14 May 2021 - Events
This article was originally published in California Lawyers Association’s Family Law News Volume 42, No. 3, in September 2020.
California family courts have broad powers under the Family Code to consider the nature of assets held directly or indirectly for the benefit of spouses and parents when determining the amount and source of support obligations. Those powers are tested, however, when the assets in question are held in trust structures governed by the California Probate Code and other state trust laws. While the law is clear on how to handle certain types of trusts in certain situations, such as when a spouse holds assets in a revocable trust for his or her own benefit, it is often less clear to family law practitioners on how the court might consider other trust assets, such as those held irrevocably for the benefit of the children in adversarial support proceedings.
For example, to what extent may a divorcing spouse in a support proceeding pursue assets held in an irrevocable trust established by the other spouse to benefit their children at a time when the parties were not restrained by an automatic temporary restraining order (“ATRO”)? Should the spouse seeking support seek to invalidate the trust, force the trust to make distributions, hold the trust jointly and severally responsible for support obligations, or simply seek to have the trust principal or income considered in the DissoMaster report? Understanding the legal landscape for managing these issues is the first key step in crafting a strategy to pursue or protect trust assets from support consideration. The trustee, acting in his or her fiduciary capacity, represents a trust in legal proceeding as a separate party entitled to separate counsel. Involving third party trusts in support disputes add another level of complexity and cost, and in some circumstances even require parallel proceedings before the California Probate Court.
This article acts as a road map for considering these issues. We first explore the trust fundamentals that are commonly involved in dissolution proceedings. Trust types and party relationships are pivotal factors in considering how the trust may be impacted by a support battle. Next, we consider how the family courts generally handle trusts where one of the spouses is the beneficiary, the trustee, or has some other direct or indirect interest in the trust. We then consider the difficult question of when it is appropriate for family courts to consider trusts created for the benefit of the children in support proceedings. Finally, we will consider other strategy considerations, including jurisdiction, tax, and ethical issues.
Types of trusts potentially at issue when determining support
A. Trust Fundamentals
To understand how a “trust” might impact support in dissolution proceedings, you must first understand trust fundamentals. Simply speaking, a trust is a legal arrangement by which title to property is held by one person, the “trustee,” for the benefit of another, the “beneficiary.” The trust creator is called the “settlor,” but is also referred to as the “trustor” or “grantor.” A settlor’s creation of a trust divides title to transferred property, with legal title in the trustee and equitable title in the beneficiary. Trust lawyers utilize many terms to characterize different trust categories.
1. Express versus Implied Trusts
California law recognizes both express and implied trusts. “Express” trusts are created by the settlor’s intentional action, and “implied” trusts, such as “resulting” and “constructive” trusts, are recognized by law regardless of intent.1 Express trusts may be either “private” trusts, which have specific persons designated as beneficiaries, or “charitable” trusts, which are established for charitable purposes and need not designate a specific ascertainable beneficiary. The California Attorney General supervises charitable trusts, and the inclusion of any charitable trust in dissolution matters will likely require notice to, and potentially the involvement of, the Attorney General. In family law matters, however, most disputes involve express private trusts.
2. Testamentary versus Living Trusts
Trusts are also classified as either “testamentary” trusts, or “inter vivos” or “living” trusts, depending on whether they become effective after the death of the settlor or during his or her life. Family law matters involve both testamentary and living trusts, as both types of trust when effective may impact support issues in a dissolution matter.
3. Revocable versus Irrevocable Trusts
An important consideration is whether a trust is, in whole or in part, classified as “revocable” or “irrevocable.” A revocable trust typically permits the settlor, when competent, to amend or completely revoke a trust. An irrevocable trust typically prohibits the settlor from revoking the trust and eliminates or significantly limits the settlor’s ability to amend the trust terms. In many estate planning scenarios irrevocability results in favorable tax treatment.
