In Carmack v. Reynolds (Frealy), released March 23, 2017, the California Supreme Court, asked by the Ninth Circuit to clarify a point of California law applicable to an ongoing bankruptcy case on appeal, held that California law does not limit a bankruptcy trustee to 25% of distributions from a third-party created spendthrift trust, but includes any past distributable amounts “due and payable”.
Most estate and tax professionals were probably unaware that a bankruptcy trustee could even include 25% of a trust’s distributions in a bankruptcy estate, much less more. Under most state laws, and bankruptcy code section 541(c)(2), such trusts are ordinarily excluded from a beneficiary’s bankruptcy estate entirely and protected from creditors. There are various exceptions to this protection, and potentially room for more (see Asset Protection Dangers When a Beneficiary Is Sole Trustee and Piercing the Third Party, Beneficiary-Controlled, Irrevocable Trust, LISI Asset Protection Planning Newsletter #339 (March 9, 2017)). California law has long had a larger creditor-friendly exception than most, and now it’s confirmed to be even larger. This case will be a boon to out of state banks and trust companies that can help ensure that Alaska, Nevada, Ohio, Delaware or other states with more debtor/beneficiary friendly state laws apply to protect a beneficiary’s trust, instead of California law.
Here’s the conclusion from the case:
We conclude that a bankruptcy trustee, standing as a hypothetical judgment creditor, can reach a beneficiary’s interest in a trust that pays entirely out of principal in two ways. It may reach up to the full amount of any distributions of principal that are currently due and payable to the beneficiary, unless the trust instrument specifies that those distributions are for the beneficiary’s support or education and the beneficiary needs those distributions for either purpose. Separately, the bankruptcy trustee can reach up to 25 percent of any anticipated payments made to, or for the benefit of, the beneficiary, reduced to the extent necessary by the support needs of the beneficiary and any dependents.
ABOUT THE AUTHOR
Edwin Morrow, J.D., LL.M., MBA, CFP®, RFC® is a board certified specialist in estate planning and trust law through the Ohio State Bar Association. He is currently the Director of Wealth Transfer and Tax Strategies for the Family Wealth Advisory Group at Key Private Bank. Ed works with family wealth financial advisory and trust teams nationwide, assisting with in-depth reviews of high net worth clients’ estate, trust, asset protection and tax planning. Prior to joining Key Bank in 2005, Ed was in private law practice in Cincinnati, Ohio, concentrating in taxation, probate, estate and business planning.
Ed can be reached by phone (937) 285-5343 or by e-mail at firstname.lastname@example.org or Edwin_P_Morrow@KeyBank.com.
OTHER ARTICLES IN THIS ISSUE
- PRACTICE-BUILDING: What Can You Sell to Existing Clients? by Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law
- ADVANCED PLANNING: The Strange Case of Dr. Jekyll and Mr. Oshins – Chapter III (First-Tier Trust States) by Steven J. Oshins Esq., AEP (Distinguished)
- LIFE INSURANCE PLANNING: 7 of the Most Common Life Settlement Situations by Daxton Fryer, Senior Life Settlement Broker