New Tax Provisions Significantly Impact Treatment of Trusts in Divorce

The Tax Cuts and Jobs Act (TCJA) has impacted many areas of law other than how much we owe in income taxes. Estate planning and divorce have also been impacted by some of the provisions of the TCJA. One of the most significant impacts of the TCJA on divorce is that alimony payments are no longer deductible for the payor or taxed as income for the payee. However, an overlooked provision of the TCJA that also impacts divorce settlements is the treatment of grantor trusts under the new tax laws. These types of issues should be addressed by an experienced wills and trusts lawyer.

Trusts and Divorces Post-Tax Changes

A very important section of the Internal Revenue Code was repealed as part of the TCJA.

When a person establishes a trust, that person pays taxes on the income from the trust as the grantor of the trust even though the person may not be a beneficiary of the trust. Section 682 of the IRC stated that income from a grantor trust paid to an ex-spouse would be taxed as income to the ex-spouse instead of taxable income for the grantor. This section of the IRC had an important role in divorce settlements involving grantor trusts.

However, the TCJA repealed this section of the IRC. Therefore, a spouse who established a grantor trust with the other spouse as the beneficiary continues to be responsible for paying taxes on income from the trust even though that income is now paid to an ex-spouse. Estate planning attorneys and divorce lawyers need to consider the estate and tax implications of this significant change in tax laws.

Some of the grantor trusts that are impacted by the new change in tax laws include:

Lifetime Qtip Trust — A Qtip Trust pays income from the trust to the spouse during the spouse’s lifetime. Many couples use the Lifetime Qtip Trust to take advantage of a spouse’s estate tax exemption. However, in a divorce, the grantor spouse is taxed on the income paid to the ex-spouse if the trust was originally established as a grantor trust.
Spousal Limited Access Trust — In most cases, a Spousal Limited Access Trust is also set up as a grantor trust, even though the trust assets are held for the benefit of a spouse and children. Even though the grantor receives nothing from the trust, the grantor is taxed on the income paid to the ex-spouse under the new tax laws.
Qualified Personal Residence Trust (QPRT) — A QPRT holds title to a grantor’s primary residence or vacation home. Most couples use a QPRT to lower the value of their estate for estate tax purposes. If an ex-spouse is a beneficiary of the trust, the grantor spouse will pay the taxes on trust income even though the ex-spouse is enjoying the benefits of the trust.

Consult a Texas Wills and Trusts Attorney Before Finalizing a Divorce

In addition to retaining an experienced divorce attorney, it is wise to consult with a Texas wills and trusts attorney before finalizing a divorce settlement. There are several options for restructuring an estate plan in conjunction with a divorce settlement. Contact the Law Office of Carey Thompson today. Working with a divorce attorney and an estate attorney during divorce negotiations can help minimize tax consequences and ensure a fair settlement is reached between the parties.