Real Property, Probate and Trust Journal: INTERESTS IN TRUSTS AS PROPERTY IN DISSOLUTION OF MARRIAGE: IDENTIFICATION AND VALUATION

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

Chorney, Marc A

Editors' Synopsis: When a trust is included as part of the divisible assets of a divorce, many complex issues associated with division and valuation of the trust arise. As the author discusses, such a division and valuation may be contrary to the settlor's intent and may require input from family members. This Article discusses the division of interests in trusts and the valuation of those interests, with the primary focus by way of example on the relevant Colorado law. Estate and gift tax valuation concepts also are discussed, and the author suggests that these concepts might be useful in valuing the interests of trusts at the dissolution of marriage. The Article concludes with a discussion of selected tax consequences of the division and valuation of a trust at the dissolution of marriage.

I. INTRODUCTION

A trust can be defined as a "legal device[ ] by which one person is enabled to deal with property for the benefit of another person."1 The simplicity of the definition belies the complexity to which trusts have evolved. The ability to create concurrent and successive equitable interests and powers in property is unique to trusts.2 Trusts have proliferated for this reason and also as a consequence of the increase in wealth in recent decades, the asset protection that a trust may provide,3 and the income, estate, gift, and generation-skipping transfer tax advantages of trusts.

The high rate of divorce in recent decades is indisputable,4 with the obvious consequence of courts making an increasing number of property divisions. Another indisputable trend is that the courts are including new types of property and interests in the pool of assets to be divided. Retirement benefits, intellectual ideas, employment perquisites, professional degrees and licenses, and a variety of other assets have been included in that pool and divided by the courts.5 "Twenty-plus years ago, many jurisdictions ignored pensions as mere contingencies and not deferred wages. Pensions were typically excluded from property settlements."6 Today, every state considers equitable division of pensions.7

A trust can constitute a complex package of present and future rights, powers, and interests, which are not necessarily fixed. If a trust is included in the pool of divisible assets on divorce, the trust instrument must be interpreted, its various interests quantified, and the value divided. Although the process and division may reflect the concept of marriage as a shared enterprise or partnership, this process and division likely will be counter to the intent of the trust's settlor and perhaps will require the participation of the family members of a beneficiary spouse in the proceedings. Those family members are likely to view the process as an unjustified appropriation of a family's wealth.

The body of law regarding division of trusts on dissolution of marriage is, in the author's opinion, too indistinct to say that the law of any one state represents a general rule or an emerging trend. However, Colorado law and, in particular, recent developments in Colorado law illustrate the struggle courts have with such divisions and the lack of a stable framework for dealing with such divisions. Divorce courts and family-law practitioners will require assistance in deciphering trust instruments and valuing temporal interests in property. Trust and estate practitioners therefore will be called upon to assist with these tasks.

This Article first discusses the division of interests in trusts on the dissolution of marriage under Colorado law. The Article then discusses the valuation of interests in trust on the dissolution of marriage, with primary emphasis on Colorado law. Next, the Article considers analogous estate and gift tax valuation concepts and how they might be useful in the valuation of such interests. Finally, the Article considers selected tax consequences that may be relevant in a division and valuation of interests in trusts on the dissolution of marriage.

II. INTERESTS IN TRUSTS AS PROPERTY: COLORADO LAW

The development of the law regarding the treatment of interests in trusts as divisible property on the dissolution of marriage has been diverse.8 Some decisions treat interests in trusts as divisible, regardless of whether the interest is vested, unvested, contingent, or remote.9 Yet some courts have held that an interest in trust is not considered property until the interest becomes possessory (the beneficiary has received or has a present right to withdraw the trust property).10 Colorado law falls between these two extremes.

A. The Enabling Statute

Colorado Revised Statutes Annotated ("C.R.S.A.") provides, in part:

In a proceeding for dissolution of marriage or . . . for legal separation . . . the court . . . shall set apart to each spouse his or her property and shall divide the marital property . . . in such proportions as the court deems just after considering all relevant factors including:

(a) The contribution of each spouse to the acquisition of the marital property, including the contribution of a spouse as homemaker;

(b) The value of the property set apart to each spouse;

(d) Any increases or decreases in the value of the separate property of the spouse during the marriage or the depletion of the separate property for marital purposes.11

C.R.S.A. defines marital property as:

[A]ll property acquired by either spouse subsequent to the marriage except:

(a) Property acquired by gift, bequest, devise, or descent;

(b) Property acquired in exchange for property acquired prior to the marriage or in exchange for property acquired by gift, bequest, devise, or descent;

(d) Property excluded by valid agreement of the parties.12

As discussed infra, Part II.J, the Colorado statute also provides that:

"[P]roperty" and "an asset of a spouse" shall not include any interest a party may have as an heir at law of a living person or any interest under any donative third party instrument which is amendable or revocable, including but not limited to third-party wills, revocable trusts, life insurance, and retirement benefit instruments, nor shall any such interests be considered as an economic circumstance or other factor.13

When making a property division, a court must determine first whether an interest constitutes property, and if it does, a court then must determine if the property is separate or marital.14 Increases in the value of separate property and income from separate property constitute marital property.15 The Colorado statute creates a rebuttable presumption that all property acquired subsequent to the marriage, regardless of titling, is marital property.16 The presumption in favor of marital property is rebuttable even if an asset is titled jointly.17 After determining whether an interest constitutes marital property, and setting aside the separate property of the spouses, the enabling statute requires the court to divide the marital property in a manner the court determines to be just, which does not necessarily mean an equal division between the spouses.18

