A large number of people embarking on the ship of matrimony are experienced sailors. In 40% of marriages, one of the partners had previously been married. [Source: Indiana Marriage Report, 1995; Connecticut Vital Statistics, 1993].
Second marriages present unique estate planning challenges. If both spouses have minor children, will there be "common" or separate guardians? How can one provide for a less well off spouse and protect his children’s inheritance? Have prior marriages been terminated for tax purposes? Will children from a former marriage assert rights in their parents’ estates? What rights can and should be waived in a prenuptial agreement?
I. PLANNING DURING THE FIRST MARRIAGE.
A. Have your Cake and Eat it, too.
Until 1981, in order to obtain the gift tax marital deduction, the donee spouse had to, in some way, have the ability to direct the disposition of the assets at her death. In 1981, Congress recognized the reality that, especially in second marriages, many people want to control the destiny of their assets, even if they cannot control their own. The result was the so-called "QTIP" Trust. For an excellent discussion of QTIPs at their "tenth anniversary," see Cornfeld, "A Tin Cup for QTIPs..." U. of Miami 26th Annual Inst. on Est. Plnng. Ch. 14 (1992).
Consider using lifetime QTIPs to absorb the spouse's "exemption" while retaining control of the disposition. Most clients love the idea of using "bypass" trusts to take advantage of both spouses’ "exemptions." Not all of them are thrilled at the prospect of transferring $2,000,000 of assets to their spouse, possibly enriching a successive (and successful) suitor. The "richer" spouse could transfer the assets to a trust for the "poorer" spouse and make the QTIP election on the gift tax return. The election must be made on or before April 15 of the following year. § 2523(f)(4)(A). Once made, the election is irrevocable. § 2523(f)(4)(B).
Other than giving the beneficiary a lifetime income interest, the trust need provide no further benefit. Children by the present (or former) marriage could be the beneficiaries if the donee spouse survives the donor spouse. The donor, in a very real sense, could retain the benefit of the assets if he is the survivor. He could have a secondary life income interest, the right to invade principal under ascertainable standards and a special power of appointment. See § 2523(f)(1) and PLR 9437032. Please note that, although the Trustee in the PLR was not the donor, there appears to be no reason why the donor could not be the Trustee. In the context of disclaimers, a spouse can disclaim assets, retain a "five and five power," as well as the ability to distribute principal to herself under an ascertainable standard and not have the assets included in her taxable estate. The same logic should apply to lifetime QTIPs. Upon the death of the donee-spouse, the assets would probably receive a stepped-up basis because they were included in the donee’s estate under § 2044. However, if the donee-spouse dies within one year of the gift and the assets returned to the donor, there may be a carryover of basis under § 1013.
Lifetime QTIPs may present a further estate planning opportunity. If, at the donee’s death, the trust is greater than the donee’s "exemption," and the donor has an income interest in the trust, then any excess could be treated as QTIP property in the donee’s estate. A lifetime QTIP could also allow the "less rich" spouse to use her entiregeneration skipping exemption by having the donor spouse make a "reverse QTIP" election on the amount between the applicable exclusion amount and the generation skipping exemption.
B. Have your Kate and Edith, too.
Consider, in drafting irrevocable life insurance trusts and all other irrevocable trust arrangements, including QPRTs, whether the beneficiary is to be the client's current spouse or a "generic spouse" -- anyone to whom the client was married at his death.
C. Protect Closely Held business Interests.
Chances are that, if your client were to be divorced, he would not be ecstatic about his "former spouse to be" playing a role in the family business.
Although "buy-sell" agreements commonly restrict the owners’ rights to dispose of their stock during lifetime and at death, most of those agreements are silent on transfers incident to divorce. The majority rule is that restrictions on the transfer of corporate stock do not encompass "involuntary" tranfers. See Zaritsky, "Forgotten Provisions In Buy-Sell Agreements," U. of Miami 19th Inst. On Est. Plnng., Ch. 6 (1985).
"...the transfer of stock ordered by the court in a marriage dissolution proceeding is an involuntary transfer not prohibited under a corporation’s general restriction against transfers unless the restriction expressly prohibits involuntary transfers. Ordinarily, for drafting purposes, we think use of the phrase 'involutary transfers' would be deemed to encompass divorce court transfers." Castonguay v. Castonguay, 306 N.W.2d. 143 (Minn. 1981).
