Is Trust Income Community?
1993? w/ 1997 Addendum
Noel C. Ice
Note: This article needs some work. Years ago I felt pretty good about it. However, the law in this area has been developing fast, and an update is desperately needed. Nevertheless, if this is a subject that interests you, this article is a good place to start, because most of the relevant pre-1998 cases are cited here.
Although the Texas Supreme Court has not ruled definitively on the issue, it is my opinion that were it to do so, it would hold that income from a trust established by someone other than the beneficiary is separate property whether or not that income is distributed. (I have been wrong before.)
It is safe to say that the law
is not fully developed in this area and that the cases and commentators are not
in agreement as to what the law is or what it should be.[1] Nonetheless, my opinion is in accordance with
the most recent case law on the subject.[2] Attached is a copy of virtually every
significant case and law review article discussing the issue of whether or not
trust income is separate or community property in
Under the Texas Constitution, separate property is property “owned or claimed before marriage, and that acquired afterwards by gift, devise, or descent,”[4] and everything else is community property. (The Constitution does not define community property. Therefore, community property may best be described as anything that is not separate property.)
A good number of the
It has been suggested that Arnold v.
One of the most often cited of the pre-Arnold cases is McClelland v. McClelland.[10] This was a divorce case in which the wife claimed entitlement to half the income payable to a trust for the husband. The trust was a support trust established under the will of the husband’s father, and the trustee had the discretion to accumulate or distribute corpus. As at least one ground for holding the accumulated income to be separate property, the court stated that the wife could not have rights greater than the husband, and since the husband could not demand a distribution of the income it could not possibly be community property. The court went further, however, and additionally held that income actually distributed to the husband (or used to improve his separate property) was his separate property. It is my opinion that McClelland is still good law.
The only cases I was able to
find holding that undistributed income was community property were Mercantile National Bank at
Note that there is at least one post-Arnold case holding that accumulated income in a self-settled trust is separate property.[14] Because the trust had not distributed the income, this case reasoned that the income had not been “acquired,” and thus could not be community property. This case is possibly inconsistent with my position as expressed in this letter, because if the trust had distributed the income, the beneficiary would have acquired it, and, in that event, if the court were to hold the distributed income to still be separate property, the court would have needed other grounds. One commentator[15] has pointed out that the reasoning in this case is contrary to two Texas Supreme Court decisions[16] holding that it should make no difference whether the property is reduced to possession or not.
A more difficult case is
presented where the income is distributed or where the beneficiary can compel a
distribution. There are a handful of Fifth Circuit tax cases decided in the
‘30s and ‘40s that in my opinion are not supported by
Importantly, Wilson and McFaddin[18] (another Fifth Circuit case) employed a look-through or conduit approach, and clearly held that if the “income” represented oil and gas royalties that would have been separate property in the absence of a trust, that the royalties would be separate property when distributed. So long as the source of the distribution can be clearly traced, I know of no cases that would convert mineral royalties into community property simply because the mineral interests were held in trust. The conduit approach, however, is inconsistent with the notion that beneficiary does not have a property interest in the trust res.[19]
We are not prepared to go as far as the
taxpayers do in their claim, that under the law of
In my opinion Porter placed
too much emphasis on intent and too little emphasis on the preexisting case
law. The court cited, and then glibly dismissed, a number of
Contrary to the Porter characterization of the McClelland holding, the McClelland court not only held that the undistributed income was not community property, but held further, that the amounts received by the husband (or used to improve his separate property) were his separate property.
[T]he wife is not entitled to any interest in the amounts received by appellant McClelland from the executors, because these amounts were his separate property, devised to him by the will, in which the wife had no community interest.[21]
In the same year the court decided Porter, it decided several other cases in which it found that the income from a trust was community property.[22] These cases add little to the development or explication of the law. McFaddin[23] involved a number of issues, but the court disposed of all of them by simply citing Porter.[24] Sims[25] is a two paragraph decision to the effect that since there was no express intent that the income be separate, Porter controls.
I want to emphasize that when a federal court interprets what it
believes to be
There are two much more recent decisions that lend support to the
notion that the Fifth Circuit made a mistake in 1935 and ‘45: Wilmington Trust Company v. United States,
4 Cl.Ct.6 (1983), 83-2 USTC ¶13,547; aff’d 753 F.2d
1055 (Federal Circuit 1985) and Taylor v.
