Using trusts in divorce tax planning.

• Author: Young, Patrick L.

The use of trusts in divorce situations is not often considered for a variety of reasons. First, only a small percentage of the divorcing population has the wealth to fund a trust with an amount sufficient to obtain significant economic and tax benefits relative to the trust's costs. Second, divorcing spouses are usually in an adversarial relationship. An inherent mistrust often exists between the parties that must be overcome to use a trust vehicle. Finally, the use of a trust may bring practitioners (and family law attorneys) into the relatively unfamiliar territory of trust taxation.

However, there are economic and tax reasons for using trusts in a divorce context. Any one of the reasons may be sufficient to justify the costs and complexities of using a trust vehicle to achieve these benefits.

Using trusts for economic protection

Either or both spouses may want to use a trust for economic protection. For example, the spouse funding the trust may be concerned that the other spouse does not have the level of financial sophistication or knowledge to prudently handle a large lump-sum settlement. The funding spouse may also want to use a trust when the other spouse is a spendthrift, a compulsive gambler, or a chemically dependent person. If the recipient spouse were to squander, for whatever reason, the wealth that might otherwise be placed in trust, the funding spouse could be exposed to continual claims for additional support.

Alternatively, the recipient spouse may be concerned that the funding spouse suffers from the same problems described in the preceding paragraph. In addition, the recipient spouse may be concerned that the funding spouse will be unable or unwilling to fulfill future financial obligations. For example, if the funding spouse currently has substantial assets and income and is involved in a very high-risk business, the recipient spouse may be concerned that the failure of the business may jeopardize the funding spouse's other income and assets and, therefore, the ability to pay future alimony, child support, or installments for property interests. A properly drafted and funded trust can help achieve the economic goals of both spouses in such situations.

A trust may also be useful when stock is a significant marital asset. If some or all of the stock is transferred to a spouse who is not active in the business, transferring the stock to a trust for the receiving spouse's benefit keeps the receiving spouse from exercising...