INTERESTS IN TRUSTS AS PROPERTY IN DISSOLUTION OF MARRIAGE: IDENTIFICATION AND VALUATION

One distinction between tax valuation and valuation for property division purposes deserves mention. In effect, the revenue law has one bite at the apple. If a transfer of property is not valued and taxed at the time of the event (e.g., gift or death), the revenue to the government is lost forever. At least in Colorado, the court may have more than one opportunity to deal with an interest in trust in a property division. If a trial court determines that the interest is too uncertain or remote because of an invasionary right to be considered property, the court still has the discretion to consider the interest as an economic circumstance of a spouse.157

VI. TAX CONSEQUENCES AS A FACTOR IN VALUATION

Should the tax treatment of the trust and the beneficiaries be considered in the valuation of an interest in trust?158 Consider a trust for which a QTIP election has been made.159 Assume that deceased father's will established a trust that provides mother with income for her life to be paid at least annually. At mother's death, the trust is to be distributed to wife. Assuming a QTIP election was made with respect to the property and the property qualifies for QTIP treatment, the trust will be included in mother's gross estate for estate tax purposes.160 Unless mother provides otherwise in her will, the QTIP trust property will be subject to estate tax at the highest marginal rate for mother's estate.161 For decedents who die in 2005, the estate tax on the QTIP property could be as much as forty-seven percent of the property's value.162 Thus, valuing wife's remainder interest in the QTIP trust for property division purposes without taking into account its estate tax treatment at the mother's death could result in a gross overstatement of value.

Income tax treatment of the trust and its beneficiaries may be another factor to consider. As a general rule, distributions from trusts are excluded from the beneficiary's gross income163 but distributions that constitute the income from trust property are not.164 In-kind distributions will not result in gain or loss or constitute income to a beneficiary, unless the trustee uses appreciated property in satisfaction of a right to receive a specific dollar amount, the distribution is in satisfaction of a right to receive property other than that distributed, or the in-kind distribution is in satisfaction of the right to receive income.165

Assuming that an in-kind distribution is excluded from the beneficiary's income, the income tax basis of the assets acquired by the beneficiary will be determined under Code section 1015. Generally, for gain purposes, the beneficiary's basis will be the grantor's basis,166 unless the rules of Code section 1014 apply (e.g., property is acquired from a decedent).

If the non-beneficiary spouse is awarded offsetting marital property, income tax consequences of a trust distribution or sale of distributed property projected to occur in the future is unlikely to be a significant factor.167 Yet, if an obligation is due to the non-beneficiary spouse at trust distribution or if the division is deferred, and a compulsory sale of the assets by the beneficiary is anticipated several years after the dissolution of marriage, the income tax payable by the beneficiary spouse may alter the intended economics of the property division. If the property settlement allows the beneficiary spouse to distribute assets in kind to the non-beneficiary spouse, a transfer occurring more than six years after the divorce is not guaranteed to qualify for non-recognition treatment under Code section 1041.168