Taylor, 680 S.W.2d 645. Tex. App.-
In Wilmington (which was the last time this issue has come up in a
federal tax case), the Court of Claims in an opinion sustained by the Federal
Circuit, unequivocally held that trust income actually distributed under a
mandatory income distribution trust was separate property.[27] The opinion expressly criticizes the earlier
Fifth Circuit decisions as misreading
It appears that the Fifth Circuit, in the two decisions previously mentioned, failed to analyze properly the community property law of Texas, as it has been developed by the Texas courts.[28]
Of all of the cases interpreting
In
* * * *
In conclusion, it is settled law that the undistributed income of a trust that is not self-settled is not community property if the beneficiary cannot compel distribution.[30] I know of no cases to the contrary.
If the trust is self-settled, there are cases holding that trust income is community,[31] and there are cases holding that it is separate.[32]
I would distinguish self-settled from spendthrift trusts. In order for the generalization --that income from separate property is community-- to be applicable, the spouse must (a) have some form of interest in the underlying separate property that produces the income and (b), what is more important, the income that interest produces must not have been a gift. In the case of a self-settled trust the relationship between the beneficiary and the corpus of the trust is disconcertingly close, and, what is more important, there is certainly no gift involved. There is no gift in what a settlor retains. And if the beneficiary has such control over the corpus of the trust as to be the equivalent of outright ownership of the trust res, such that the doctrine of merger would apply, then it might make sense to say that the beneficiary owned the property that produced the income, and therefore the income was acquired from the property and not by gift.[33]
If the beneficiary can compel distribution, or if the income is actually distributed, and if the trust is not self-settled, all of the cases that I have been able to find, other than tax cases decided by the Fifth Circuit, have held that the income is separate property, whether the income was subject to mandatory or discretionary distribution.[34] I conclude, based upon existing relevant case law, that if the Texas Supreme Court were faced with this issue, the court would hold that income distributed from a trust established by someone other than the beneficiary is the separate property of the beneficiary.
(The cases seem to consider the intent of the donor as being important. I do not see the constitutional significance of this, but I note that as between husband and wife, it is statutorily permissible to make a gift of the income from separate property given by one spouse to another, with the result that such income is the separate property of the donee spouse, and that, in fact, such an intent to do so will be presumed.[35])
I would reach the same conclusion as the primary line of cases, based on the application of the Constitutional definition of separate property as property acquired by gift. Art. XVI, section 15 defines separate property as follows:
All property, both real and personal, a spouse owned or claimed before marriage, and that acquired afterwards by gift, devise, or descent, shall be the separate property of that spouse.
Recall that community property is not defined, other than by
negative implication. Community property is property that is not separate
property. It is true that in
This “gift” analysis has had a long history in that it has been raised from time to time even in the older cases. However, the theory has never been given its due, in my opinion. This theory was apparently proffered in the Fifth Circuit decisions, albeit unsuccessfully. One basis for rejecting the theory is found in the early U.S. Supreme Court decision of Irwin v. Gavit.[37] In that case, for federal gift tax purposes, Justice Holmes found that a distribution from a trust was not a gift and that “a gift of the income of a fund ordinarily is treated by equity as creating an interest in the fund.”[38] Under this approach, one would look to the beneficial ownership in the trust as the “property” “acquired.”[39] The income from this beneficial ownership would be community property. Irwin v. Gavit was cited in Porter; however, as mentioned above, this approach is inconsistent with the look through theory that Porter and McFaddin used to find that oil and gas royalties earned by the trust were separate property when distributed to the beneficiaries.
In any event, I question the relevancy of applying federal estate and gift tax principles to state property characterization issues; moreover, even federal gift tax law will recognize that a gift has been made if a donor transfers the right to the income from a piece of property, retaining a reversion.
If a donor transfers property to a trust, giving B the income for life, remainder to C, it would be absurd to say that for state property law purposes there is no gift to B. Granting, as we must, that B is the recipient of a gift, of what does the gift consist? Is it a gift of the income or a gift of the beneficial interest? Does it make any difference?