Partnership and LLC interests might conceivably be treated differently. The Uniform Partnership Act provides that an involuntary transferee is an assignee, and not a partner. Nevertheless, it would make sense to insert clearly worded restrictions in both partnership and corporate buy-sell agreements to the effect that any attempt by a spouse or creditor to reach the assets will be treated as an offer to buy by an outsider. Consider language such as the following:
"Section ?. Security Transfers.
All involuntary encumbrances, pledges, attachments, levies, executions and other legal or equitable means to take or reach a Shareholder's Stock Interest, including transfers incident to divorce, are called 'Security Transfers.' The Shareholder against whom a security transfer is made, filed or recorded, is called the 'Deemed Offeror.' The making, filing or recording of any Security Transfer shall have the same effect as if the Deemed Offeror had notified the other Shareholder of his intent to transfer stock under Subsection 1 of Section A of this ARTICLE FOUR. All of the provisions of that Subsection 1 shall apply, except that the purchase right shall remain in effect for one hundred eighty days, rather than for thirty days.”
Treating an attempted involuntary transfer as an offer to purchase could lead to inequities if the affected owner’s interest is bought out by his partners. The Castonguay case seems to suggest that an outright prohibition on involuntary transfers would be respected.
II. PLANNING IN THE INTER-SPOUSAL PERIOD.
A. Contemplation of Marriage Provisions.
If your state statutes void wills upon the testator's remarriage, consider providing that the will (and revocable trust) is not revoked if the testator marries in haste, giving no thought to his will. Language such as the following may be included:
"Section ?. Marriage to Have No Effect on Will.
If I marry after executing this Will, I direct that my marriage have no effect upon this Will. I intend that all of the beneficial provisions of this Will and the provisions appointing my Executor remain in full force and effect, notwithstanding the fact that I marry after I execute this Will.”
B. Make Sure that Ex-Spouse not Beneficiary of Non-Testamentary Dispositions.
Statutes eliminating provisions for spouses upon divorce generally only apply to wills. Life insurance policies, retirement plans, jointly owned assets, revocable trusts and other "will substitutes" may be unaffected. Have your client provide a complete list of assets and check to see that the former spouse is not still a taker (no pun intended).
C. Safeguarding What’s Yours.
1. Revocable Living Trusts. Consider creating and funding a revocable trust in a jurisdiction in which the trust would not be subject to spousal elective share rights. See, e.g., Cherniack v. Home National Bank, 158 Conn. 367, 198 A.2d. 58 (1964).
In Soltis v. First of America Bank-Muskegon, 203 Mich. App., 435, 513 N.W.2d 148 (1994) the court found that the trust was not testamentary or illusory and held that:
"Absent any showing of fraud upon [the surviving spouse's] marital rights, we must conclude that decedent's assets in the inter vivos trust do not fall within the spousal election provision."
It would appear prudent to show some nexus with the chosen jurisdiction. At the very least there should be a local co-trustee.
On the other hand, if a trust is created "in contemplation of death" and with a view toward defeating spousal elective rights, the existence of the trust may be ignored. For example, in Weitzman v. Fort Wayne National Bank, 724 N.E.2d 1120 (Ind.App., 2000) , the Court, citing Dunnewind v. Cook, 697 N.E.2d 485, 488 (Ind. Ct. App., 1998), trans. denied, 706 N.E.2d 180 (Ind. 1998), held that:
"[w]hen a testator executes a trust in contemplation of his impending death and does so in order to defeat the surviving spouse's statutory share, the trust will be considered testamentary in nature and will not defeat the spouse's share."
See also Seifert v. Southern Nat’l. Bank, 305 S.C. 353, 409 So.2d 337 (1991).
2. QPRTs. If a personal residence is a significant asset, creating a Qualified Personal Residence Trust would probably remove it from the reach of an after acquired spouse. But query, if the spouse is considered a "creditor", might she be able to make a claim on the value of retained occupancy right? See, e.g., Greenwich Trust Co. v. Tyson, 129 Conn. 211, 27 A.2d. 166 (1942).
3. FLPs. Transferring securities, real property, business interests and other assets to an FLP or LLC, and making gifts of some of the limited interests to trusts for children might be helpful in mitigating or eliminating claims of an after-acquired spouse, especially where remarriage to a specific individual is not contemplated. Gifts will only be rescinded as being fraudulent if the donor has present, or reasonably contemplated, creditors. As long as no claims loom on the horizon, the gift should be respected. Presumably, the same logic should apply to spousal rights. If the donor is single, and not contemplating marriage, then attacks by a subsequent spouse might be blunted.