B. In re Marriage of Balanson

In re Marriage of Balanson19 ("Balanson II") concerned the determination of whether a wife's remainder interest in a trust constituted property for purposes of property division in a dissolution of marriage. Wife's parents created a joint revocable trust, which at the death of wife's mother divided into two irrevocable trusts.20 The settlors intended the "A" trust to be a combined trust consisting of the surviving father's assets and the deceased mother's assets, which would have qualified the trust for the federal estate tax marital deduction at the mother's death.21 The settlors intended the "B" trust to be a credit shelter trust, with the intent that it would not be subject to estate tax at the surviving father's death.22 Both trusts provided wife's father with a mandatory income interest and the power, as the trustee, to distribute principal to himself for his support, care, and maintenance. At father's death, the A trust would be distributed in accordance with father's general power of appointment exercisable by will and if not exercised, then in accordance with the B trust. The B trust was to be divided at father's death into as many equal shares as there were living children of the mother and father. Wife and her brother were the only living children of wife's parents. Wife's father was the trustee of both trusts and the trust instrument designated wife's brother as the successor trustee at the death of wife's father.

The issue in Balanson II was whether wife's remainder interest in the B trust constituted property under C.R.S.A. section 14-10-113. In reversing the Colorado Court of Appeals' holding in Balanson I that wife's interest was an expectancy that did not rise to the level of a property interest,23 the Colorado Supreme Court determined that wife had a "future, vested interest not within the discretion of the trustee to withhold"24 and held that wife's interest in the B trust constituted property, as opposed to a mere expectancy.25 The court reached this conclusion despite the father's income interest and right to invade the principal. According to the court, "[t]hese factors render the value of wife's remainder interest uncertain, but do not convert her interest into a mere expectancy."26 The remainder interest constituted wife's separate property, and the appreciation in the value of her separate property constituted marital property under the statute.27

C. Power of Appointment

The Colorado Supreme Court in Balanson II did not address whether wife held a property interest in the A trust. The parties apparently did not disagree in any of the appellate proceedings that wife's interest in the A trust did not constitute property for purposes of the division. The court of appeals, however, observed in Balanson I that wife's interest in the A trust was "merely an expectancy."28 The court of appeals found it significant that "wife's father was given a power of appointment to pass the entire remaining corpus of trust A through his last will, without any limitation as to the beneficiaries who could be designated in such will."29

1. General Power of Appointment

At least by way of dicta, Colorado authority suggests that a general power of appointment,30 which may defeat a spouse's interest in a trust, will render such interest a contingency. A general power of appointment marital trust, sometimes referred to as a "(b)(5) trust,"31 will grant a surviving spouse the type of general power held by wife's father over the A trust in Balanson, and it would seem that such trusts should not be included in the pool of divisible assets.

2. Special Power of Appointment

Whether a special power of appointment should cause the same result is less certain. For both practical and tax reasons, many settlors give trust beneficiaries special powers of appointment. If wife's father in Balanson had held a special power of appointment over the B trust, would the result have been the same?

If the test in Balanson II is that vested interests, even those subject to complete defeasance, constitute property interests, one can argue that the result would have been the same.32 If this position is correct, a trial court would be faced with the choice of completely ignoring the power of appointment in valuing the interest or determining a reduction in the value of the interest attributable to the power of appointment. Such a determination necessarily would require a trial court to weigh subjective criteria and calculate a risk factor as to whether and to what extent a power will be exercised.

D. In re Marriage of Beadle

Other state courts have considered trusts in which a spouse's equitable interest has been vested but is subject to defeasance by reason of a power of appointment. In re Marriage of Beadle33 concerned a trust similar in design to the Balanson B trust, except husband's mother held a special testamentary power of appointment exercisable in favor of descendants. The trial court held that the remainder interest, though initially vested, no longer was vested by virtue of the mother's execution of a codicil to her will that would have defeated husband's interest.34 The Montana Supreme Court affirmed, but instead reasoned that husband's remainder could not be vested until the power holder's death. In the author's opinion, this logic is flawed and a consequence of attempting to reconcile the law of future interests with equitable property divisions. A more logical rationale is that, vested or not, some interests are simply too uncertain to constitute property.

E. Massachusetts Law

In S.L. v. R.L.,35 the court considered whether five trusts would be included in the marital estate for property division purposes.36 One of the trusts was a marital trust in which wife's mother held a general power of appointment exercisable by will. The court held that the trust should not have been included in the marital estate because wife's remainder interest was "susceptible of complete divestment upon the wife's mother's exercise of the power."37 Under this logic, whether the power was general or special and whether the trust was or was not a marital trust is irrelevant.

The court reached an opposite conclusion as to wife's interests in the other trusts, one of which was almost identical in design to the Balanson B trust. The distinction drawn by the court was that wife's interest in the nonmarital trusts "[was] subject only to her surviving her [then living] mother, a condition [that Massachusetts precedent] considered not to bar inclusion within the marital estate."38

Similarly, in D.L. v. G.L.,39 the marital estate did not include husband's vested remainder interest in a trust, subject to divestment, because the interest "was susceptible of complete divestment upon the [husband's father's] exercise"40 of a testamentary special power of appointment, and as a consequence, "the equivalent of an expectancy under a will."41 Husband's grandmother created a trust that would be distributed to the husband and others upon the death of the father in default of the exercise of the power of appointment. Until final distribution, the trustee had the power to spray distributions of income and principal among a broad class of trust beneficiaries.