During the time that a trust is revocable and the person holding the power to revoke the trust is competent, that person and not the beneficiary, has the rights afforded beneficiaries.2 In support matters, the issues of revocability and trust control are paramount to determining whether a spouse has an enforceable interest in trust held assets that should be considered in support proceedings.
B. Probate court’s exclusive and concurrent jurisdiction rules
In addition, the Probate Code’s special jurisdictional and venue rules may impact how a party approaches issues of trust administration in support disputes. The Probate Code sets forth specific rules governing trust proceedings, including provisions relating to jurisdiction and venue, notice, and petitions relating to the internal affairs and existence of trusts.3 In determining jurisdiction and venue in trust proceedings, “the principal place of administration of the trust” is defined as the usual place where the day-to-day activity of the trust is carried on by the trustee or the trustee’s representative who is primarily responsible for the trust’s administration.4 This means that a family law matter and a trust matter may have different proper venues.
The Probate Code states that the superior court having jurisdiction over a trust has exclusive jurisdiction of proceedings concerning its internal affairs.5 This “probate division” also has concurrent jurisdiction over proceedings to determine the existence of the trust, actions and proceedings by or against creditors or debtors of the trust, and other actions and proceedings involving the trustee or trustees and third persons.6 Trustees also regularly represent trusts in non-Probate Code matters without triggering the exclusive jurisdiction of the probate division. For example, family courts may join trusts as parties to matrimonial matters in family court in enforcement actions in situations that do not involve internal trust administration.7
C. Typical Parent/Child Roles in Trusts
It is also important to scrutinize how the players in a matrimonial dispute are related to any trusts at issue. Understanding a spouse or child’s role and respective rights and responsibilities under the trust and governing trust law must occur first before understanding how those roles interplay with family law and established support considerations.
1. Spouse/Parent(s) as Settlors
Family courts generally treat assets held in revocable trusts settled by one or both of the spouses in a dissolution matter in the same manner as if the assets had not been transferred to the trust. Transmutations reflected in the trust language or in separate documents may still be valid, but title transfer is ignored as the power to revoke permits the spouse access to the funds for both dissolution and support purposes.
2. Spouse/Parent(s) as Trustees
While a spouse may hold legal title to an asset as trustee, the spouse does so in a fiduciary capacity. Unless there are fraudulent transfer or equitable issues in play, the family court typically does not consider assets held in trust by a spouse or parent in a support scenario unless one of the spouses is either the settlor or the beneficiary, or when the trust itself is established to address support.
3. Spouse/Parent(s) as Beneficiaries
A family court’s broad authority relating to family support obligations allow it to consider the assets of a trust benefitting a spouse/parent when determining either spousal or child support.8 The Family Code considers all sources of income to a parent, including income received from a trust.9 Although it is well-established that regularly distributed trust income received by a parent is considered when determining income available for support, it is less clear how to handle sporadic distributions. As discussed below, interests in discretionary trusts are more difficult for the family courts to ascertain because the distributions may be frequent, scarce, or even nonexistent.
4. Children as Beneficiaries
Unlike with parent beneficiaries, a court will not typically consider a child’s income when determining a parent’s spousal support award. A court may, however, consider a child’s trust when determining child support under limited circumstances. These circumstances are explored in detail below and include a consideration of the precise language of the trust, fraudulent activity, and whether the parents have sufficient income to provide for the child’s basic needs.
D. Common Types of Distributive Terms
A trust’s terms dictate how its assets may be distributed. Courts have held that the particular distributive language of a trust is an important consideration when making support orders.10 The common distributive trust terms scrutinized in family support proceedings include:
- Fully Discretionary. A discretionary trust typically directs a trustee to distribute to beneficiaries any amount the trustee deems appropriate, either at set intervals or events, or completely at the trustee’s discretion.
- Ascertainable Standards. Trusts often include an ascertainable standard to guide a trustee’s discretion, such as the health, education, maintenance, and support (“HEMS”) of its beneficiary.