Family limited partnerships have been the focus of many estate planning articles, mostly discussing valuation discounts. A donor who is not inclined to make outright gifts in contemplation of the possibility of marriage might be willing to make gifts if he could retain control as a general partner or manager of an LLC. Protection from claims of a possible future spouse is certainly a non-tax "business purpose" which would help negate a claim by the Service that the transaction was entered into primarily for tax reasons.
III. DURING THE ENGAGEMENT
A. Review all Divorce Decrees.
Carefully study all of your client's and, if possible, his or her intended mate's, prior divorce decrees.
1. Disposition May Violate Provisions of Decree. Bequests and devises which deviate from the terms of a divorce decree may be void or may give rise to a will contest. The writer was involved as an expert witness in the well publicized "Johnson v. Johnson" litigation. Mr. Johnson's divorce decree provided that he leave a percentage of his estate to his children by a prior marriage. He and his ex-wife made an "extra judicial modification" to the decree.
His will left his entire estate to his third wife, Barbara. The children eventually received over $100 Million and Barbara brought a malpractice action against the draftsmen alleging, in part, that they knew or should have known that, under local law, a modification of a divorce decree which was not entered as a judgment was invalid.
2. Marital Deduction May Be in Jeopardy. Whenever a client has been divorced, or is married to someone who has, we need to obtain all of the facts surrounding the divorce(s) if any decree was entered in a state or country other than that of the residence of the client and his or her spouse. Did the court have personal jurisdiction over the parties? Did the defendant appear or was the decree entered ex parte? Was the divorce entered on grounds which were insufficient in the couple’s state of residence?
Copies of all divorce decrees, as well as local law, should be examined to determine the couple’s "tax marital status." In Borax v. Comm’r, C.A.2, 349 Fd.2d. 666 (1965) cert. den. 383 U.S. 935 (1966) a foreign divorce decree was accorded validity despite having been voided by a state court judgment. The court stated that "the subsequent declaration of invalidity by a jurisdiction other than the one that decreed the divorce is of no consequence." The Service does not follow the Borax decision and will follow the later judgment if the court had either personal or subject matter jurisdiction. Rev. Rul. 67-442, 1967-2C.B. 65. Some courts have taken a "middle ground" position between the wooden results in Borax and the Ruling. Several cases have held that where there are conflicting decrees, the decision which courts in the decedent’s domicilliary estate would follow will control for federal estate tax purposes. Spalding v. Comm’r, C.A.2, 537 F.2d. 666 (1976); Goldwater v. Comm’r, C.A.2, 539 F.2d. 878 (1976) and Steffke v. Comm’r, C.A.7. 538 F.2d. 730 (1976). See Crown, "Divorce, Remarriage and the Marital Deduction," Estates, Gifts and Trusts Journal, September-October, 1978, p. 18.
B. Planning and Drafting the Prenuptial Agreement.
1. State Law Requirements Re: Validity.
a. Separate Representation. Each prospective spouse should have separate, independently selected counsel, who advises him or her of what rights he or she would have in the absence of the prenuptial agreement and the effect of the agreement on those rights. Consider having each lawyer certify, as part of the agreement, that he has been employed and compensated by his client and that he has fully explained the effect of the agreement on his or her rights.
In a case involving the major league baseball player, Barry Bonds, the California Appellate Court invalidated a pre-nuptial agreement on the grounds that the wife did not have independent counsel. The Court held that:
"when a party challenging a premarital agreement establishes that he or she did not have legal counsel while the other party had such assistance, and the unrepresented party did not have the opportunity to obtain legal counsel or did not knowingly refuse legal counsel, the court must strictly scrutinize the totality of the circumstances involved in the execution of the contract." and noted that: "Nothing raises the warning flag of unfairness more often than when an unrepresented party contracts with another party who is represented by an attorney and the unrepresented party waives statutory rights." In re Marriage of Bonds, 71 Cal. App. 4th 290, 72 Cal. App. 4th 94, 83 Cal. Rptr. 2d 783 (1999).
On the other hand, where the "unrepresented party" was afforded, and rejected, the opportunity to receive independent advice, and, additionally waived her right to consult with independent counsel, the agreement was held valid. In re Marriage of McKee-Johnson, 444 N.W. 2d 259 (Minn. 1989).
