B. Wife’s brother would then become the trustee and would be required under the trust instrument to divide Trust B into as many equal shares as there were living children of the trustors. At the time of the separation, wife and her brother were the only living children of their parents.
The Colorado Supreme Court discussed its earlier holding in In Re: Marriage of Jones, 812 P.2d 1152, 1158 (Colo. 1991) , where a trustee had uncontrolled discretion to distribute income and principal from the trust to “the wife’s father, the wife, or her descendants, for expenses deemed necessary for their health, welfare, comfort, support, maintenance, and education.” Balanson at 41. Upon the father’s death, the trust proceeds were to be distributed to the wife’s descendants, if any, otherwise to the mother’s heirs. After reviewing the relevant case law in Colorado as to whether such an interest constituted property, the Court concluded that “one’s enforceable contract right gives rise to a property interest, while an unenforceable interest constitutes a mere expectancy.” Id. (In Jones, because the Court found that the trust in that case was completely discretionary, it determined that the wife had no contractual or enforceable right to income or principal from the trust and therefore the wife’s interest in the discretionary trust was not property and that the income received by the wife from the trust was more properly characterized as a gift).
In making its decision in Balanson, the Colorado Supreme Court relied upon the Massachusetts case of Davidson v. Davidson, 474 N.E.2d 1137, 19 Mass. App. Ct. 364 (Mass. App. Ct. 1985) and the Wisconsin case of Trowbridge v. Trowbridge, 114 N.W.2d 129 (Wis. 1962) (holding that a beneficiary’s remainder interest in a trust from which the beneficiary’s mother is entitled to (1) the net income for as long as she lives, and (2) to withdraw up to $5,000 from principal in any year plus any additional amounts deemed by the trustee to be necessary or advisable for certain purposes, constituted both a real and personal property interest). Under the facts of Balanson, the court ruled that:
In the present case, Wife has a future, vested interest not within the discretion of the trustee to withhold. Such interests are distinguishable from interests in discretionary trusts because although the value of such interests may be uncertain at the time of the dissolution of marriage, they nonetheless constitute property because they are certain, fixed interests subject only to the condition of survivorship.
Balanson at 41. For this reason, the Court found that the wife’s interest in the family trust constituted “property” as opposed to a mere expectancy, even though the wife’s father had to pay the entire income to himself from both trusts during his lifetime and had discretion to invade the corpus for his own support, care, and maintenance. These factors rendered the value of the wife’s remainder interest uncertain, but did not convert her interests into a mere expectancy.
A self-settled trust is a trust created by a party who may also be a beneficiary. A self-settled trust may be revocable or irrevocable. If the trust is revocable, the trust assets are subject to the claims of the party’s creditors. If the trust is irrevocable, the universal common law is that the assets in the trust are subject to the grantor’s creditors, assuming full exercise of maximum discretion by the trustee. Ware v. Gulda, 117 N.E.2d 137, 331 Mass. 68 (Mass. 1954); State Street Bank & Trust Co. v. Reiser , 389 N.E.2d 768, 7 Mass. App. Ct. 633 (Mass. App. Ct. 1979); Restatement (Second) of Trusts, § 156 (1957); Restatement (Third) of Trusts, § 58 (2003).
In State Street Bank & Trust Co. v. Reiser, 389 N.E.2d 768, 7 Mass. App. Ct. 633 (Mass. App. Ct. 1979) , the settlor of a trust transferred virtually all of his assets to an intervivos revocable trust prior to obtaining a personal loan from a bank. Subsequently, the settlor died and the settlor’s estate had insufficient assets to repay the balance owed. The bank filed suit against the trustee of the trust and the Court found: (1) transferring the assets to the trust was done without fraudulent intent, but (2) because the settlor retained the power to amend or revoke and the right to direct the disposition of income and principal, the settlor had retained such authority during his life that the bank could reach the trust assets to pay the debt after death to the extent the settlor’s estate was insufficient to satisfy such debts. State Street at 771. The Court noted that the bank’s access to trust assets was limited to those assets over which the settlor had retained control during the settlor’s lifetime. In reaching its decision, the court followed the case of Ware v. Gulda, 117 N.E.2d 137, 331 Mass. 68 (Mass. 1954) and the Restatement (Second) of Trusts, § 156(2) (1959).
In the context of spousal relationships, Massachusetts has always given full effect to intervivos trusts, notwithstanding retention of powers to amend and revoke during life, even though this resulted in disinheritance of a spouse or child and nullified the policy which allows a spouse to waive the will and claim a statutory share. Id., citing Nat’l Shawmut Bank v. Joy, 53 N.E.2d 113, 315 Mass. 457 (Mass. 1944); Kerwin v. Donaghy, 59 N.E.2d 299, 317 Mass. 559 (Mass. 1945); Ascher v. Cohen, 131 N.E.2d 198, 333 Mass. 397 (Mass. 1956).
PLANNING NOTE : State Street v. Reiser was decided before Sullivan v. Burkin, 390 Mass. 864 (1984), which held for the first time that assets in a revocable trust would be subject to the surviving spouse’s statutory share, but only on a “prospective” basis setting forth a very clear rule that such assets in a revocable trust are available to satisfy claims of the settlor.
