By H. Van Smith, Esquire*,
Hayden-Anne Breedlove, Second Year Student, and Nicole M. Zettel, Third Year Student, University of Richmond School of Law
An “inheritance trust,” a trust, which is inherited from a third party before, during, or after the marriage, could be created as either a revocable or irrevocable trust. Inheritance trusts are considered separate for purposes of asset division, provided the assets within the inheritance trust have not been comingled, liquidated, or deposited into a joint marital account.
Revocable Living Trust
During one’s lifetime, a settlor can create a trust that takes effect while the settlor is still alive. This is known as an inter vivos or living trust. Settlors usually place assets within the trust of which they want to maintain absolute control over both during and after their lifetime. Living trusts are revocable and changeable during a settlor’s lifetime.
A living trust can be created as joint or separate, depending on how the settlor wants their assets to be modified and distributed upon death. This consideration is often specified in the marital agreement; a document often relied upon to clarify how property in a joint trust should be distributed upon divorce. The marital agreement needs to be signed on or before the signed date of the trust itself. (See Appendix A for an example of a marital agreement). Additionally, the trust should provide the ownership and modification provisions in the trust itself.
Irrevocable Asset Protection Trust
Asset protection trusts are created in order to protect the settlor’s assets from tax consequences, bankruptcy proceedings, or division of assets in divorce. These trusts can be established in all states, with some states, specifically Nevada, South Dakota, and Wyoming, being extremely trust friendly because of state law provisions.
Locating Trust Assets in Divorce
Trust assets in divorce litigation can be located through numerous processes such as, 1) discovery, 2) affidavits, or 3) forensic accountants.
Discovery is useful in locating trust assets in divorce because it mandates that each party provide documents that are critical in ensuring all assets are located. Through this discovery process, a lawyer can request the production of documents, interrogatories, capital admissions, and the other relevant documents in this process.
Requests for admissions are an often-overlooked tool for locating trust assets. Clients are required to admit a fact or the authenticity of a document. When creating these requests, lawyers should create each request to consist of one fact only as opposed to a compound series of questions. This avoids the opportunity or possibility of denying a request simply because one part of the statement is untrue.
An ideal discovery plan would resemble that shown below:
30 days after receipt of mandatory disclosures
Issue written interrogatories for information not included in mandatory disclosure, or follow up to those disclosures.
Issue subpoenas to all employers or trustees of other party.
Issue request to produce documents for those documents not included with mandatory disclosures, or for documents based upon information contained in mandatory disclosures.
30-60 days after receipt of written discovery
Issue subpoenas to banks, credit card companies, trust advisories services, and other repositories of documents not completely provided by other party, or referred to in the follow up discovery.
Communicate with plan administrator for all retirement benefit plans disclosed by written discovery or response to subpoenas to employers, trust and financial advisor services requesting rules, protocols, and forms or formats for Qualified Domestic Relations Orders (QDRO’s).
120-180 days after filing
Serve written interrogatories seeking identity of all trial witnesses and testimony, including lay and opinion (expert) witnesses.
14-30 days after receipt of expert’s report
Contact expert (or opposing counsel) to arrange for discovery deposition of expert and opinion witnesses.
120 days prior to trial
Review, file and insure all witness disclosure has been completed, deposition scheduled or taken. Consider forensic expert to identify domestic or offshore trust fund or financial account.
60-90 days prior to trial
Serve notice for deposition of party, and requests to update and supplement earlier discovery responses.
90 days prior to trial
Prepare and file any discovery related motions (i.e., motion to compel, motion to bar witness as sanction, etc.).
45-60 days prior to trial
Prepare and serve subpoenas to all witnesses who will testify at trial.
Affidavits are another helpful way of locating trust assets. Affidavits sworn under oath can be used as a form of certifying the truth and accuracy of all asset and debt disclosures. This is helpful in cases where clients choose a settlement option.
Additionally, forensic accountants can be used in locating trust assets. Forensic accounting allows for audits and accounting research to be conducted to produce any financial documents. However, forensic accounting is often under-utilized. With today’s advancements in technology and digitization, it is easier to locate financial data. Parties with connections abroad have an increased likelihood of using offshore havens to shield assets from detection and division. With the help of forensic financial accountants, these offshore accounts can be detected easier. Particular attention should be paid to both the Cayman and Virgin Islands, which are two common areas for offshore accounts. (see Samuels v. State, 11 So. 3d 413 holding Husband hid over $3 million of marital assets, both in his name and in other people’s names, in the Cayman Islands to conceal from the divorce judge and put it beyond the reach of former Wife)(Florida 2009).
