9. What is the potential impact of divorce on a trust created for the benefit of a spouse?

Trusts for the benefit of a spouse and descendants are typically structured as irrevocable grantor trusts, and the grantor is personally taxed on the income because distributions may be made to the grantor’s spouse. In the event of a divorce, the grantor may still be liable to pay the tax on the income earned by a trust set up for the benefit of a now ex-spouse. Possible post-divorce solutions include modifying the trust agreement, terminating the trust, distributing the assets to the spouse, or creating an agreement as part of the divorce settlement to have the ex-spouse reimburse the grantor for the taxes paid.

Planning point: Taxpayers typically do not set up trusts for the benefit of a spouse when contemplating a divorce. In the event of divorce, the trust should be carefully considered in the divorce proceedings and the divorce agreement to ensure the spouses understand the trust’s income tax impact.