The Massachusetts Supreme Judicial Court has adopted the reasoning in United States v. Ritter, 558 F.2d 1165 (4 th Cir. 1977), where that Court observed that it would violate public policy for an individual to have an estate to live on, but not an estate to pay his debts with. The Court also noted that the Internal Revenue Code institutionalizes the concept that a settlor of a trust who retains administrative powers, power to revoke, or power to control beneficial enjoyment “owns” that trust property and provides that it shall be included in the settlor’s personal estate. I.R.C. § 2038; I.R.C. § 2041.
Thus, where a person places property in trust and reserves the right to amend and revoke, or to direct disposition of principal and income, the settlor’s creditors may, following the death of the settlor, reach in satisfaction of the settlor’s debts to them, to the extent not satisfied by the settlor’s estate, those assets owned by the trust over which the settlor had such control at the time of his death as would have enabled the settlor to use the trust assets for his own benefit. Assets which pour over into such a trust as a consequence of the settlor’s death, or after the settlor’s death, over which the settlor did not have control during his life, are not subject to the reach of creditors since, as to those assets, the equitable principals do not apply, which place assets subject to creditors disposal.
Domestic Asset Protection Trusts & Spousal Rights :
A number of states, including Delaware, Alaska, and Rhode Island, have enacted so-called “domestic asset protection” trusts. The significant provision of the domestic asset protection trust is that the grantor is usually a discretionary beneficiary and, by statute, creditors of the grantor are not permitted to reach the assets of the trust, provided certain criteria are met. Also, certain creditors, such as a spouse, may be excluded from the list of creditors who cannot attach trust assets.
The Delaware Qualified Dispositions and Trust Act (the “Act”) was initially enacted on July 9, 1997 and has been amended several times. The Act requires that, “Any action involving a Delaware asset protection trust, be brought in the Delaware Court of Chancery.” Del. Code Ann. Title 12, Section 3572(a).
Under the Act, a creditor is not permitted to reach and apply the trust assets if a creditor’s claim arose before the qualified disposition was made, unless the creditor brings suit within four years after the qualified disposition was made or, if later, within one year after the creditor discovered (or should have discovered) the qualified disposition. The creditor must prove by clear and convincing evidence that the transfer was fraudulent. Del. Code Ann. Title 12, Section 3572(b).
A spouse who’s claim results from an agreement or court order providing for alimony, child support, or property division, can reach and apply funds if that spouse was married to the grantor of the trust when it was created. Del. Code Ann. Title 12, Section 3573. However, a surviving spouse is not permitted to reach the assets of the trust by electing a statutory share against a will after death. Id.
The Alaska Trust Act was enacted on April 2, 1997 and has subsequently been amended. A creditor may reach the assets of an Alaska trust if: (1) the transfer to the trust was intended to defraud the creditors; (2) the settlor can revoke or terminate all or part of the trust without the consent of the person who has a significant adverse beneficial interest; (3) the trust instrument requires that all or a part of the trust income or principal, or both, be distributed to the settlor; or, (4) at the time of the transfer, the settlor is in default by thirty days or more of making a payment under a child support judgment or order. Alaska Statute, Section 34.40.110(b).
Note that the Alaska Act does not provide an exception for claims by existing or former spouses or minor children. It does appear that a spouse may elect against the will in which case, the assets of the Alaska Asset Protection Trust would be includible in the estate for purposes of the elective share. Alaska Statute, Section 13.12.205(2)(A).
4. Rhode Island
The Rhode Island statute, entitled the “Qualified Dispositions and Trust Act” was enacted on July 1, 1999. Like the Delaware statute, a creditor may reach the assets of the asset protection trust if: (1) the creditor’s claim arose before the transfer was made and the creditor brings suit within four years after the qualified disposition was made or, if later, within one year after the creditor discovered, or should have discovered, the qualified disposition; (2) the creditor’s claim arose after the qualified disposition was made and the creditor brings suit within four years after the qualified disposition was made, unless the creditor does not exist and is not foreseeable when the asset protection trust was created; and (3) a person to whom the transfer is indebted on or before the date of a qualified disposition on account of an agreement or court order providing for alimony, child support, or property division. Rhode Island General Laws, Section 18-9.2-5(1).
Limited and General Powers of Appointment :
A trust beneficiary may have either a limited or general power of appointment and it may be either exercisable during life or upon the beneficiary’s death. In Cooley v. Cooley, 628 A.2d 608 (Conn. App. Ct. 1993), the Connecticut Court of Appeals determined that a husband’s limited power to appoint property during his life in favor of the wife and the husband’s brothers should not be considered part of the marital estate and therefore not subject to division as part of a divorce. The Court found that the Trial Court could not order the husband to exercise his limited power of appointment. The Court also distinguished a limited power from a general power of appointment where the holder of a general power of appointment is generally considered the owner of the underlying property over which there is a power, whereas, the holder of a limited power, at least in the facts of this case, did not have any interest in the underlying property, beneficial or otherwise.
