Article on Marital Property Characterization of Trust Income

Steven D. Baker, JD, CPA, has published an article entitled, The Texas Mess: Marital PropertyCharacterization of Trust Income, 5 Est. Plan. & Cmty. Prop. L.J. 217 (Summer2013).  Provided below is theintroduction to his article:

Thelast time the Texas Supreme Court considered the marital property character ofincome of a trust funded with a spouse’s separate property was in 1890. Since then, a spouse’s rights to control and manage her own property and theincome it generates has evolved, divorce has become more common, estateplanning has become more sophisticated, and income tax and estate tax consequenceshave come to bear on this issue.  Accordingly, both the lower Texasappellate courts and the federal courts have grappled with this issue withmixed results, “creat[ing] one of the more obtuse areas of Texas law.”  Asthis article demonstrates, the appellate courts in Fort Worth, San Antonio,Texarkana, and Tyler all follow one rule; the Dallas Court of Appeals refers toa different principle; and the appellate courts in both Corpus Christi and Houston(the 14th District) apply yet another theory.  As a matter ofconstitutional interpretation, this issue begs for clarification by the Texas SupremeCourt.

Thesource of this inconsistent rule application among Texas courts is the clashbetween two divergent sources of property law.  In one corner is articleXVI, section 15 of the Texas constitution based on Spanish civil law, whichdefines the couple’s marital property rights as the property the couple acquiresduring their marriage.  In the other corner is the law of trusts, whichrecognizes and upholds the settlor’s property right to convey property in trustto the beneficiaries of the settlor’s choosing, provided that such conveyancedoes not violate public policy.  All too often, courts and commentatorstake the position—or simply make an assumption—that one set of principlesshould trump the other; they form an opinion without giving much, if any,consideration to the different purposes of each of these competing principlesand without recognizing that they can possibly strike a consistent and workablebalance between the two.

Thisarticle begins with a historical summary of the relevant aspects of the law ofmarital property and trusts, and it explains certain unique features of Texaslaw that raise the issue addressed in this article—the characterization of abeneficiary spouse’s interest in the income of a trust funded with separateproperty.  Next, Part III of this article discusses the evolution of threegeneral approaches to such characterizations under the current case law, andPart IV of this article details how different circumstances might affect thischaracterization under each of these approaches.  This article concludeswith a discussion of two coherent and workable approaches, each of which seeksto strike a balance between these two different areas of property law.