- Spendthrift and Shutdown Clauses. A spendthrift clause provides that the beneficiary may not assign her interest in the trust and the trust is not subject to the claims of creditors. In this way, a spendthrift clause protects a beneficiary’s trust funds from creditors before distribution. A related tool is a “shutdown clause,” so called because it prohibits a trustee from making certain distributions if they would become subject to creditors’ claims.
The family court’s potential approach to a trust created for a parent/spouse’s benefit in support proceedings
As outlined above, the types of trusts and trust roles directly impact how a trust may be considered in a support context. In the context of analyzing the parent/ spouse’s current and future interest in a trust for support purposes, you typically see the court handle trust assets, income and/or trust distributions in three ways: (1) treat as available income for all purposes; (2) impute a hypothetical income stream for the purpose of support; or (3) analyze what assets are available for enforcing support obligations. Understanding each of these tools is fundamental to pursuing or defending a potential trust or income stream.
A. Trust income or distributions as part of gross income available for support
California family courts have broad discretion to consider a party’s income available for support when determining an appropriate child or spousal support award. When calculating support, a court may consider all of a parent’s income, from whatever source derived and without confinement to community property or income.11 The Family Code specifically authorizes the consideration of trust income when establishing a parent’s annual gross income available for support.12 The court may also consider issues of control and concealment in the context of treating third party trust income as parent/spouse income.13 Whether the “trust income” at issue is that income received by the trust or that income received from the trust, family courts may use their discretion to consider whether such income will be considered available for support.
1. Income received by the trust included in support calculations as income received by the spouse.
In order for the court to consider the income received by the trust to be included in a party’s available income for support, there must be a theory as to why—despite the transfer of title to a trust—the trust’s income stream should be considered the spouse’s income in the support context. This comes up in several scenarios:
- As stated above, the assets of a revocable trust established by a parent/spouse may be treated directly as the spouse’s assets for all support purposes because the spouse has the ability to revoke the trust and control the assets for support purposes.
- A parent/spouse is the trustor and/or trustee of an irrevocable trust, but retains certain distributive rights permitting them to control what income they may receive as beneficiary (or assets they may remove as trustor). Similar to the revocable trust scenario, this is where a spouse retains rights to trust income or assets in a manner where the spouse should be able to make them available for support if such power was exercised.
- A party seeking support alleges that a trust established by the opposing party should be disregarded or invalidated because the trust was formed for an improper purpose, was created in violation of the ATRO, or is an alter ego created to cause injustice. The attacking attorney will need to consider whether to just attack the trust for support calculation purposes, or to take the extra step to invalidate the trust for enforcement purposes, as discussed further below.
- A party created a valid trust but under inequitable circumstances, such that the total support calculations should consider the income even though the spouse has no legal entitlement to the trust income and the court does not disturb the trust structure.
The primary way courts handle including income received by the trust as income to the spouse is through imputation. The Family Code expressly authorizes a court to attribute income to a parent when determining support, without regard to deliberate attempts by the parent to reduce income.14 For an irrevocable trust, if the family court is simply including the trust’s income in support calculations that mathematical computation can occur without seeking an order invalidating the trust structure or taking any other actions that may invoke the exclusive jurisdiction of the probate court.
2. Distributions received by spouse included in support calculations as income.
In trusts with simple non-variable, non-discretionary, and/or predictable distribution terms, the court will obviously treat these distributions as part of a parent’s gross income available for support.15 However, when trust distributions are variable, wholly, or partially discretionary or unpredictable, courts will consider trust income in relation to support issues on a case-by-case basis as discussed below.
