Nelson v. Nelson, — So.3d —-, 2016 WL 7322546 (Fla. 2d DCA December 16, 2016)

Multi-generational irrevocable trusts (often referred to as “dynasty” trusts) have always been around, but changes to federal estate tax laws in the mid-1980s sparked a huge surge in their popularity (see here). Ever since they’ve been the darlings of the estate planning world. And for good reason; these trusts allow families to transfer wealth over multiple generations free from the grip of creditors, the IRS, state and local tax authorities, litigators, and — perhaps most importantly — ex-spouses (see here, here).

What divorce attorneys need to know about irrevocable trusts:

Irrevocable trusts are so ubiquitous you need to assume they’re going to factor into most divorces involving high net worth individuals. And if an irrevocable trust is going to get dragged into divorce-related litigation it’s probably going to be for one of two reasons: alimony claims or property-division claims (i.e., equitable distribution).

In the Berlinger case the 2d DCA told us how irrevocable trusts can be pierced to collect unpaid alimony (see here). This time around the 2d DCA addresses the nuclear option: equitable distribution.

For irrevocable trusts equitable distribution is basically a death sentence. The court isn’t just exposing the trust’s assets to pay a certain debt (i.e., alimony); if a trust is subject to equitable distribution it gets terminated and its assets split up. Is this a viable threat in a Florida divorce proceeding? According to the trial judge in the Nelson case linked-to above the answer is YES. That result would shock most trust and estate lawyers.

Can a divorce court force you to terminate your irrevocable trust and split the assets with your ex’? 2d DCA says NO

In this case a husband and wife residing in Florida bought a second home in California and put this home into an irrevocable trust for the benefit of wife and her daughter from a prior marriage. During the divorce husband argued that because the trust was funded with marital assets it was subject to equitable distribution, wife said no way. Who won? Trial court said YES (big win for husband), 2d DCA said NO (bigger win for wife).

What’s seductive (and dangerous) about husband’s argument in this case is that it’s only half wrong. YES, under F.S. 61.075 assets acquired during a marriage are presumed to be marital assets. But NO, they don’t retain their marital-asset status once they’ve been gifted away, which is what happens when a marital asset is transferred to an irrevocable trust. So saith the 2d DCA:

Although the California home became a marital asset pursuant to section 61.075(6)(a)(1)(a) at the time the Former Husband purchased the home and jointly titled it in the parties’ names, the California home ceased in character to be a marital asset upon its transfer into the Trust. At that point, the California home became part of the assets of the Trust, an entity distinct from the Former Husband and the Former Wife. See Juliano v. Juliano, 991 So.2d 394, 396 (Fla. 4th DCA 2008) (treating a trust as a distinct entity from husband settlor); 2 Brett R. Turner, Equitable Distribution of Property § 6:94 (3d ed. 2005) (providing that an irrevocable trust is a distinct entity capable of holding title to property). Transferring the home into the Trust placed the home beyond the trial court’s reach for purposes of equitable distribution. See Juliano, 991 So.2d at 396; In re Chamberlin, 155 N.H. 13,918 A.2d 1, 17 (2007) (holding that assets used to fund an irrevocable trust were not marital assets because they ceased being property belonging to either spouse once the assets were placed in the trust and beyond the reach of the parties).

. . .

Akin to assets owned by a corporation, limited liability company, or partnership “[t]he individual assets owned by an irrevocable trust are … ordinarily third-party property which cannot be divided upon divorce.” Turner, supra, § 6:94 (citing, inter alia, Seggelke v. Seggelke, 319 S.W.3d 461, 467 (Mo. Ct. App. 2010) (holding that a bank account owned by an irrevocable trust was not marital property); Wilburn v. Wilburn, 403 S.C. 372, 743 S.E.2d 734, 742 (2013) (noting that where spouses created an irrevocable trust, “the trust corpus is not the property of either spouse and thus cannot be marital property”)).

So what’s the take away?

Irrevocable trusts do shelter assets in the context of a divorce, but this shield isn’t foolproof (alimony claims remain viable) and these trusts remain subject to the same vagaries plaguing all litigants in our underfunded and overworked state court system (remember the trust failed at the trial court level in this case). So what’s the take away?

If you’re an estate planner, the message to your clients needs to be that while irrevocable trusts are crucial estate planning tools, they can’t do it all. If you want to be sure your trust doesn’t get sucked into a divorce there’s no substitute for a well drafted prenuptial agreement.

And if you’re a litigator, the lesson to be drawn from this case is that parties will continue to target trust assets in divorce proceedings for one simple reason — that’s where the money is! Vast sums of wealth are held in family trusts, and the size of these trusts is only getting bigger (see here).

In this case husband’s divorce counsel constructed an equitably compelling and technically creative argument for why the trust assets should have been split up in the divorce. And it almost worked. So don’t think for a moment this is the last we’ll see of this kind of attack on trust assets in divorce proceedings. When the next trust/divorce dispute comes along the 2d DCA’s opinion in this case will be required reading for all concerned.