One of the commissioners that drafted the Uniform Antenuptial Agreements Act explained that parties need their own attorneys to "trot out the parade of horribles to their clients..." Proceedings in Committee of the Whole, Uniform Antenuptial Agreements Act, July 23, 1983, pp 52-53.
b. Full and Adequare Disclosure of Assets.
"When [a prenuptial agreement] provides disproportionately less than the party challenging it would have received under an equitable distribution, the burden is on the one claiming the validity of the contract to show that the other party entered into it with the benefit of full knowledge or disclosure of the assets of the proponent ." Fletcher v. Fletcher, 68 Ohio St. 3d. 464 (1994).
2. What spousal rights are the parties waiving?
a. To receive assets as an heir at law.
b. To contest the provisions of any will or trust agreement.
c. To any widow’s elective share. See Zaritsky, "Attack of the Surviving Spouse: The Evolving Problems of Elective Share," U. of Miami 23d Inst. on Est. Plnng., Ch. 5 (1989)
d. Dower or curtesy.
e. Homestead rights.
f. Alimony or separate maintenance.
g. To act as the spouse’s administrator or as preliminary administrator.
h. To receive damages for wrongful death or loss of consortium.
3. Community Property. Consider providing that the assets and income of each of the prospective spouses, including proceeds and reinvestments, remain separate, notwithstanding any community property laws.
4. Caveat re: Qualified Plans. The Retirement Equity Act was supposed to ensure that the spouse of a qualified plan recipient receives survivor benefits from the plan even if the participant dies before reaching retirement age. Pub. L. 98-397, 98 Stat. 1426 (1984). The REA established clear criteria for a waiver of benefits by the spouse. No waiver shall be effective unless the participant’s spouse consents in writing. The election may not be changed without the spouse’s consent unless she has agreed to allow amendments.
The issue becomes whether, and to what extent, a spouse may waive her rights in a prenuptial agreement. Several courts have held that, in the context of divorce, spousal rights in qualified plans may be waived prior to marriage.. Critchell v. Critchell, 746 A.2d., 282 (D.C. 2000); In re Marriage of Rahn, 914 P.2d. 463 (Colo. App. 1995); Richards v. Richards, 640 N.Y.S. 2d. 709 (1995).
Death benefits under pension and profit sharing plans are treated differently. It appears that those benefits may not be waived, except by a "spouse." Since the parties to a prenuptial are not yet spouses, a waiver might not be effective. See, e.g. Hurwitz v. Sher, 982 F.2d 778 (2nd Cir., 1992) Perhaps a variation of a "no contest" clause would be useful. If the spouse agrees to waive her rights after marriage and has not done so, other provisions for her would be reduced by the value of the retirement benefits she received.
5. Doubling up Exclusions. Consider providing that, to the extent that all gifts within a single calendar year are completely covered by annual exclusions, each spouse agrees to gift splitting.
C. Discuss and Implement Guardianship Provisions.
Who has the right to designate guardians? If both spouses have minor children by prior marriages, who would be best suited to be their guardian? Can a "custodial parent" name her second husband as guardian? If there is truly a "blended family," can one person be guardian of all the children?
IV. AFTER THE SECOND HONEYMOON.
A. Avoiding Inter-Generational Conflict.
1. QTIPs and April-October Marriages. EXAMPLE: Mr. Altermann, age 60, married his high school sweetheart, Miss Lindy-Lou, age 30 (he stayed back a lot in school). Some of Mr. Altermann’s children are older than his wife. Mr. Altermann wants to do right by both Lindy-Lou and the "kids." If he creates a QTIP, the remaindermen are likely to be his grandchildren. Life insurance owned and purchased by the children with annual exclusion gifts or owned by an ILIT could guarantee them an inheritance and make their relations with their "stepmother" smoother.
2. Using Total Return Trusts. Traditional split interest trusts typical provide for the trust accounting income to be distributed to the second spouse, with the remainder passing to the settlor’s issue. This arrangement not only can create irresoluble tensions between the spouse and the stepchildren, but almost inevitably lead to sub-par investment performance. Indeed, some of the criticism heaped upon corporate fiduciaries for lackluster returns should more properly be reserved for the draftsmen of "wooden" trust documents.
Recommending the "private unitrust" as a "default" trust design, William Hoisington wrote that "income to ‘A’, remainder to ‘B’ "trusts will, most probably, underperform the market, benefiting neither the spouse nor the children.
