Trusts are commonly used by individuals in estate planning, yet they create very uncommon problems in divorce. Trusts can be extremely complicated and each one will have variations depending upon the family or individual who created them. It’s important to consider Trusts and how they affect your separate and community property before, during and after your marriage. Trusts also create a unique opportunity to commit fraud upon the marital estate.
For example, a husband had created a Revocable Living Trust prior to marriage and placed a considerable amount of assets into it. It was a second marriage, later in life, for both he and his wife. The marriage lasted about six years, however, the husband seemed to plan fraud upon the marital estate from day one by putting all his income into the trust.
He was the grantor/settlor of the Trust and the initial Trustee. As the Trustee, he was responsible for administering the Revocable Living Trust according to its terms as well as the Texas Trust Code. This requires accounting for each transaction and tracking the corpus of the trust (principal) and the income separately. In Texas, the income is generally considered community property and owed to the marital estate.
In this case, the husband retained the income in his Trust plus added all of his earned income from other sources into the Trust, which was considered community property of his marital estate. If this was accounted for, kept track of and agreed to by his spouse, and maintained as community party in some fashion, it would have been acceptable. However, he denied the existence of the funds upon filing for divorce, indicating a fraudulent conveyance from the marital estate. Adding to that, he failed to report a good deal of the funds on his tax returns, creating a potential tax liability.
By failing to maintain any accounting for the funds, books or records for the Trust, and refusing to provide much of anything during Discovery proceedings, he created a nightmare for his spouse’s legal counsel. His sworn Inventory and Appraisement filed shortly after filing the divorce lawsuit provided no insight for the retained income and transferred income which he generated during their marriage. His spouse and legal counsel had some inkling of hidden assets but no idea of how much or where the funds were located. The case lingered for about 18 months with little to no progress, but lots of legal fees with aggressive proactive (but false) filings by his legal counsel.
Trusts in Texas are required to be heard in District Court, not Family Court, so immediately the complexity escalated. The Family Court judge could not proceed without knowing the status of the husband’s trust with regards to characterization of assets, retained community property, commingling of marital assets, and whether the Trust would remain intact or not.
The wife’s legal counsel hired a CPA to investigate and determine the facts. Fortunately, they had received copies of all the bank statements and canceled checks (for 18 different bank accounts!). By reviewing each transaction, the disclosed assets, their tax returns and his Inventory and Appraisement, the CPA was able to recreate financial statements. This allowed them to see the one million dollars of hidden income in his trust which had been hopeless commingled with the corpus. In Texas, once the commingling is hopeless, generally all of the funds (and/or assets) may be considered marital estate property. Sometimes certain assets will be visible and remain Trust corpus, so each case will vary. However, in this case, without books and records, the commingling was hopeless and quite apparent to the court.
Texas Trusts do not characterize the assets as separate or community property, since the grantor/settlor of the Revocable Trust retains an equitable interest in the Trust which is another entity, like a corporation or LLC. Therefore this Trust was composed of corpus, retained income and fraudulently conveyed marital estate assets. This meant that the District Court would probably appoint a Receiver to takeover administering the Trust and account for all the assets. Eventually the Marital Assets would be repaid to the Marital Estate and the Family Court divorce case could proceed. When confronted with the facts during a court required mediation, the husband was forced into a mediated settlement agreement to avoid losing control of all Trust assets to a Receiver.
This case ended in favor of the innocent spouse, however, not until over $200,000 of legal fees had been incurred. If you have a notion that assets are being hidden, especially in a Trust, it’s always a good idea to consult with a Forensic Accountant to determine where you stand. The earlier the better. Once both sides see the true hidden picture, the parties might realize that continued litigation is expensive and the outcome fairly obvious.
Remember, see the Disclaimer for this website. This article is not intended as legal advice.