Wednesday, November 6, 2013

If any person gives substantial assets to their children (whether held in trust or not)…beware, or at least be aware!

By Robin De Respino

Trusts have historically been used for protection from estate taxes. Now, for most people, protection from the estate tax is not necessary, but one reason (there are many other reasons) trusts may still be needed to protect assets for descendants in the event of a divorce of a descendant.

Most likely, your children will get married, and although everyone wants to believe that their children are getting married for life, that is not always the ending. Many states treat the income and appreciation of separate property held by a married child as deemed marital property for purpose of divorce.

In at least three states (Colorado, Oregon and Massachusetts), the appreciation of property that is held in an irrevocable trust and is not subject to divestment may be deemed to be marital property. In Arizona, the courts have held that the appreciation on assets that increase in value because of efforts of a spouse during marriage (“sweat equity”) are deemed to be marital property. The result of deemed marital property is that the separate property is used in valuation of the marital assets for divorce.

Consider this example: You give your son a lake house in Michigan, either outright or in trust. Your son gets married soon afterwards. Your son and his wife move to Colorado. When the couple got married, the house was worth $500,000. The couple decides to divorce in ten years while they are still in Colorado and the house is worth $1,000,000 at that time. The couple’s assets, including the lake house, are valued at $2,000,000 at date of divorce. Query whether the beginning value should be established at time of move to Colorado or at time of marriage? Your son may receive only $250,000 of the couples’ joint assets. The remaining $750,000 will be transferred to his soon to be ex-wife.

One solution is to contribute the property to a trust for the benefit of your son and include a provision in the trust such that no distributions will be made to a beneficiary unless he or she has a qualified premarital agreement (one that prevents sole and separate assets, and the income and appreciation on such assets, from being deemed to be marital assets for division upon divorce). This is used as a hammer, by you, the parents, and not by your son, to extract a qualified premarital agreement from your son’s wife that can prevent your hard earned assets from being counted against your son in the event of a divorce. It may be surprising how many of your clients may have a child living in a state where this may occur, or may move to such a state at some point in their lifetime.