F. Is Balanson II a Bright Line Test?

If Balanson II is the bright line test that vested remainders, though subject to divestment, constitute property, unexpected and unusual results likely will follow.42 A different interpretation, however, is possible. Balanson II may, and in this author's opinion should be, interpreted as a more limited holding. The vested remainder interest in the B trust, which was subject only to conditions of survivorship and the invasion of trust principal for the care and maintenance of the beneficiary with the then current interest, constituted property under the facts and circumstances of that case. Under this interpretation, the type, number, and extent of the contingencies, both under the instrument and under the facts and circumstances of each case could result in a determination that the interest, even though vested, is too susceptible to complete divestment to constitute property (whether by reason of a power of appointment, trustee power, or the needs of the current beneficiaries). If this more limited interpretation is correct, the corollary is that not every vested remainder interest in a trust is property for purposes of C.R.S.A. Section 14-10-113.

This suggested facts and circumstances approach will require the trial court to consider the contingencies to which interests in trusts are subject and the facts and circumstances surrounding the trust and its beneficiaries. At some point, a court appropriately may say the contingencies render the interest too uncertain, remote, or speculative to constitute property. The court then could avoid the issues and difficulties that otherwise would ensue when quantifying those contingencies and predicting the likelihood of an exercise of powers. Balanson II then would be viewed as a marker on one end of the spectrum. Vesting would not serve as a talisman and to the extent this bright line rule now exists, it would be dimmed. More than one court has said that "the concept of vesting should probably find no significant place in the developing law of equitable distribution."43

G. In re Marriage of Jones and In re Marriage of Rosenblum

In arriving at its decision in Balanson II, the court distinguished its prior decision in In re Marriage of Jones.44 In Jones wife became a beneficiary of a trust created by the mother's will during the marriage. A bank and wife's father, as trustees, "had [the] uncontrolled discretion to distribute income and principal from the trust to [the father], the wife, or to the wife's descendants for expenses that the trustees determined to be necessary for their 'health, welfare, comfort, support, maintenance and education.'"45 The trust was to terminate upon the death of both the wife's father and wife, at which time the trust assets were to be distributed to wife's descendants and if there were no descendants, to the mother's heirs.

Husband argued that the trust was the separate property of his wife and that the increase in the value of the trust principal was marital property. The court held that wife's rights in the trusts were "merely an expectancy and [did] not rise to the level of property."46

The court provided three distinct and inconsistent rationales for its holding. First, the trust was "completely discretionary"47 and wife "could not force the trustee to pay income or principal unless she could establish fraud or abuse."48 This rationale raises the question of whether the result would differ if the trustee were required to distribute the trust property for wife's reasonable needs. Second, the court stated that the interest in the trust was "not assignable and [could not] be reached by [the beneficiary's] creditors."49 Spendthrift provisions typically are included in trust instruments, and the existence of those provisions has been irrelevant in the analysis of whether beneficial interests in trusts constitute property.50 If the result turns on whether a trust instrument contains a spendthrift clause, very few trusts would be included in the pool of divisible assets. Third, the court distinguished "a discretionary trust from those trusts that grant the beneficiary some future, vested benefit not within the discretion of the trustee to withhold, but whose value may be uncertain at the dissolution of the marriage."51 The distinction drawn by the court does not, in the author's opinion, require that vested beneficial interests necessarily constitute property.52

The Jones court cited with approval the Colorado Court of Appeals' decision in Rosenblum,53 which held that an interest in a trust was not property for purposes of a division.54 In Rosenblum husband's mother created an irrevocable trust and designated husband and his sister as the cotrustees with authority "in their absolute discretion to distribute 'all, none or any part' of the net income and principal to any of the beneficiaries [husband and his descendants], to make unequal distributions, or to withhold all income from One or more or all.'"55 The trust instrument stated that "no beneficiary shall have any right or power to enforce the payment of principal or income to himself or any other person."56 At husband's death, the trust assets were to be divided and held in trust for the benefit of his children (or descendants of a deceased child).57

Jones may be viewed narrowly as holding that discretionary trusts, with designs similar to the trusts reviewed in Jones and Rosenblum, are not property for purposes of C.R.S.A. section 14-10-113 and constitute mere expectancies. Yet Jones may be viewed expansively as holding that an interest in trust must be vested in a property law sense for a court to consider whether the interest constitutes property within the meaning of the statute. At this point in time, both interpretations are possible. However, if the concept of vesting is disregarded as to avoid automatic inclusion of an interest in the pool of divisible assets, disregarding the concept to avoid a rule of automatic exclusion of an interest seems equally valid.

Consider the following trust disposition:

The will of husband's mother created a trust that designated the husband as the sole trustee with the power to designate and remove successor trustees. The trust agreement states that the trustee shall distribute to husband such amounts of the trust income or principal as the trustee determines necessary or desirable for husband's health, maintenance, and support. At husband's death, the trust property shall be distributed in accordance with a power of appointment exercisable by husband in his will. The power is exercisable in favor of any person or persons except his estate, his creditors, or the creditors of his estate. To the extent such power is not exercised, the trust shall be distributed at husband's death to his descendants by representation. The trust agreement states that the needs, comfort, and welfare of husband are of primary concern to the trustee, and the interests of all other beneficiaries are secondary. The trustee may, pursuant to such guideline, exhaust the entire trust for the benefit of husband to the exclusion of all other beneficiaries. In addition, the trustee may, but need not, consider other resources available to husband when making distributions to him. As trustee, husband has distributed all the income of the trust and substantial amounts of the principal to himself. No other beneficiary has received any trust distributions.