B. Calculation of hypothetical income from a trust to a parent beneficiary
The primary way courts handle variable or discretionary trust income is through imputation of a hypothetical income stream included as part of the analysis of a parent’s potential earning capacity. In general, family courts are likely to treat discretionary trust income like other uncertain or sporadic income, such as stock options and contingent bonuses. The family court has recognized the difficulties inherent in calculating support based on uncertain and/or sporadic income, but has stated that this impediment does not justify excluding such income from a support calculation.16 Trial courts are permitted to adjust the award where the guideline “monthly net disposable income figure does not accurately reflect the actual or prospective earnings of the parties”.17 In addition, courts have discretion to impute reasonable income to a party based on her assets and “adjust the child support order as appropriate to accommodate seasonal or fluctuating income.”18
There are a number of unique considerations for calculating potential income from a trust in the support analysis. These include:
- Do the trust terms impact future distributions? Will the trust change (will it split, beneficiaries change, etc.) based upon some future condition?
- If there is more than one beneficiary, how do the other beneficiaries’ rights impact distribution streams?
- How has the trust historically been administered?
- How will a third-party trustee impact the predictability of the income stream?
- What are the assets and when will they exhaust?
- Will the family court’s potential findings impact estate or income tax treatment?
Like in a business scenario, the court’s income stream analysis for a trust involves looking at the complete circumstances and will often involve competing expert witness reports.
C. Enforcement of support obligations against trust distributions or the trust itself
Support obligations belong to a parent, so in a typical situation you would not expect a third-party trustee to be a support-debtor in a family law matter. However, in cases where a spouse cannot or has not satisfied the court’s support orders or in situations where equity demands trust responsibility, family courts will be asked to consider enforcing orders against future trust distributions or against the trust assets themselves. Even where a trust beneficiary’s co-parent has obtained an order directing the beneficiary to pay a specified amount for support, the co-parent cannot compel the trustee to fulfill the support obligation without an enforcement order from the court. Enforcement tools can include:
- Order Compelling Trustee to Divert Funds Earmarked for Beneficiary Spouse to Payment of Support Obligations. Under existing garnishment laws, a creditor-spouse can apply to have trust income streams garnished for support purposes.19 These orders can require the trustee to make the distribution payment directly to the support-creditor spouse to satisfy all or part of the debtor-creditor’s support obligations.
- Order Compelling Trustee to Make Distributions for Purpose of Support. In cases where a trustee has discretion to make or withhold distributions to a debtor-spouse in a support situation, practitioners often seek orders compelling the trustee to make distributions.
- Order to Enforce Support Obligation Against Trust Principal. Practitioners sometimes seek to enforce support obligations directly against the trust and its assets as a joined party.20 These efforts typically involve a litigant either seeking to invalidate the trust, seeking to utilize the fraudulent transfer laws to find liability against the trust, or efforts to have the trust deemed an alter ego of the debtor-spouse. If these efforts seek to challenge the validity of the trust or alter the distributive terms in any way, then these efforts may require a probate court action due to that court’s exclusive jurisdiction over internal trust administration matters.21
A spendthrift or shutdown clause alone is unlikely to protect against a beneficiary’s child and spousal support obligations.22 Probate Code section 15305 specifically allows support orders to be enforced against a beneficiary/support-debtor’s trust containing spendthrift provisions.23 The law provides courts the power to prevent a trustee from exercising trust discretion with an improper motive by withholding distributions to the support-debtor.24 If payments from the trust are discretionary, the court may order support payments to be made “out of all or part of future payments that the trustee, pursuant to the exercise of the trustee’s discretion, determines to make to or for the beneficiary’s benefit.”25
Cases reflect the willingness of courts to order third-party trustees to make distributions when justified by the circumstances. Those circumstances can include where a spouse with support arrearages is both the settlor and the beneficiary,26 a beneficiary with the right to compel trust distributions,27 a beneficiary of trust where the trustors’ intent is to provide support for beneficiary’s children,28 or a spendthrift trust beneficiary with income in excess of the amount needed for the spouse’s health, education, maintenance or support.29 It is important to remember, however, the more one relies upon the trust terms to seek a distribution, the more a proceeding becomes directly related to the internal trust administration, bringing the matter under the probate court’s exclusion jurisdiction.30
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