In a divorce, the laws of equitable distribution distinguish marital property from separate property. Technically, only marital property, that is, property acquired after the parties’ wedding date, will be divided between the parties in a divorce. Separate property, that is, property that is acquired before the parties’ wedding date or through inheritance or a gift made directly to a party during the marriage and which remains titled solely in that party’s name, is not subject to equitable distribution between the spouses absent specific circumstances.
Generally, trusts are considered the separate property of the beneficiary spouse and the assets in a trust are not subject to equitable distribution unless they contain marital property. Further, any income and principal paid from a separate property trust to a beneficiary spouse remains the separate property of that spouse provided it is maintained in an account in the name of the beneficiary spouse and not commingled with marital funds. However, if the trust funds are put into a joint account, used to buy a marital asset, or used to pay ordinary marital expenses, those amounts cease to be separate property and become marital property, subject to equitable distribution with one exception. Separate property contributions that are used as a down payment on or for capital improvements on an asset retain their separate property character provided documents exist to trace said contribution. Any funds remaining in the trust or in a separate account will continue to be the separate property of the beneficiary spouse.
There are legitimate reasons why a spouse would want to set up a trust during marriage, including for tax or Medicaid planning purposes as part of a robust estate plan. However, a spouse who attempts to shield assets that are marital from equitable distribution by placing them into a trust will fail in his/her goal. Putting marital assets into a trust does not make those assets separate property. In the divorce action, the non-beneficiary spouse may trace the source of the assets in the trust to determine if they are actually marital property and thus, subject to equitable distribution.
Consequently, even though assets in a separate property trust are generally considered to retain their separate property character absent the exceptions noted above, there are two circumstances where those assets may be considered marital in nature. These are if the assets are commingled with or transmuted into marital assets or if the assets in the trust started out as marital assets and the beneficiary spouse is trying to shield them from equitable distribution.
It is important for spouses to understand the rules governing separate and marital property to avoid inadvertently changing the character of those assets. It is equally important for a divorcing spouse to examine the assets in a trust to make sure that those assets are not really marital in nature. If you are considering a divorce, and you know that one of the potential assets is a trust, please contact us to learn more.