Does Jones require that the trust be excluded as property for purposes of C.R.S.A. section 14-10-113?58

Whether a bundle of rights and powers in a discretionary trust, though technically not equating to a vested interest, might, in the aggregate, amount to a property interest subject to division is undetermined at this time. As discussed, some courts apparently have moved in that direction,59 but the author believes it is too early to predict that such a view represents a growing trend in the law.

H. Trust as Economic Circumstance and Trust Income as Gift

Jones also held that wife's interest, though not property, should be considered as an "economic circumstance."60 As discussed infra Part II.J., the enabling statute provides that:

"[P]roperty" and an "asset of a spouse" shall not include any interest a party may have as an heir at law of a living person or any interest under any donative third party instrument which is amendable or revocable, including but not limited to third-party wills, revocable trusts, life insurance, and retirement benefit instruments, nor shall any such interests be considered as an economic circumstance or other factor.61

Jones may be the basis of a dichotomy regarding economic circumstance. If the trust is not amendable or revocable, the trust may be considered as an economic circumstance, but if amendable or revocable, the trust cannot be considered as an economic circumstance. The statute does not define the terms "amendable or revocable" and, as discussed infra Part II.J., a beneficiary's power of appointment or a trustee's amendment power possibly could render the trust amendable or revocable. If this is the case, the statute may have overruled legislatively the portion of the Jones court's holding that required the trust to be considered an economic circumstance.

Finally, Jones can be cited for the proposition that income distributed from a discretionary trust is a "gift" within the meaning of C.R.S.A. section 14-10-113(2).62

I. In re Marriage of Guinn

In re Marriage of Guinn63 held that property for purposes of C.R.S.A. section 14-10-113 should not include a spouse's income interest in an irrevocable trust. In Guinn, husband's parents created an irrevocable generation-skipping trust.64 Husband was entitled to the net income from the trust, which was to be distributed at least annually. Discretionary distributions of trust principal to husband were permitted if such payments were reasonably necessary for husband's health, maintenance, support, and education. Upon husband's death, the principal was to remain in trust for the benefit of husband's descendants. Husband had no power of appointment with respect to the trust. Husband's parents were the trustees of the trust. Specifically, the trust instrument allowed the trustee to determine, in the trustee's reasonable discretion, what was principal and what was income of the trust. The trust instrument allowed the trustee to allocate capital gains to income. Testimony established that capital gains had been allocated to the principal, and interest and dividend income had been allocated to the income interest during the entire term of the trust.65

Wife contended that husband's income interest in the trust constituted property under C.R.S.A. section 14-10-113.66 The court of appeals decided otherwise and held that husband's income interest in the trust was not property under the statute.67 The court stated that "when the beneficiary has no interest in the corpus, and no right to control how the corpus is invested, . . . the income is a mere gratuity deriving from the beneficence of the settlors."68

J. C.R.S.A. section 14-10-113(7)(b)

In In re Marriage of Gorman,69 husband's living mother created a typical revocable trust in which she retained all the income from the trust, the right to receive distributions of principal for her benefit, and the power to revoke or amend the trust. Upon the mother's death, the trust was to be distributed to the husband and his siblings.

The trial court held that husband did not possess a property interest with respect to the trust, but only a mere expectancy.70 The court of appeals reversed and held that husband's vested remainder interest had to be treated in the same manner as the vested remainder interest considered in Balanson II.71 The court acknowledged the difficulty in valuing such an interest and suggested that the property division could be delayed until husband came into actual possession of the interest.72

In response to Gorman, the Colorado legislature revised C.R.S.A. section 14-10-113, effective July 1, 2002.73 The revised statute states, in pertinent part:

The statute does not define the terms "amendable" and "revocable," and the meaning of those terms will be fertile ground for controversy and litigation. Many trust instruments grant powers of appointment, both inter vivos and testamentary, for persons who are typically, but not necessarily, beneficiaries of the trust. The practical effect of exercising a power of appointment on the beneficial interest of a divorcing spouse is no different than if a settlor of a revocable trust amended or revoked the terms of the trust altering or eliminating the beneficial interest. Similarly, a trustee's or trust protector's power also might be considered substantial enough to render the beneficial interest amendable or revocable.75

Even if a court determined that a power of appointment or other power rendered the interest in trust too remote to constitute property, a remaining issue is whether the beneficial interest may be considered as an "economic circumstance or other factor."76 As previously discussed, Jones held that an interest in a trust that was deemed to be a mere expectancy and not property should be considered as an economic circumstance under C.R.S.A. section 14-10-113(1)(c).77 The extent to which C.R.S.A. section 14-10-113(7)(b) overrules that holding is unknown at this time.

Dale78 held that wife's remainder interest in an irrevocable trust created by her grandfather constituted property within the meaning of C.R.S.A. section 14-10-113. The court determined that wife's interest was indistinguishable from the remainder interest in Balanson.79

Wife contended that she held the remainder interest by virtue of being an "heir at law"80 of her living father. Because C.R.S.A. section 14-10-113(7)(b) excludes "any interest a party may have as an heir at law of a living person,"81 the remainder interest, according to wife, was not property. The court noted that the definition of an "heir" is "a person who, under the laws of intestacy, is entitled to receive an intestate decedent's property."82 The court reasoned that wife held her remainder interest in the trust not as an heir at law under the laws of intestacy, but as a vested beneficiary of an irrevocable trust.83

Although the court stated that it need not consider any other interpretive aids, the opinion then added:

The legislative history shows that § 14-10-113(7)(b) was adopted to overturn the holding in In re Marriage of Gorman, supra, that a vested remainder interest in a revocable or modifiable trust is a property interest subject to division. Speakers on behalf of the bill specifically referenced the Gorman decision and explained that subsection (7)(b) was drafted as a noncompromise measure to accomplish a complete reversal of that holding. The speakers also clearly advised that the statutory change did not address the holding in In re Marriage of Balanson, supra, and was not intended to change the classification of remainder interests in irrevocable trusts as property subject to division. . . . Hearings on S.B. 02-160 before the Senate Judiciary Committee and the House Judiciary Committee, 63rd General Assembly, Second Regular Session (Jan. 9, 2002).84

Perhaps C.R.S.A. section 14-10-113(7)(b) could have been more explicit, but in this author's opinion, criticism of the statutory revision is undeserved. The amendment overruled the Gorman decision that was, in the author's opinion, clearly wrong. The amendment succeeded in its primary objective, and any uncertainty created by the statute is minor relative to the problem that it cured.