Present and Future Value of Assets in Trust
Most clients value closure over the value of future payments, unless present values do not accurately capture anticipated growth of investment. Lawyers should apportion assets to avoid division of trust property. Therefore, once a present value is agreed upon, the challenge is to value the assets while taking the trust value of the property into account. This analysis is highly sophisticated and requires much analysis, thus making it a job for an accountant.
Important factors to consider in deciding whether to pursue litigation over future value of assets include 1) the amount in issue, 2) the costs associated with determining future value, and 3) the time the process will take. Clients should weigh these factors in determining whether the costs of pursuing litigation over the future value, both financially and time-wise, are worth the potential outcome.
Proving Trusts and Divisible Assets
In proving whether a trust is marital or separate, the court looks to a variety of factors. The court asks 1) what was the nature of the asset going into the trust, 2) what type of trust now holds the assets, 3) is there a marital agreement that sets forth the characterization of the property, and 4) is there a prenuptial agreement? (see Kelln v. Kelln, 30 Va. App. 113, holding that, in the absence of clear and unambiguous evidence of intent to create a separate estate in the other party, an inter-spousal gift is ineffective as a device to transform an asset into the separate property of the donee spouse; see also Rahbaran v. Rahbaran, 26 Va. App. 195, 208 holding “if a party chooses to commingle marital and non-marital funds to the point that direct tracing is impossible, the claimed separate property loses its separate status.”).
i. Rahbaran v. Rahbaran, 26 Va. App. 195
The parties were married in 1984.
Wife filed for divorce in 1995.
Facts sufficient to prove both parties had committed adultery were presented.
A divorce was granted on the ground that the parties had lived separate and apart for more than one year, noting the mutuality of extramarital affairs from both parties.
In 1983, prior to the marriage, Husband's father transferred money to him from a foreign account.
Husband opened Royal Shoe.
In 1986, after the marriage, Husband moved Royal Shoe inventory, known as Kami, Inc., with additional funds provided to him by his father.
Testimony was provided that Husband’s father had transferred nearly $ 105,000 in funds to Husband.
Husband did not maintain separate records of his business and personal expenses, keeping one checking account before, during, and after the marriage.
Husband argued that funds provided to him by his father both before, during, and after his marriage were his separate funds and should not have been included in marital property.
Husband voluntarily commingled the funds from his father that he received before the marriage with marital property, which transmuted the separate property to marital property.
The funds received after the marriage appeared to be investments and part of marital property, not a gift.
Even if a party can prove that some part of an asset is separate, if the court cannot determine the separate amount, the "unknown amount contributed from the separate source transmutes by commingling and becomes marital property." Rahbaran v. Rahbaran, 26 Va. App. 195, 208 (citing Brett R. Turner, Equitable Distribution of Property 268 (1994)).
Counter-Arguing Trusts as Assets
In arguing that trusts are not considered assets in divorce proceedings, is it important to consider the nature of the trust and whether it was held as a joint or marital trust throughout the marriage. Prenuptial or postnuptial agreements usually address the classification of these assets.
Tax Considerations and Transfer Fees
Trusts are often created as a means of avoiding the costs associated with the probate process or the estate tax (currently a 40% tax on $5 million estates in Virginia). When couples divorce, their assets are taken out of the trust. Each separate spouse either needs to place the assets back in a separate trust or their property will go through probate.
Kelln v. Kelln, 30 Va. App. 113 (1999)
Husband and Wife entered into two revocable living trusts in one marital agreement.
The trusts divided the parties’ estates into two shares.
The trust stated that “[t]o the extent that either spouse’s share of assets exceeds his or her contribution to the Trust, the amount of the difference or excess contribution shall constitute a completed gift from the other [spouse].”
Mr. Kelln revoked the trust before the parties separated and he filed for divorce
Mrs. Kelln claimed that the parties’ share of the property granted to her under the trust was a completed gift and her separate property for the purposes of equitable distribution.
Distribution of trust property upon divorce – are assets commingled? Tax considerations?
Court found the trust was entered into for purposes of minimizing federal estate taxes and held that the standard for determining whether the assets transferred to Mrs. Kelln were a separate or marital gift was whether or notthe grantor “intended to give the asset as the other spouse’s separate property or merely intended to make a gift during the marriage, which becomes marital property.”
Asset Management for Disabled Spouse
If a disabled spouse is under the age of 65, a Special Needs Trust (SNT) may be established for their benefit. SNT’s are usually irrevocable, meaning a trustee is required to manage the trust for the disabled spouse. If a spouse is over the age of 65, government sponsored benefits such as Medicare help support the spouse financially. Income distributed from an SNT must be within a certain income threshold to ensure the disabled spouse can still receive social security disability benefits.
Once an SNT is established for a disabled spouse, a trustee must be either named or appointed. The trustee is usually either a family member or commercial entity such as a CPA or a financial advisor. Some nonprofit organizations can also serve as trustees.