"[The] traditional formula is almost certain to result in second-rate and ill suited investment performance and a steady decline in the market value of the trust property when adjusted for inflation. There are vastly superior trust architectures." "Modern Trust Design; New Paradigms for the 21st Century," U. of Miami 31st Ann. Inst. On Est. Plnng. Ch. 6 (1997).
Not only is the fiduciary of a "traditional" trust restrained from following a modern "total return" investment plan, but the trustee often finds himself caught between the entreaties of the life beneficiary for more income and the demands of the children to retain or enhance the real value of the principal. The private unitrust or "total return trust" reduces or eliminates this conflict. Both the wife and her inherited progeny share a common goal of increasing the value of the fund.
There does not appear to be any reason why a "total return trust" cannot be structured as a QTIP. As long as the surviving spouse has the right to all of the income, and no one else has any power to appoint the trust property to anyone other than her during her lifetime, the trust should qualify for the marital deduction if the distribution to the spouse were not expressed purely as a percentage but as the greater of a unitrust percentage or the annual net income of the trust. See Wolf, " Defeating the Duty to Disappoint Equally—the Total Return Trust," 23 ACTEC Notes 46, 60 (1997) and Wolf, " Total Return Trusts, Can Your Client Afford Anything Less? 24 ACTEC Notes 45 (1998). This is similar to the treatment of IRAs in QTIPs. See Rev. Rul. 89-89 and Rev. Rul. 2000-2.
3. Equalizing the "First Crop" and the "Second Crop." Mr. Gottesdiener has two sons by his first marriage. He has provided them with educations and also has created trusts for their benefit. He now has two children with his second wife and wants to treat all of his children "equally."
a. Equalizing now. If Mr. Gottesdiener has sufficient assets, he could create trusts for his younger children which approximate the current value of his older children’s assets and the cost of their educations.
b. Equalizing later. In one Will that the writer drafted, assets were allocated to a trust for "younger children" equal to the lesser of a specified dollar amount, with inflation adjustments or the donor’s then available "exemption."
c. Tax Equity. In all equalization schemes, one has to consider the effect on one group of beneficiaries of using tax "exemptions," for the benefit of others.
B. Possibility of Will Contests -- The Love Child Trust.
One of the writer’s clients had a child in Europe for whom he wished to provide "something." At the same time, the client did not want the child to contest his will, of which his wife and "American" children were beneficiaries. He created a trust for his European offspring which provided that, if no action were taken to contest the will, the child was a beneficiary. This same device can be used to insulate assets passing to a second spouse from claims of children by a former marriage. See Crown, "!BATTLE STATIONS! -- Evasive, Defensive and Attack Maneuvers for Will Contests," U. of Miami 23d Annual Inst. on Est. Plnng., Ch. 6 (1989).
C. Health Care Issues and Durable Powers of Attorney for Health Care.
Who should the health care agent be? Although most of us name our spouse as health care agent, adult children from prior marriages could feel "cut out" if no role is given to them. In some situations, it may be preferable to name one or more children, and not the spouse. In others, the second husband or wife could act jointly with one or more of the children.
D. Don’t Inadvertently Benefit Ex-Spouse.
1. Consider what would happen to assets of a trust for a child of a prior marriage who survives the settlor, but dies prior to termination of trust without issue. Assets could go to surviving parent if there is a disposition to the child’s "heirs" or if the child were to be given a broad power of appointment. Be careful that only the settlor’s issue are remaindermen and that powers of appointment prohibit exercising in favor of the ex-spouse.
2. In trusts for children by a prior marriage, perhaps avoid use of word "support" or make trust look a little like a special needs trust to avoid having funds used for child’s support, thereby enriching the other parent by taking burden off of him.
Today, marriage is, unfortunately, not necessarily forever. Fifty percent of marriages end in divorce. Forty percent of marriages are entered into with a "pre-owned" spouse. To some extent, planning for the second marriage can begin during the first marriage. Although it is a difficult subject to broach with clients, the possibility of divorce and remarriage should possibly be discussed, particularly with regard to irrevocable arrangements.
All divorce decrees should be carefully reviewed. There may be obligations of which the client is not aware. "Foreign" decrees deserve special scrutiny to be sure that the client is married to his current spouse for tax purposes.
The issues discussed in this outline are only the ones that the writer has thought of. There are, undoubtedly, many others which will occur to all of us over time. Planning for the second marriage is both a challenge and an opportunity. Good luck and be careful.