What happens to a trust during a divorce? The answer is, “It depends.” Denny Taylor, MBA CPA ABV CFF, a forensic and valuation principal with TD&T CPAs and Advisors, P.C. addresses this situation. “Suppose a husband and wife are getting divorced and the wife is a beneficiary of a trust. A court will rule on what is equitable. Sometimes either the husband or wife is named as the beneficiary of a trust. Is that marital property? Is it separate property that belongs to one of the spouses? Or is it not property at all?”
The Eddy Case Provides an Example
In 1991, Judith C. Eddy petitioned the Appellate Court of Illinois, First District, Second Division, regarding a circuit court’s judgment regarding the dissolution of her marriage to J. Michael Eddy. She challenged the circuit court’s decision on several points, some of which related to non-marital property. In the year before the divorce, Michael had earned $250,000 from his position at the Eddy Corporation, a company he and his brother had grown from an initial business started with funds from their father. The business eventually owned three McDonald’s restaurants and other holdings.
The circuit court determined that an oral agreement existed between all parties that separated what Judith and Michael individually owned. Although Michael and his brother had started the Eddy Corporation during the marriage, because it involved no family income or marital money, it could not be counted as marital property. The court eventually ruled in Michael’s favor on the ownership of the companies.
But, What About the Trust?
Also during the marriage, Judith’s grandmother, Constance Blumenthal, died. She left two trusts each valued at $1.9 million in diversified portfolios of which the current primary beneficiaries were Judith’s elderly parents. The court declared the Blumenthal trusts to be property and valued Judith’s share at 50%, or $1.9 million. Judith’s petition argued that the circuit court made a mistake in classifying the assets of the trusts as property. She also said that the court’s decision that she could control the trust investment was an error. Because she could not control the trusts, the total potential ownership value of the trusts should not have been considered when determining the division of property. Thus, the way the District Court distributed property included the value of the trusts and therefore left her with a $60,000 annual shortfall, she argued.
In fact, the trust specified that the trustee had to pay the beneficiaries or their dependents, giving priority to the primary beneficiaries first (Judith’s parents) and then the secondary beneficiaries. The trust document made it clear that Judith didn’t have a present interest of the $1.9 million in the trusts. Further, Judith was not a trustee of either trust. Although Michael asserted that she had control over the funds, she clearly did not. She had only a current right to benefits subject to the discretion of the trustee and her father. The appeals court determined that because she had no present interest, she could not expect anything more than what she received. This future interest could not be considered property in a divorce. On this point, the appeals court sent the case back to the circuit report to determine a more equitable handling of Judith’s shortfall.
The Importance of Valuing a Trust Correctly
“In the Eddy case,” Denny said, “the wife, Judith, was named as beneficiary of the trust but she did not have a present interest ownership at the time of divorce. The District Court incorrectly treated expected future benefits as property in the dissolution of marriage. Judith only had a future discretionary income interest, which is not equivalent to present ownership of property.” The Appellate Court eventually reversed that ruling. In valuing a trust, it helps to have the assistance of skilled professionals who have the knowledge and experience in asset valuation when determining the value of a trust or any other asset. TD&T CPAs and Advisors can provide that expert assistance.