I would concede that a spouse’s “beneficial interest” in a trust may be “property” subject to division on divorce, if the interest belongs to the community, such as might be the case in a pension plan established by an employer for an employee, contributions to which are made while the employee was married.[40] But in that case the interest was not acquired by gift.[41]
If the gift of the right to the income from a trust is a gift of a “beneficial interest” in the trust, of what does the beneficial interest consist if not the right to the income? If one is inclined toward abstraction and favors the beneficial interest approach, then my rejoinder is that the income is the reification of the beneficial interest; which is to say, more or less, that it is the same thing. One might conclude that B received an equitable interest in the trust, the proceeds of which on sale would be separate property; however this abstraction has little basis in reality, particularly in the case of a spendthrift trust where alienation of the interest is impossible.
By way of contrast, consider the case of a life estate in property[42]: the life tenant has the right to use and possess the property, including the right to make the property productive and to enjoy the income from it. A life tenant actually has a legal and possessory interest in the property; whereas a beneficiary of a trust merely has an equitable nonpossessory interest in the trust. Therefore, even if the income from a life estate is community property, it does not follow that the income from a mandatory income distribution trust is community property, because, the only interest that a beneficiary of a trust has in the trust is the right to distributions.
A trust beneficiary does not own the corpus of a trust and therefore any income produced by the corpus is not necessarily produced by the spouse’s separate property. More to the point, if it is conceded that a spouse’s beneficial interest in a trust was acquired by gift (and is therefore separate property), it does not follow that the income produced by the trust is income from the beneficial interest: the income is the beneficial interest! At least that is my position, and, as indicated above, the result at least is supported by recent case law. (Admittedly, reasonable minds can, and do, differ on this issue.[43])
The fact that the Constitution defines separate property, relegating to the community everything else, rather than the other way around, tends to support the notion that trust distributions are separate property. If the distributions are acquired by gift or inheritance, the distributions cannot be community property.[44] In the case of a mandatory income only trust, the income is the gift. If it’s not, what is? Is the result different if corpus can be invaded for the beneficiary’s benefit? I don’t see why it should be. If the income were a gift where there was no right to the corpus, it ought still to be a gift notwithstanding that the gift has been augmented.
ADDENDUM
1997
Since writing the above, several new cases have come to my attention. The very latest case —decided late last year and only published in 1997— is Cleaver v. Cleaver, 935 S.W.2d 491 (Tex. App.—Tyler 1996, writ den.).[45] This case represents the latest in a developing line that strongly support the notion that the only portion of a trust that is community property is the income on the portion that could have been distributed at the [unfettered?] option of the beneficiary. Trust income that is required to be distributed and is, is separate property. The income from that income will ordinarily be community property, whether distributed or not. In Cleaver, the beneficiary spouse was not the trustee and had no interest in the corpus.
Another recent case, Lemke v. Lemke, 929 S.W.2d 662 (Tex.
App.-
In the instant case, the trust contained a spendthrift clause, which prevented Jacob from alienating, anticipating, assigning, encumbering, or hypothecating his interest in the principal or income of the trust. The trustee of Jacob's trust had the absolute discretion to distribute as much of the corpus and income of the trust as she deemed appropriate for Jacob's health, education, maintenance, and welfare needs. Following Burns, we hold that the undistributed trust income that accrued during Jacob's marriage to Joyce remained a part of the separate trust estate and was not subject to division by the court because it was not community property. Points of error one and two are overruled.[47] [Emphasis added.]
In Lemke, both corpus and income were distributable. Lemke appears to involve a self-settled trust established for the benefit of the beneficiary out of the proceeds of a malpractice case he had just won, which makes the case particularly interesting. In any event, in Lemke, the opinion stated:
The trust instrument provides that the trustee has the sole discretion to distribute as much of the trust income and corpus as the trustee deems appropriate for Jacob's health, education, maintenance, and welfare needs. Following Burns, we hold that the undistributed trust income that accrued during Jacob's marriage to Joyce remained a part of the separate trust estate and was not subject to division by the court because it was not community property. Points of error one and two are overruled.
True, the Lemke court did not discuss the status of income that was distributed. But this was done in Cleaver, where it was clearly held that income that is distributed is separate property. One naturally assumes that in Lemke any income distributed would have been separate also, unless the fact that the trust were self-settled changed things.
In conclusion, my reading of the cases is (1) the Cleaver cases hold that income required to be distributed is separate property; (2) Lemke holds that income that is not required to be distributed is separate property; and (3) under Long, income on property that used to be held in trust but which is no longer subject to a fiduciary distribution standard is community if earned after the trust’s termination date.