III. THE PENSION ANALOGY

To view the development of the law regarding pensions and interests in trusts as parallel and analogous is tempting and, indeed, the analogy may be appropriate in some respects. For example, interests in pensions and trusts may be vested or unvested, and the enjoyment of the benefits may be defeated by the death of the participant or beneficiary.85 However, pensions and interests in trusts can be incongruous in other respects. Some interests in trusts, though vested, may be decreased or eliminated by powers of appointment, distributions to other beneficiaries, and payment of death taxes due upon the death of a current beneficiary of the trust. Other interests, though not vested, may give the beneficiary such a degree of control and enjoyment of the trust property that, when considered as a whole, the bundle of powers and rights is the practical equivalent of ownership of the trust property.

As discussed infra Part IV.B, the dissenting opinion in Jones suggested that interests in trusts may be valued similarly to prospective pension payments. Courts in other states have made the same analogy.86

A. Net Present Value Method

Colorado recognizes three methods of distribution to divide a pension upon dissolution-the "net present value" method, the "deferred distribution" method, and the "reserve jurisdiction" method.87 The net present value method, also referred to as the "immediate offset" method, results in immediate distribution to the non-employee spouse. The Hunt court noted: "If using this method, the trial court, guided by actuarial data, values the future benefit, considers a number of different factors, including certain risks . . ., and accords a present value to the future benefit."88 The lump sum that represents the present value is offset by the value of other marital property.

Applying the net present value method to trusts presents special issues. A frequent uncertainty in the valuation of an interest in a trust arises as a consequence of a right of a current beneficiary (other than the beneficiary spouse) to receive discretionary distributions from the trust. Many trusts are drafted with, and the tax law encourages, the creation of discretionary interests in trusts for the benefit of an older generation because it allows flexible access to trust property without subjecting the trust property to estate tax at the older generation. A preceding invasionary right can produce a range of outcomes, depending on the circumstances. At one end of the spectrum, the invasionary right might be ignored, but at the other end, the invasionary right might render a divorcing spouse's interest in the trust too uncertain and speculative to be quantified.

Present value calculations involving pensions have been the source of significant litigation, which have required expert testimony, and the resulting calculations can vary significantly.89 The potential for experts to disagree will be even greater in valuing interests in trusts. The terms of trust instruments will vary more significantly than those of retirement plans. Trusts will involve more subjective valuation factors and perhaps multiple measuring lives. In addition, actuaries and accountants may be ill-equipped to decipher trust instruments and their estate, gift, and generation-skipping transfer tax consequences. Finally, as with pension assets, the offsetting assets may not be sufficient to equal the share awarded to the non-beneficiary spouse.

B. Deferred Distribution and Reserve Jurisdiction Methods

Under the deferred distribution and reserve jurisdiction methods, the latter of which also is referred to as the "wait and see" method, the nonemployee spouse does not receive any benefits until they actually are paid to the employee spouse or the employee spouse becomes eligible to receive benefits. The deferred distribution method requires the court to predetermine the non-employee spouse's percentage of the pension stream that the non-employee spouse will be eligible to receive, once the pension is both vested and matured. In Hunt the court observed: "If the court reserves jurisdiction, the non-employee spouse's percentage share is calculated later at the time when the pension has vested and matured."90

To date, the Colorado appellate courts have not reviewed the application of the deferred distribution or reserve jurisdiction methods in the context of a trust, but courts of other jurisdictions have.91

IV. VALUATION OF INTERESTS IN TRUSTS

Once a court has determined that an interest in trust constitutes property for purposes of property division, another more complex analysis may be involved in determining the value of the interest. Trusts are designed to accomplish a variety of purposes, and the design of dispositive trust provisions are almost unlimited. Courts will be required to analyze not only the interests of the trust beneficiaries, but also the powers, duties, discretions, and guidelines of the trustee. The task will be challenging for a court in its review of a well-drawn trust instrument. Unfortunately, not all trust instruments are well-drawn, and a court may be required first to construe the meaning of an ambiguous document before assigning a value. In addition, valuation of interests in trusts may require a trial court to consider matters extrinsic to the trust instrument and the marriage that typically are not considered in a proceeding for a dissolution of marriage or legal separation.

A. Colorado Law

To date, the Colorado decisions have provided only general guidance as to methods of valuing interests in trusts. As discussed below, the appellate decisions do, however, vest broad discretion in the trial court to determine appropriate valuation methods.

