Divorce Protection in Estate Planning: A Summarization - Vandrew ...

There have been several posts recently about protecting children or other loved ones from divorce. Many clients hope to create a financial safety net for their loved ones that won't be lost if those loved ones find themselves in a messy divorce or even bankruptcy. This financial safety net could be in the form of an inheritance after death or a gift during life.

Because there have been so many posts on the topic, a few readers have requested that I synthesize all of the prior information into one location for easier reading. I liked the idea, so that will be the goal of this post.

One common goal many parents have when planning their estates is protecting their children's inheritances from a child's divorcing spouse. With the divorce rate at 50%, this is a wise concern.

The most common way to protect the assets you desire to leave your children from divorcing spouses or any other creditor is through use of a discretionary trust. A discretionary trust is a legal relationship that can either be created during your life or after your death in your will. Like any other trust, it has a funky way of functioning.

The major parties involved in operation of a trust are the trustee and the beneficiaries. The trustee must undertake all of his actions in the best interests of the beneficiaries, or else he may be sued.

The operation of a discretionary trust can be broken down pretty simply. Think of the assets that are put into the trust as being held in a box where (for the most part) no one can get to them. No one can open the box other than the trustee. However, the trustee cannot remove the assets from the box for his own personal purposes. As soon as the trustee opens the lid on the box and starts taking stuff out, that stuff goes directly to the beneficiaries. While stuff is in the box, creditors (and divorcing spouses) shouldn't be able to touch it.

As you can see, this is a pretty good setup. You can leave your children their inheritances in trust and when they need money for legitimate purposes, the trustee opens up the box and gives them what they need. When a spouse files for divorce on the other hand, the box stays shut and the assets stay out of reach. If you have sufficiently responsible beneficiaries, you can even choose to give them the final say over who acts as trustee when you're gone.

Such a trust can also be a testamentary trust, which means it is created in your will. The advantage of a testamentary trust is that it doesn't come into existence until after you have passed away. While you are still alive, all of your assets are yours and yours alone as normal. You may also change your mind and eliminate or change any testamentary trust at any time before you die.

The divorce protection from trusts was specifically validated by the New Jersey Supreme Court in?Tannen v. Tannen, making them an even more attractive option.

Outside of the will and trust context, many families are using LLCs to either operate a family business, to hold family investments, to save on estate taxes, or to protect assets. LLCs also provide opportunities for divorce protection.

Many clients have hesitation in gifting ownership interests in the family business or investment LLC to children for a variety of reasons despite the fact that such gifts can be a great tool for reducing taxes and protecting assets. There are many valid reasons for this hesitation. The good news is that we can usually address all of these concerns through a properly drafted operating agreement for the LLC. One concern that comes up often is a divorcing spouse of a family member getting ahold of that family member's ownership interest.

The key to dealing with this is a properly drafted operating agreement and a knowledge of the law. The way I like to protect ownership interests from divorce is through use of a buyout provision. Such a provision states that if one member of an LLC gets divorced and the divorcing spouse is to be awarded any interest in the LLC, the other members of the LLC have an option to purchase the that interest at a predetermined price. In Estate of Cohen v. Booth Computers, 421 N.J.Super. 134 (2011), it was held that said buyout price does not need to be market value. The strategy, then, is to include a divorce buyout clause with a predetermined price that is far less than fair value. This makes an LLC ownership interest very unattractive to a divorcing spouse. If you are interested in learning more about uses of LLCs or protecting inheritances from divorce, feel free to contact me.

TAX ADVICE DISCLAIMER: Any tax advice contained in this communication (including attachments) was not intended or written to be used, and it cannot be used, by you for the purpose of (1) avoiding any penalty that may be imposed by the Internal Revenue Service or (2) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

NOT LEGAL ADVICE. Everything posted here is for educational purposes only, and is not to be construed as legal advice. Do not take any action, postpone any action, or decline to take any proposed action based on this information without first engaging the representation of me or another qualified attorney. Nothing posted on Twitter or on any website shall be construed in any way as legal advice.

DISCLAIMER: I am an attorney and a CPA, however I am neither your attorney nor your CPA, and therefore no communications between us are covered by attorney-client or accountant-client privilege unless you possess a signed document which states that I currently represent you as an attorney or a CPA. In the case that such a document exists, the existence or waiver of attorney-client privilege or accountant-client privilege shall be controlled by the signed fee agreement or engagement letter.

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