Page 59 - Family Law Services

Trusts

In most circumstances, trusts are not appropriate for the payment of alimony. The cost of creating and
administering the trust far outweighs the benefits that accrue. Most times, trusts are used to provide eco-
nomic protection to the grantor, beneficiary, or both. They may also be used as a planning device to
transfer property from the estate of the grantor.

Alimony trusts are described in IRC Section 682. An alimony trust is a grantor trust, but for the provi-
sions of IRC Section 682. Assets generating sufficient income to fund the support are transferred into
the trust, and the income is taxable to the person who receives the income from the trust. Even though
the trust assets may revert to the grantor at some point in the future, its income is taxed to its beneficiary
as it is distributed. If the income is not distributed, it is taxed to the grantor. The advantage is that the
distributions are not subject to recapture and can continue after the recipient’s death.

Trusts under IRC Section 682 can be used to pay both child support and spousal support. To the extent
that the trust instrument designates a portion of the distributions to be child support, the grantor is taxed,
and the beneficiary is not. The distributions that are not designated as child support can decrease on the
occurrence of a landmark event associated with a child and still be treated as income to the beneficiary.

Spousal Support in Property Divisions

It is common to structure some property divisions within spousal support payments in order to have the
property transferred from one party to the other. This is particularly true in circumstances in which the
property is an asset that recognizes income as it is received, such as with stock options, nonqualified re-
tirement plans, and qualified retirement plans. In these circumstances, it is common to effectuate the
transfer of the value of the property from its owner to his or her ex-spouse as deductible spousal support,
while the owner retains ownership of the property. When this technique is used, the CPA should consid-
er potential recapture issues. Recapture will be addressed in more detail in chapter 8.

In order to qualify as spousal support for income tax purposes, the support must terminate on the recipi-
ent’s death. If, instead of support, an individual is awarded property, the individual is able to bequeath
the property upon his or her death. Support payments made after the recipient’s death are not tax-
deductible, a stipulation enacted by Congress to limit the transfer of property as payment for support.

Under normal circumstances, this situation could be remedied with life insurance. It would make sense
for the payor, who is receiving the income tax benefit, to provide life insurance on the life of the payee,
allowing the payee to name his or her own beneficiaries, to replace the potential property lost on death.
A problem occurs, however, if the payor owns the life insurance on the payee’s life used to secure the
payment of alimony with the payee’s estate as the beneficiary. In that circumstance, the spousal support
payments’ deductibility will be disallowed. The temporary regulations promulgated under IRC Section
71, Temporary Treasury Regulation Section 1.71-1T detail which payments occurring after the death of
the payee will be treated as disqualifying the tax benefits associated with the payment of support. To
avoid the problem, the same results can be achieved by the payor, increasing the amount of the spousal
support payments by the insurance premium, grossed up for the tax consequences to the payee, with the
payee owning and paying for his or her own premiums. With this structure, there are no required support
payments after the death of the payee. The support becomes deductible.

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