A spouse’s interest in a trust is either going to be characterized as either separate or community property. The property interest of a trust typically involves two distinctive categories that must be characterized:
The character of a spouse’s beneficial interest in the trust corpus depends on the character of the property that makes up the corpus. If the corpus is funded with separate property, the corpus will be separate property; if the corpus is funded with community property, the corpus will be community property. See, e.g., Dickinson v. Dickinson, 324 S.W.3d 653, 658-59 (Tex. App.—Fort Worth 2010, no pet.). A distribution of the trust corpus retains the character of the corpus. See, e.g., Taylor v. Taylor, 680 S.W.2d 645, 649-50 (Tex. App.—Beaumont 1984, writ ref’d n.r.e.).
A spouse can be made the beneficiary of trust income. Texas appellate courts have held, “in the context of a distribution of trust income under an irrevocable trust during the marriage, income distributions are community property only if the recipient has a present possessory right to part of the corpus, even if the recipient has chosen not to exercise that right….” Sharma v. Routh, 302 S.W.3d 355, 361 (Tex. App.—Houston [14th Dist.] 2009, no pet). In other words, if a spouse has the present possessory right to the corpus (interestingly, the phrase “present possessory right” is not found in any Texas statute or the Internal Revenue Code), then all the income from the corpus will be community property. If the spouse does not have a “present possessory right,” then the income from the corpus will be separate property.
The Internal Revenue Code allows for a beneficiary to have the “power to consume, invade, or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to health, education, support, or maintenance of the decedent” and yet this is “not [to] be deemed a general power of appointment.” I.R.C. § 2041(b)(1)(A). No Texas court has addressed whether the health, education, support, or maintenance (commonly referred to as HEMS) language gives the beneficiary a present possessory interest in a trust. The question would seem to turn on a fact issue – how much control does the HEMS language give to the individual beneficiary? This question remains to be answered by Texas appellate courts.
What does this all mean when faced with a divorce? Generally speaking, it means that a spouse’s interest in a trust must be looked at very carefully in a divorce. The character of the corpus and the spouse’s right to that corpus could have a dramatic effect on the overall property division. If you are going through a high-asset and complex divorce, it is in your best interest to hire an attorney that is experienced in property division.
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