B. Jones and Balanson

As previously discussed, Jones92 held that a beneficiary's interest in the principal of the trust did not constitute the separate property of a spouse for purposes of division under C.R.S.A. section 14-10-113. In the dissenting opinion in Jones, one justice stated that he would have treated the increase in the value of the trust assets during the marriage as marital property.93 Acknowledging that apportioning the increase in the value of a trust may be difficult, the dissenting opinion stated that trial courts are faced with valuation difficulties every day. The dissent stated:

As in the case of valuing prospective pension payments, a court can employ any of several alternatives. One alternative might [be] to place a value on [the beneficiary's] interest in the increased value of the trust corpus by utilizing a table similar to that for valuing a remainder interest for purposes of estate taxes. Another alternative might consist of ordering a percentage of future funds received by the beneficiary to be paid over to the other spouse. Other alternative methods can be employed, based upon a trial court's "experience, insight and knowledge."94

Balanson II provided trial courts with similar but less specific guidance in valuing interests:

Other courts that have addressed the valuation of similar interests have suggested an approach similar to that taken when valuing pensions. Under this approach, we conclude that the trial court may consider a variety of circumstances when determining the present value of the trust, including actuarial information concerning the life expectancy of [the beneficiary holding the current possessory interest in the trust] and information concerning the probability and extent to which [the beneficiary holding the current possessory interest] will need to invade principal for [the beneficiary's] maintenance.95

In the author's opinion, Balanson II and the dissent in Jones provide trial courts with the following guidance in valuation:

1. A trial court may value beneficial interests in trusts in the same actuarial manner utilized for federal transfer tax purposes.96

2. A trial court may order that a percentage of trust distributions received by the beneficiary's spouse subsequent to a legal separation or dissolution of the marriage be paid to the nonbeneficiary spouse.97

3. A trial court may utilize other unspecified valuation methods based upon the court's "experience, insight and knowledge."98

4. A trial court may consider a variety of circumstances, including actuarial information, concerning the life expectancy of other beneficiaries of the trust, and the extent to which other beneficiaries of the trust eligible for distributions may require principal distributions.99 Impliedly, an invasion power exercisable in favor of a non-spouse beneficiary may be quantified in the calculation of the beneficiary spouse's interest.

C. In re Marriage of Mohrlang

In re Marriage of Mohrlang100 concerned husband's interest in an irrevocable trust that was "not modifiable."101 The trust principal consisted of stock in a closely-held corporation, which had appreciated since the date of the marriage.102 Income of the trust was required to be distributed to husband at least quarterly, and principal distributions to husband could be made to him for his health, maintenance, support, and education, within the discretion of the trustee. Husband's interest would terminate if he predeceased his parents, in which case his share would be divided among his children and the descendants of any of his deceased children. Apparently, the trust principal would be distributed to husband upon his parents' deaths. No other person held an interest in the trust that preceded or existed concurrently with husband's interest in the trust.103

The trial court did not discount to present value husband's interest in the trust. At issue on appeal was whether the trial court erred in failing to discount the interest to its present value.104 The court of appeals held that the trial court "should have considered actuarial information concerning the life expectancy of husband's parents and . . . the likelihood that the trustee would invade the trust corpus in the future."105 The trial court was reversed and the case was remanded to "reconsider whether the value of husband's trust interest . . . should be discounted by an appropriate rate because of the delay in husband's receiving his interest, the possibility of forfeiture, and other contingencies."106

Mohrlang raises the following questions:

1. How is an appropriate discount rate determined?107

2. What tables are used in determining life expectancy of a measuring life?

3. Should the analysis be limited to actuarial tables or should other factors such as the actual health of a measuring life (e.g., the parents of husband) be considered?

4. Does the possibility of husband's death prior to his parents' death reduce the value of the interest in the trust?108

5. Assuming the trust instrument allows for discretionary distributions, how might a history of discretionary distributions of principal affect valuation?

6. What are the "other contingencies" mentioned in Mohrlang for a trial court to consider?109

As many questions as Mohrlang raises, it may provide one bright line rule. Regardless of whether the beneficiary is entitled to mandatory income distributions and discretionary distributions of principal, the trial court at least must consider if the interest in the trust should be discounted to its present value for the period of time until the interest becomes possessory.

D. In re Marriage of Dale

In Dale the Colorado Court of Appeals affirmed the trial court's valuation of a remainder interest that was, according to the court, similar to the remainder interest of the B trust in Balanson II.110 The trial court valued the marital appreciation in wife's interest at $313,962 and awarded husband $120,867.50 of that amount. One-half of the amount was to be paid within sixty days after the death of wife's father (the current beneficiary), and the other half was to be paid after the death of wife's mother.111 The trial court discounted the interest to present value by applying a six percent discount rate.112 The court based the term of the present value calculation on the mortality table in C.R.S.A. section 13-25-103.113

Wife argued that the valuation was defective because the valuation was not based on expert testimony, no rationale for the discount rate was provided, and the discount rate did not account sufficiently for the mother's usufructuary interest, trustee fees, tax liabilities, market changes in the value of trust principal, or capital gains tax due on trust distribution. The court rejected those arguments and held that the trial court's calculations were reasonable based on the limited information from which the trial court could determine value.114

E. Extrinsic Matters

Depending upon the terms of the trust instrument, potential matters subject to discovery include the trust assets, prior trust distributions, accountings and tax returns of the trust, and the age, health, and financial resources (including other trusts) of beneficiaries of the trust who possess beneficial interests that precede or exist concurrently with the beneficial interest of the divorcing or separating spouse. A more subjective analysis may be involved when the holder of a power of appointment, trustee power, or trust protector power could exercise such power to the detriment of a divorcing or separating spouse, assuming that such a power does not render the interest too remote to constitute property.

F. Other Jurisdictions

Other states have addressed valuation of interests in trusts, and the methods of valuation have been diverse and, in some instances, not well reasoned. The following discussion is a sample of methods employed by various jurisdictions.

