An irrevocable trust could be a key component of a divorce settlement. Revocable trusts transfer legal ownership of the corpus (property in the trust) from the individual to the trust. A trust is not a legal party in a divorce proceeding, so the corpus is not subject to classification and division by the court.
The settlor (person who creates the irrevocable trust) does not control the corpus, but the settlor does receive any income the corpus generates.
The same ownership principles apply to property controlled by an LLP (limited liability partnership) or an LLC (limited liability corporation). The entity, not a husband or wife, legally owns the property. However, the prior owner is the LLC or LLP Manager. Therefore, the husband or wife retains control of the entity.
Be advised this strategy doesn’t always work. The other spouse could argue that the irrevocable trust, LLC, or LLP fraudulently conceals assets properly subject to equitable or other division. Most states refer to this issue as dissipation (waste) of marital assets.
Avoiding Irrevocable Trust and Divorce Settlement Problems
A premarital agreement, along with an early transfer of assets, usually short-circuits this potential argument.
Both spouses sign premarital agreements, so both spouses have official notice of an irrevocable trust or other asset transfer long before divorce settlement negotiations begin. This advanced notice makes it very difficult for one spouse to claim the other spouse tried to pull a fast one.
We should briefly mention some other benefits of prenuptial agreements. Other than infidelity, money is the leading cause of divorce. A prenuptial agreement removes money from the equation, so these disputes don’t have a chance to poison your relationship. Additionally, prenups often cover inheritance and succession matters. So, prenups minimize future non-divorce disputes as well.
Commingling, another possible issue, normally isn’t a problem in irrevocable trust matters. The settlor cannot add or remove items from the corpus. But commingling could be an issue in LLC and LLP matters.
Assume that Ben acquired a rental property prior to his marriage to Mary. Just before he walks down the aisle, Ben transfers the property to Ben, LLC. Mary uses a wedding gift from her family to renovate and update the rental property. Even though Ben, LLC is clearly Ben’s separate property, based on these facts, Mary might have a claim to at least part of the house’s past and future rental income.
Property and control are usually separate issues. In the above example, at best, Mary only has a claim to the income related to house A. The house itself legally belongs to Ben. In most cases, he may keep it, sell it, give it away, or do pretty much anything else.
Mary could try to stop a transfer. But since she has no legal interest in the house, she faces an expensive uphill climb.
Spouse as Trust Beneficiary
Frequently, the opposite issue arises regarding irrevocable trusts and divorce settlements. The settlor named a spouse as a beneficiary, and at the time of divorce, the settlor wants to reverse that decision.
In most states, marriage dissolution doesn’t alter the terms of an irrevocable trust. Therefore, if an ex-spouse is a named beneficiary, s/he will likely receive distributions under the terms of the trust. Designating a contingent beneficiary at the time of trust formation, if the couple divorces, could prevent this outcome.
Irrevocable Trust Income and Divorce Settlements
As mentioned, a spouse cannot claim a share of the property in an irrevocable trust, LLC, or LLP. However, the money in that trust could affect child and spousal support amount and duration calculations.
Incidentally, a revocable trust doesn’t shield property in a divorce settlement, since the settlor can add to, or subtract from, the corpus.
Legal Options After a Marriage Unravels
We covered this point above, but it’s so important that it’s worth restating. Most marriage dissolutions are slow-fade divorces. Problems build up over time and eventually become unmanageable, at least as far as the filing spouse is concerned.
So, if Ben creates Ben, LLC a month after the honeymoon, that LLC might shield the rental house, especially if he created the LLC before he accepted Mary’s gift. At some point, however, the transfer was fraudulent, because it was made in anticipation of divorce.