Alimony Trusts

June 30, 2012 | Trusts & Estates

Trusts have become increasingly popular for asset protection and tax planning and yet the skills of an estate planning attorney are frequently not considered relevant when prenuptial agreements or divorce settlements are contemplated.  This misstep results in the loss of many estate and tax planning opportunities.  For example, one useful option to consider when alimony is involved, particularly in acrimonious divorces or when the spouse required to pay alimony (i.e. the payor ex-spouse) owns business interests but has little liquidity, are alimony trusts. 

When the divorce has shattered the relationship of the couple, an alimony trust can be managed by a neutral third party trustee who can act as an intermediary between the former spouses. Moreover, the alimony trust will provide the spouse receiving the alimony payment (i.e. the payee ex-spouse) protection from the unexpected death or insolvency of the payor ex-spouse while also providing assurance to the divorcing couple that transferred property remaining at the end of the defined term will pass to the designated beneficiaries or since these trusts are not required to terminate at the death of the payee ex-spouse, the trusts may continue for the benefit of the divorcing couple’s children.

The alimony trust is also an excellent option for the payor ex-spouse/business owner who because of lack of liquidity would otherwise be force to sell an interest in the family business to fundamaintenance payments.  The trust can be funded with equity in the business and the terms of the agreement can direct that the income generated by the equity be shifted to the payee ex-spouse for a defined term.  The payor ex-spouse can retain control by being designated the trustee and at the end of the defined term the shares in the business revert back to the payor ex-spouse.

There are numerous other advantages to alimony trusts.  For example, the alimony trust can be structured to provide that the payee ex-spouse, not the payor, will be taxed on income received. Further, with an alimony trust the payor ex-spouse can “front load” alimony payments when funding the trust and payments may be made from the trust in decreasing amounts without incurring a tax penalty.  Finally, these trusts are not subject to the “Anti-Lester” Rule which requires that the payor ex-spouse, not the payee ex-spouse, include as income any payments (except child support payments) that terminate upon the occurrence of a contingent event related to a child.  For example, the payor ex-spouse must pay alimony to the payee ex-spouse until their child graduates from high school.  If these payments are made directly, the payor ex-spouse must include these payments in his income because of the contingent event related to the child. However, if these payments were made from an alimony trust, this is avoided and the payee ex-spouse would pay the tax on the income received. 

This is just one of the many options that may be available to couples contemplating divorce or anxious to protect assets from future marital discord.  And because divorce is always difficult, regardless of the amount of advance planning, and no one solution will work in every instance, consulting an estate planning attorney to consider the estate and tax consequences is always  beneficial.

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