On the other hand, in Ruml v. Ruml, 738 N.E.2d 1131, 50 Mass. App. Ct. 500 (Mass. App. Ct. 2000), the Massachusetts Appeals Court upheld a probate decision that awarded the spouse all of the trust property where the trust had been created by the husband for the benefit of his “spouse and children” and over which the husband held a limited power of appointment exercisable in favor of a broad class of individuals, including the spouse of the settlor. The Court initially ordered the husband to “assign” to the wife all of the trust property, but, following the husband’s failure to do so, the Court awarded all of the trust property to the wife. Ruml at 1142.
Is A General Power of Appointment in a Self-Settled Trust a Property Interest ?
The American Law Institute has abandoned any distinction between ownership and a power finding instead that an unexercised general power of appointment is an ownership equivalent power. Restatement (Third) of Trusts, § 74, Comment A (PD) (4-2005). This is in contrast to earlier court decisions where it was held that unexercised general powers of appointment are not property and cannot be reached by the creditors of the power holder. See Nat’l Shawmut Bank v. Joy, 53 N.E.2d 113, 315 Mass. 457 (Mass. 1944).
Using General Power of Appointment Trusts
PLR 200101021 (January 8, 2001), PLR 200210051 (March 8, 2002), PLR 200403094 (January 16, 2004), and PLR 200604028 (January 27, 2006).
In each of these rulings, the taxpayer proposed to establish a single revocable trust and fund it with his own assets, but giving his wife a general power of appointment over a portion of the assets in the husband’s trust equal to the value of the wife’s remaining applicable exclusion amount less the value of the wife’s taxable estate determined as if she did not possess this power.
In PLR 200403094 and PLR 200604028, the wife executed a Will, which exercised the general power of appointment. Upon wife’s death, who has little or no assets, the husband is required to pay over such amount from his trust to the wife’s estate whereupon such assets will be held in a traditional by-pass share as though the wife had established the by-pass share for the benefit of husband. The husband was the sole trustee of the wife’s by-pass trust (which was funded with the husband’s assets taken out of his revocable trust).
The trust provides that the trustee will pay to the husband and to the husband’s descendants any amount of income and principal of the wife’s by-pass trust that the trustees deem necessary and advisable for the health, education, support, and maintenance of the husband and his descendants.
If the trust holds wife’s residence, during his life, husband will have the exclusive use of that residence and the wife’s family trust will pay all costs associated with that use. Husband also will have a testamentary limited power of appointment to appoint the assets of the wife’s by-pass trust among his then living descendants. Any assets not so appointed, will be distributed to the wife’s then living descendants by right of representation.
(1) On the death of the wife, if wife exercises the power of appointment granted, husband will be treated as making a gift that qualifies for the federal gift tax marital deduction to wife with respect to that portion of the trust appointed by wife.
(2) If wife predeceases husband, the value of trust assets over which wife holds general power of appointment will be included in wife’s gross estate.
(3) Any assets that originated in husband’s trust and that pass to wife’s by-pass trust will not constitute a gift from husband to other beneficiaries of wife’s by-pass trust.
(4) Any assets that originated in husband’s trust and that pass to wife’s by-pass trust established under her Will would not be included in husband’s gross estate.
The IRS answered all questions favorably.
|Ruling 1:||If wife predeceases husband, the value of trust assets over which wife holds a general power of appointment will be included in wife’s gross estate.|
|Ruling 2:||If wife exercises that power of appointment, husband is treated as relinquishing his dominion and control over the property subject to that power of appointment. Accordingly, on the death of wife, if wife exercises the power of appointment granted her, husband will have made a completed gift to her under Section 2501 and will be eligible for the federal gift tax marital deduction under Section 2523.|
|Ruling 3:||Any assets that originated in husband’s revocable trust and that pass to the wife’s by-pass trust will not constitute a gift from husband to the other beneficiaries of the wife’s trust since wife, at her death, will be treated as the owner of the trust assets she appoints.|
|Ruling 4:||None of the assets in the wife’s by-pass trust will be includible in the husband’s estate since, in his role as either a beneficiary or a trustee, husband will not have a general power of appointment under Section 2041 because distributions of income and principal from wife’s family trust are subject to an ascertainable standard. Also, any interest husband may have under wife’s by-pass trust in a residence in which he may have had an ownership interest would not cause that residence to be includible in his gross estate under Section 2036. As a result, none of the assets in the wife’s by-pass trust will be includible in the husband’s gross estate.|
|Question:||Does the spouse actually have to exercise the power to achieve the same result?|
In PLR 200403094 and in PLR 200604028, the facts showed that the wife intended to actually exercise the general power of appointment. In PLR 200101021, the power of appointment was not expressly exercised and the assets passed in default of appointment to a by-pass trust for the benefit of the donor. The IRS ruled that the gift qualified for the gift tax marital deduction.
Treasury Regulations 25.2523(e)-1(G)(2) provides that the actual exercise of a testamentary general power of appointment is not required in order to qualify for the gift tax marital deduction. The Regulations provide that an income interest coupled with a general power of appointment will qualify for the gift tax marital deduction even though the donee spouse does not exercise the power and takers in default designated by the donor spouse ultimately receive the property.