In McCain v. McCain,115 husband possessed remainder interests in two tracts of farmland subject to life estates of one aunt for one tract and another aunt for the second tract. The court valued husband's remainder interest as it would have been valued for federal estate tax purposes, which is a present value calculation.116

In In re Marriage of Von Ofenheim,117 the court of appeals accepted the trial court's calculation of the present value of husband's interests in three trusts and wife's award of the marital assets was determined to be a sum secured by husband's interest in the trusts.118 The award was to be paid on the date one of the trusts was to terminate, with interest to accrue until payment.119

The Montana Supreme Court in Buxbaum v. Buxbaum120 reviewed the valuation of a trust beneficiary's vested remainder interest subject to defeasance by a power of invasion for the benefit of the beneficiary's living mother. After first concluding that the remainder interest should be included in the marital estate, the court affirmed the trial court's valuation of the remainder using the undiscounted appraised value of the trust assets. Rejecting the beneficiary spouse's contention that the discounted present value of the interest be used, the court reasoned that the current value of the remainder interest was used as collateral by a corporation of which the trust was a thirty-five percent shareholder.121

In Fox v. Fox,122 the Supreme Court of North Dakota considered the value of wife's interest in an irrevocable life insurance trust that held life insurance policies insuring husband's life. The policies had a cash value of $290,000, and wife was the trustee of the trust. Wife was entitled to all the trust income from its inception and after husband's death. Wife, during any calendar year, also could withdraw the greater of $5,000 or five percent of the trust principal. In determining the value of wife's interest in the trust, the trial court agreed with the approach propounded by wife's expert, who provided several different scenarios.123

The expert calculated the value of wife's interest in the following manner:

1. The cash values of the life insurance policies were determined.

2. A payment stream of the income until husband's projected date of death was calculated using an assumed interest rate.124

3. The trust income for wife's remaining life expectancy after the husband's projected date of death was calculated in addition to the greater of $5,000 or five percent of the trust principal per year.

4. The sum of the income and withdrawn principal was discounted to its present value.125

The North Dakota Supreme Court upheld the trial court's determination as being within the range of its discretion.126

In Fox the income beneficiary's interest was valued for purposes of a property division.127 It appears, however, that the analysis would have been applicable for the valuation of the remainder interest in the irrevocable life insurance trust. If the court sought a valuation of the remainder interest, the interest would have been the current value of the trust assets reduced by the present value of the income beneficiary's interest.

As mentioned, the trust reviewed in Fox was an irrevocable life insurance trust.128 Irrevocable life insurance trusts are common estate planning devices that are used to make life insurance policy proceeds available to an insured's family without subjecting the proceeds to estate tax at the deaths of the insured or the insured's spouse. With the frequent use of irrevocable life insurance trusts, courts likely will encounter them in identifying and valuing interests in trusts.

In Trowbridge v. Trowbridge,129 husband was entitled to a future distribution of a remainder interest that was subject to husband's mother's income interest, her right to withdraw $5,000 of trust principal in any year, and her right to receive additional amounts of principal as the bank trustee "deem[ed] necessary or advisable for certain purposes."130 The Wisconsin Supreme Court approved the trial court's decision to award wife thirty percent of whatever accrued to husband.131 The court further stated that the trial court

could properly order [husband] to transfer to [wife] or her heirs, legatees, or assigns, 30 per cent of any funds received by [husband] from the trust and could contain other provisions to make that one effective, such as retaining jurisdiction for the purpose of enforcement, enjoining [husband] from attempting to transfer or surrender his interest, or otherwise act to prejudice [wife's] rights, and imposing a lien upon the assets now assigned to [husband] as security for the transfer of 30 per cent of the trust proceeds.132

In Zuger v. Zuger,133 husband's deceased father created a testamentary trust that was valued at $936,000 at the time of trial. The surviving spouse, husband's mother, possessed a mandatory income interest during her life and a right to withdraw the greater of $5,000 or five percent of the trust principal each calendar year on a noncumulative basis. At the mother's death, the principal was to be distributed equally between husband and his three siblings. Because the principal could be invaded, the trial court concluded that an award to wife of a specific dollar amount would be speculative, and instead ordered that wife receive one-half of husband's share when it became available to him. The North Dakota Supreme Court upheld the percentage and the method of distribution.134

Notably, husband's interest in the trust in Zuger could have been quantified easily by making a present value calculation.135 Although the approach in Zuger eased the burden of the trial court by eliminating complex analysis, this author believes that courts should rely on such an approach only as a last resort. Otherwise the risk that the divorced spouses, trustees, and other trust beneficiaries will become entangled in controversies regarding the administration of trusts and the exercise of powers and discretions is significant. A court may be tempted to use a method that avoids the current valuation of an interest in a trust, such as when the parties provide little evidence to establish a value; but the failure to quantify an award raises the risk of continuing financial and emotional entanglement of ex-spouses and their families.

V. ESTATE AND GIFT TAX VALUATION OF TEMPORAL INTERESTS

Determining the value of a future interest in a trust on the basis of relevant facts and circumstances may require consideration of matters such as the health of beneficiaries, the specific assets held in trust, the past performance of trust investments, the projections for future performance, the prior trust distributions, the identity of the trustees, and a number of other subjective factors. To avoid a facts and circumstances analysis, Congress mandated the use of actuarial valuation tables for certain tax purposes.136

Valuation under Code section 7520 is a present value calculation that applies mortality and interest rate factors mandated by the Code.137 In other present value calculations, the selection of discount rates may vary depending upon market conditions and the specific assets being valued. Similarly, other mortality tables exist that produce values different from that required by Code section 7520.