* * * *
I just discovered a new case
holding that trust income is community property, at least under some ci
[1]Compare “Income Distributions from Trusts Separate or Community Property?” by Frank G. Newman, 29 Texas Bar Journal 449 (1966) and “Trust Income-Separate or Community Property?” by William V. Counts, 30 Texas Bar Journal 851 (1967) with “Marital Property Law in Texas; The Past, Present and Future,” by Thomas M. Featherston, Jr. and Julie A. Springer, Vol. 39:861 Baylor Law Review, p. 902 (1987) and “Income Arising from Trusts during Marriage is Community Property” by Harvey L. Davis, 30 Texas Bar Journal 901 (1967).
[2]
[3] Unfortunately, I cannot find this document. Darn.
[4]
[5]Hutchison v. Mitchell, 39
[6]
[7]“Income Arising from Trusts during Marriage is Community Property” by Harvey L. Davis, 30 Texas Bar Journal 901 (1967).
[8]Buckler v. Buckler, 424 S.W.2d 514 (Tex.
Civ. App.-
[9]Buckler v. Buckler, 424 S.W.2d 514 (Tex.
Civ. App.-
[10]McClelland v. McClelland, 37 S.W.350 (Tex. Civ. App.-1896, writ ref’d).
[11]Mercantile National Bank at
[12]Re Marriage of Long, 542 S.W.2d 712 (Tex. Civ. App.-Texarkana 1976, no writ).
[13]It is important to note that this decision was made while the beneficiary was married, but after separation. Therefore, it is hard to tell whether the court ruled the way it did on a fraudulent conveyance theory or because the beneficiary was the “in effect” transferor.
[14]Re Marriage of Burns, 573 S.W.2d 555 (Tex. Civ. App.-Texarkana 1978, writ dism’d).
[15]See “Characterization of Marital Property,” 1991 Advanced Family Law Course, sponsored by the State Bar of Texas, at p. J-145.
[16]Herring v. Blakely, 385
S.W.2d 843 (
[17]Commissioner v.
[18]McFaddin v. Commissioner, 148 F.2d 570 (5th Cir. 1945).
[19]See “Community Property and the Law of Trusts” by Harvie Branscomb, Jr. and G. Ray Miller, Jr., 20 Southwestern Law Journal 699 (1966) at pp. 716-721.
[20]Commissioner v. Porter, 148 F.2d 566 (5th Cir. 1945), at p. 568.
[21]McClelland v. McClelland, 37 S.W.350 (Tex. Civ. App.-1896, writ ref’d), at p.859.
[22]Commissioner v. Sims, 148 F.2d 574 (5th Cir. 1945). McFaddin v. Commissioner, 148 F.2d 570 (5th Cir. 1945).
[23]McFaddin v. Commissioner, 148 F.2d 570 (5th Cir. 1945).
[24]
[25]Commissioner v. Sims, 148 F.2d 574 (5th Cir. 1945).
[26]Stare decisis is Latin for to abide by, or adhere to, decided cases.
[27]
[28]
[29]
[30]McClelland v. McClelland, 37 S.W.350
(Tex. Civ. App.-1896, writ ref’d). Buckler
v. Buckler, 424 S.W.2d 514 (Tex. Civ. App.-
[31]Mercantile National Bank at
[32]Shepflin v. Small, 23 S.W. 432 (Tex. Civ. App.-1893, no writ). Monday v. Vance, 32 S.W. 559 (Tex. Civ. App.-1895, no writ). Re Marriage of Burns, 573 S.W.2d 555 (Tex. Civ. App.-Texarkana 1978, writ dism’d).
[33]Re Marriage of Long, 542 S.W.2d 712 (Tex. Civ. App.-Texarkana 1976, no writ).
[34]Hutchison v. Mitchell, 39
[35]
[36]Colden v. Alexander, 171 S.W.2d
328, 334 (
[37]Irwin v. Gavit,
268
[38]
[39]See “Community Property and the Law of Trusts” by Harvie Branscomb, Jr. and G. Ray Miller, Jr., 20 Southwestern Law Journal 699 (1966) at p. 713.
[40]Herring v. Blakely, 385
S.W.2d 843 (
[41]Lee v. Lee, 112
[42]If I ever revisit this issue, I would like to examine the cases to see if there are any decisions characterizing income from a donated life estate where a trust is not involved.
[43]“Marital
Property Law in
[44]
[45] Cf. Cleaver v. George Staton Co., Inc., 908 S.W.2d 468 (Tex. App.-Tyler 1995).
[46]
[47]