We previously blogged about Philadelphia based law firm Cozen O’Conner’s efforts to obtain a guidance as to how to pay-out the profit sharing plan of one of their partners who was in a same-sex marriage. Cozen was presented with a beneficiary designation form which appears to grant the partner’s parents the benefit.

Muddying the issue was that Ms. Farley’s marriage to Ms. Tobitz occurred in Toronto in 2006; a marriage that was not recognized by her home state of Illinois or Cozen’s home state of Pennsylvania.

But no longer – today, Illinois’s governor signs into law the legal recognition of civil unions. Beginning in June 2011, the state will begin issuing licenses to both heterosexual and homosexual partners.

How this will impact the beneficiary issue is unclear since even if the type of union Ms. Farley and Ms. Tobitz had is now recognized by the state, Ms. Farley’s death may preclude a legal recognition of its existence. On the other hand, it is possible that Ms. Tobitz may seek validation of her Canadian marriage under Illinois law, thereby establishing herself as Ms. Farley’s legal heir – to the exclusion of Ms. Farley’s parents.

All married couples should have an estate plan. For those with special needs or large estates estate planning often involves the creation of trusts.  Trusts are a device by which the owner of property conveys it to others to hold for a defined purpose. It is often a means of avoiding estate tax, personal property tax or even creditors who might otherwise claim an interest.  Trusts have been around for centuries, most often used as a means for the grantor (the donor) of controlling property after his lifetime.

There are many forms of specialized trusts.  Some are used to allow the property to gain value without that value going into the taxable estate of the grantor.  A classic example of this is something dubbed QPRT or Qualified Personal Residence Trust. You own a piece of real estate.  You anticipate that it is going to appreciate substantially in the future. Your taxable estate is already at the point where the federal government is going to want a slice (beyond $2 million currently). The plan would be for your kids to inherit the real estate anyway. For this a QPRT may be an answer.  You convey the property to a trust set up to hold it.  You can continue to use the property and pay the expenses associated with it. After you have left in the trust for a period of time, typically ten years, the property goes to your kids (or other beneficiaries you name). Any appreciation that occurred during the ten years the property was in trust is not in your estate but is something your kids will have to deal with. So long as the property you conveyed was worth $1,000,000 or less at the time you established the trust, there is no federal estate tax associated with the gift to the trust. And in valuing the gift, the IRS discounts the value of the house because it was conveyed subject to your right to occupy it for a term of years. If you want to stay in the house after 10 years, you will have to pay a fair rental value to your kids in their capacity as new owners

As with all good tax strategies, there are quirks. Don’t die before the property gets transferred to the kids because the property will still be considered part of your estate, including the appreciated value. Stay friendly with your kids because once the trust term has expired and they get title, they don’t have to rent it to you or let you use it.  It’s theirs.

So having described this cute but otherwise legal tax scheme, why do we discuss it in the context of divorce. Because the transaction is a nightmare.  At one point (pre trust) there was a $1 million asset to divide.  Now, there is a completed gift subject to a right to occupy for a fixed term of years.  The only asset left is the value of the 10 year lease and that can be tough to calculate especially if the property is in a volatile resort market.

In a similar vein, we are working with a situation where our client decided that he would be generous to his second wife and her kids from her first marriage by putting a vacation home in trust for her benefit. The trust was to give her income for life and provided that the property could be disposed of to meet her financial needs. Once she died, whatever was left from the property was designated as a gift for wife’s children.

The house tripled in value in the past 15 years. But while the estate plan was well mapped out it did not include a divorce contingency. The parties are separated and wife has chosen to occupy the house and sue the husband for support. When husband suggested that the $1,500,000 in equity could help to support her and pointed to the trust instrument’s income provisions, wife responded that she has only a life estate and that is all that could be valued as “hers” for purposes of equitable distribution.  Now the trustee (wife’s son from the prior marriage) has mortgaged the vacation house to acquire another $500,000 residence for his mother but the claim is still made that she has almost no interest in the home and that her husband (who created the trust for her support) must supplement her needs including the cost of the house that he put in trust to support her. The estate planning aspect of this transaction was masterful.  That is, until the divorce intervened. 

So the message is that if you are doing estate planning ask your attorney about the “divorce” contingency. And if you are in a divorce, make certain that your counsel understands trust property as well as marital property.

23 Pa.C.S.A. 3323(d.1) was added to the divorce code in 2007, and states that where grounds for the divorce have been established prior to the death of one of the parties, the parties’ econmic rights are to be determined under the divorce code, not 20 Pa.C.S.A (relating to decedents, estates and fiduciaries).

In Yelenic v. Clark, an April 2007 decision of the Superior Court, it was held that where Husband died prior to the execution of a settlement agreement and prior to the entry of the divorce decree, Section 3323(d.1) required that the parties assets be distributed pursuant to the divorce code, but that no "posthumous divorce decree" would be issued.

The Estate of the husband made an interesting argument, claiming that the failure of the court to enter a divorce decree might permit a "double dip" by the surviving spouse.  She could be entitled to additional property as the beneficiary of insurance policies and retirement accounts that were not updated prior to the death of the husband.  Even though the agreement of the parties or the court’s order might hold that the deceased was to retain property, if the named beneficiary on the policy or account was the surviving spouse, the surviving spouse would receive those funds as the named beneficiary despite the equitable distribution scheme.

The Estate concluded this argument, pointing out that if a divorce decree were issued, this unfair result would be avoided.

The Superior Court’s response was interesting.  In upholding the trial court’s conclusion that Section 3323(d.1) only permits the resolution of the economic rights, and not the entry of a divorce decree, the Superior court went on to say:

"… parties to divorce actions would be well advised to change their wills or prepare a will before grounds for divorce are established." [emphasis added]

This is good advice – clients should be advised that they should be looking at their estate plans during their divorce.