For interests in trusts to which Code section 7520 would apply, a trial court likely could use those principles within the exercise of its discretion and eliminate considerable uncertainty in valuing future interests in trusts in a property division.138

In valuing a remainder interest under Code section 7520 for gift tax purposes, the calculation does not take into account the risk that a remainder beneficiary's death may occur prior to trust distribution. In the context of a property division, reducing the value of a beneficiary's interest by a factor attributable to the risk that the beneficiary might not survive until the projected date of distribution (e.g., the death of the current trust beneficiary) may be appropriate. The same mortality tables could be used to determine a reduction in the value of a remainder interest attributable to the possible death of the remainder beneficiary prior to the distribution of the remainder interest.

Some interests in trusts cannot be valued actuarially for tax purposes because of a contingency, power, or other restriction,139 and if the tables are not applicable, the value for tax purposes is based on all the facts and circumstances.140 Diversions of income and corpus also may prevent the application of the Code section 7520 tables for tax valuations,141 as will a terminal illness for a measuring life.142 If valuation under the tables is not allowed for tax purposes in these situations, logic dictates that valuation by exclusive reliance on the tables for the purposes of a property division is also inappropriate.

Some interests in trusts, though subject to contingencies and diversions, will be certain enough to constitute property for purposes of property division. This category of interests will present the greatest challenge to a trial court. A number of factors may be relevant in valuing these interests, including a review of prior diversions of trust property and the resources of current trust beneficiaries. In those instances, qualitative analysis and creative solutions by trial courts will be required. Complex discovery and the participation of trustees and family members in the proceedings also will be required.

Even in those situations in which contingencies and diversions require a facts and circumstances analysis, tax valuation principles still may be useful to a trial court. For example, if a court determined that a power of invasion in a trust for the support of a divorcing spouse's parent might reduce the value of the trust corpus by as much as one-half, would a Code section 7520 valuation of the spouse's remainder interest utilizing one-half of the value of the trust corpus be beyond the bounds of a trial court's exercise of reasonable discretion? Tax law also may be useful, at least by way of analogy, in instances in which a trial court exercises discretion in quantifying contingencies and diversions.

A power of invasion or a contingency over trust principal does not, under tax law, necessarily render actuarial valuation inapplicable. If the possibility of the diversion of principal is negligible or remote, the diversionary right may be ignored. For example, if a gift to charity is dependent upon a condition or power, no estate tax charitable deduction is allowed unless the possibility that the charitable interest would not become effective is so remote as to be negligible.143 In Estate of Jack v. Commissioner,144 a widow's right to discretionary distributions of trust principal for comfort and support had no value because the widow's property and the income from the trust substantially exceeded her needs, the widow was of advanced age, no distributions of principal were made to the widow, and distributions were allowed only to maintain the widow's standard of living and only if the income of the trust was insufficient. Accordingly, the remainder's passing to charity qualified for the estate tax charitable deduction.145 In Estate of De Foucaucourt v. Commissioner,146 the ability of an elderly and disabled individual to have or adopt children also was considered so remote as to be negligible and did not disqualify the deduction for the remainder interest's passing to charity.147 In the context of dividing interests in trust in a property division, this principle would be equally applicable, and the remainder interest of a spouse should be undiminished by the diversionary rights of current trust beneficiaries in some circumstances.

In Estate of Gokey v. Commissioner,148 the Tax Court valued two remainder interests passing to the decedent's children on the basis of the actuarial tables for estate tax purposes.149 The remainder interests were subject to the corporate trustee's power to invade income or principal for the benefit of the settlor's spouse if the trustee determined such use necessary for the spouse's care, comfort, support, or welfare.150 The trust instrument did not require the trustee to consider any of the spouse's other assets. The taxpayer argued that the remainder interests had no value because no one would buy a remainder interest subject to a spendthrift provision and power of invasion.151 The Seventh Circuit reversed the Tax Court,152 holding that the tables did not apply and that the value must be determined under the willing buyer and willing seller test because of the power of invasion.153 The Seventh Circuit also determined that the value of the remainder interest was not reduced by the spendthrift provision because the inability to sell the remainder interests was offset by the inability of creditors to reach the assets.154 On remand, the Tax Court considered the needs of the spouse for the rest of her life by reviewing her recent expenditures and the value of her other assets.155 Noting the "inherent uncertainty in any valuation case,"156 the Tax Court then valued the remainder interests at approximately twenty-four percent of the value of the interests under the tables. The opinion did not disclose how the Tax Court arrived at the values.

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

VII. CONCLUSION

Considering the vast amount of wealth held in trusts, the stakes will be high when interests in trusts fall within the pool of divisible assets in a dissolution of marriage. The issues will be technical and the process is likely to spark antagonism and conflict. If any prediction is possible regarding the evolution of the law in this area, the prediction is that change is extremely likely and uniformity among the jurisdictions is unlikely. Needless to say, dividing interests in trusts in a dissolution of marriage will be challenging.

Marc A. Chorney*

* Chorney and Associates, LLC, Englewood, Colorado. The author is a fellow of the American College of Trust and Estate Counsel and is listed in The Best Lawyers in America. He is an associate acquisitions editor of the American Bar Association's Real Property, Probate & Trust Journal and an instructor for the University of Denver Graduate Tax Program. He has served as an adjunct professor for the University of Denver School of Law and the University of Denver Graduate Tax Program. He received a B.S. (accounting) from the University of Colorado, a J.D., with honors, from Gonzaga University, and an LL.M in Taxation from the University of Denver.