We continue this week with our Family Legacy Planning segment on “the year of the wedding.” As mentioned last week, much of the goal of protecting family assets can be achieved outside of a prenup agreement through a “prenup alternative.” A prenup alternative utilizes irrevocable trusts and/or entities to protect assets. By carefully using these common estate planning tools, you can convert what would’ve been “marital property” into “non-marital property,” an important distinction.
All assets benefitting a Texas married person fall into one of two categories: marital property and non-marital property. Within the category of marital property, there are two sub-categories: community property and separate property. Separate property consists of assets owned before marriage or acquired during marriage by inheritance or gift. All of a spouse’s other assets, including income received from separate property, are community property. There is a presumption that all assets are community property, barring clear and convincing evidence that an asset is separate property. When separate and community are commingled, the commingling generally results in the assets becoming community. When a family court divides community property, it doesn’t necessarily divide it 50/50. The court can make a “just and right” division and award more than one-half to a spouse, taking into consideration equitable factors. One of the factors that a court can weigh is whether one of the spouses has more separate property than the other. So even though separate property cannot be awarded to the other spouse, it is still on the table for consideration and can impact the way a court divides the community property. On the other hand, non-marital property is not on the table for consideration in a divorce settlement.
Assets owned by a carefully drafted irrevocable trust are non-marital property. Ideally, parents will direct that all gifts and assets passing at death go to such a trust for their child. Single adults who have already accumulated assets in their own name can transfer assets to certain “self-settled” non-Texas trusts or can sell assets to a 678 Trust. When assets are transferred to a self-settled non-Texas trust or sold before marriage to a 678 Trust, the assets in the trust will continue to be non-marital property, even as they grow. If the assets were sold for a promissory note, the note will be separate property. However, the note will be frozen in size and is the type of asset not susceptible to being commingled. Irrevocable trusts are far less likely than prenups to be subjected to legal challenge. Legal precedent tends to favor respecting the integrity of the trust. Furthermore, unlike a prenup where both future spouses are involved and have to sign the document, a trust is easier on the relationship since the future spouse plays no role with the trust and needn’t sign anything with respect to the trust.
Another prenup alternative is to transfer assets before marriage into an entity, such as a limited liability company or limited partnership. In Texas, although a spouse’s outside ownership interest in a partnership is marital property, assets owned inside a partnership, as well as income earned but undistributed, aren’t divisible upon divorce. Contrast this with income earned on separate property that was not placed inside an entity or trust. Income on a Texas spouse’s separate property is community, whereas income accumulated in the entity or trust is non-marital property. It’s easy to see the substantial benefits prenup alternatives can provide.
Can you achieve all the protection you need through prenup alternatives and avoid the need for a prenup? There are certain protections that still require a prenup, but perhaps it could be a scaled-back prenup. Those entering into second marriages may need to address obligations to former spouses. A child from a prior relationship requires special planning to diminish the risk of later friction between the child and a stepparent. If a spouse is in a high-liability-risk profession, a prenup can provide an added layer of protection for the other spouse’s property. The prenup can also specify how assets are divided when a marriage ends, whether by divorce or by a spouse’s death. In addition, if assets were transferred before marriage to an entity, once the entity makes distributions, the distributions are generally treated as community property. A prenup can override that treatment and characterize those distributions as separate property. Therefore, many do both a prenup and a prenup alternative (sort of a belt and suspenders approach). However, if the primary goal is to only protect certain family legacy assets, sufficient protection can often be achieved by only doing prenup alternatives.
In the Family Business magazine article “In a Divorce, Who Gets What?,” Jon Moore discusses the Amazon divorce of Jeff Bezos and MacKenzie Scott. Scott received a 4% stake in Amazon, valued at $38 billion, but agreed Bezos could retain voting control over her shares. Moore describes a three-step process to protect the shares of stock in a family corporation: (1) put title to the shares in a spouse’s name as separate property (a “belt”); (2) declare in a prenup that the family business is separate property, including any future income or growth in value of the business (“suspenders”); and (3) hold the business in a corporation with a Shareholders’ Agreement specifying that a divorced spouse cannot be a shareholder of the corporation (a “second belt”). Many family corporations have a buy-sell agreement providing that if a divorcing spouse acquires a right to stock, that spouse must sell the stock back to the family at a pre-agreed price. Moore adds that another tool is to transfer the stock to an irrevocable trust, as a prenup alternative, as we suggested above.
As is evident, there are multiple techniques and considerations in deciding how to best protect family assets. It’s not a “one size fits all.” However, with the grim statistic that about half of first marriages in the United States end in divorce, pre-marital planning to protect family assets is the responsible thing to do. The Blum Firm would be honored to help you weigh all the options and decide what is best for your family.
Marvin E. Blum