What Survivor Must Do When Trust Mandates Split on First Death

SEPTEMBER 14, 2015 VOLUME 22 NUMBER 33

Once in a while we read an appellate court decision that nicely addresses a subject which isn’t the issue before the court. A recent Arizona Court of Appeals case illustrates this phenomenon nicely.

The legal issue was technical and would appeal only to lawyers — and probably only to appellate lawyers, at that. After the probate court ruled against them, some of the beneficiaries to a trust filed a motion to have the court reconsider its decision. When that also failed they appealed, but alleged that the probate court should have considered an argument similar to but different from the one they actually made. That approach was, unsurprisingly, unsuccessful.

What’s more interesting about the decision, though, is the background of the dispute. It involved a joint revocable trust that mandated division of a married couple’s assets into two equal shares on the death of the first spouse.

A little background might be appropriate here. Joint revocable trusts are fairly common in Arizona, and provisions like those involved in this case are far from unusual. Until recent years, the mandatory division was often a tax-driven decision, in order to minimize estate taxes on a married couple’s assets. Today that is less likely to be the reason for a mandatory trust split, since only very large estates face any tax liability at all and surviving spouses inherit their deceased spouse’s estate tax exemption amount, to the extent that it is unused.

The combined estate in the recent appellate case was apparently modest, and so estate taxes seem unlikely to have been the reason for the mandatory split. What other reason, then, might a married couple have for ordering a split of assets on the first death? Second marriages.

Dale and Mary were married for some years. They each had children from a prior marriage, and they owned their home in Green Valley, Arizona. In order to make sure that their home’s value was split equally between the two families, they created a trust to hold just their residence. That trust included a mandatory split into two shares on the first death, and directed that each half-interest in the trust would pass to one spouse’s children. That way they could assure the division even if the survivor lived for years after the death of the first spouse.

As it happens, Dale died first — in 2005. Mary died four years later. Though she was trustee of the trust holding the residence, she never actually divided the trust in half. She did, however, use the home as security for a loan she took out after her husband’s death.

Four years after Mary died, one of Dale’s children filed an action to compel Mary’s children to account for the administration of the trust, and to perfect the claim to half the house. The probate judge hearing the matter did not order an accounting, but did order half of the home’s value to be distributed to Dale’s children — along with $33,429.33 from Mary’s half, to make up for the fact that her children had used the residence after Mary died. The judge also ordered an offset for the loan Mary took out against the house after Dale’s death.

Mary’s children asked the probate judge to reconsider his decision, which he declined. That set up the actual legal argument in the appellate case, which (as we’ve already noted) as actually less interesting than the mandatory trust split issue. Suffice it to say that the Court of Appeals chose not to upset the probate court’s judgment directing distribution of the trust according to its terms, plus damages for Mary’s (and her children’s) misuse of the trust’s sole asset. In Re Newman-Pauley Residential Trust, August 31, 2015 (an unpublished decision).

Why is the uncompleted split so much more interesting than the actual legal issue in Dale and Mary’s trust case? Precisely because it is so commonplace.

We regularly meet with surviving spouses who have not gotten around to the division of assets mandated by a joint trust document. Sometimes the trust might include provisions that allow the surviving spouse to skip the requirement, or to undo it. But if the trust unequivocally directs such a division and the surviving spouse does not follow that direction, the courts will ultimately order a split to reconstruct what should have happened months, years or sometimes decades before.

Of course these disputes are most common in second-marriage situations, where each spouse has children — often children who were grown when the marriage took place. They also occur in family situations where each spouse is closer to one child or one group of children. Sometimes we see them when the couple operated a family business, and less than all of the children are involved in managing the business after one spouse’s death.

What is the lesson to be taken away from the dispute between Mary’s and Dale’s children? Get legal advice early, and follow it. If Mary had talked with her lawyer shortly after Dale’s death, she might have gotten direction about how to actually make the trust split. Her expectations — and those of her children — might have been set more reasonably, too. That might have saved the later dispute and attendant legal expenses.

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