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Appeals Court Case Potentially Undermines Phannenstiehl Protections

By Harry S. Margolis

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The case of Phannenstiehl v. Phannenstiehl (475 Mass. 105, 2016) established the rule that if your parents create a trust for your benefit and leave discretion over distributions in the hands of the trustee, the funds in that trust will not be considered part of the marital estate upon your divorce. (See our description of this case: In Pfannenstiehl Case, MA SJC Affirms Use of Asset Protection Trusts.) A recent Massachusetts Appeals Court decision appears to narrow this rule. 

The Holding

In Savoy v. Savoy (Mass. App. 19-P-1076, July 8, 2020, unpublished), the Massachusetts Appeals Court reverses a probate court decision applying the Phannenstiehl rule. Instead, it finds that the particular circumstances of the trust created for the benefit of Geraldine Savoy by her mother render it subject to inclusion in determining the division of the Savoys’ assets.

The court holds that the determination whether trust assets should be included in the marital estate

turns on the attributes of the specific trust, requiring evaluation not only of the trust instrument but also the facts and circumstances of each case.

The court quotes the Phannenstiehl decision to the effect that “[i]nterests in discretionary trusts generally are treated as expectancies and as too remote for inclusion in a marital estate,” but contrasts it with Mrs. Savoy’s trust, quoting the trial judge’s findings that her “interest in the trust was ‘neither remote nor speculative’; she ‘has essentially unfettered ability to utilize significant funds from the [trust] to support herself.'”

In contrast with the Phannenstiehl trust, Mrs. Savoy is the sole trustee of her own trust. She and her children and grandchildren are beneficiaries. Her discretion to make distributions to her offspring is unfettered. Her discretion to make distributions to herself is limited by the HEMS standard, meaning that she can only make distributions to herself or make payments on her behalf for her health, education, maintenance, and support.

The Court Misreads the Trust

The Court makes a couple of errors in its evaluation of the trust. First, it says that Mrs. Savoy’s right to make distributions to herself is not limited by any obligation to determine the needs of other beneficiaries. It finds that

[t]he wife effectively has a “present right to use the trust principal, and can [] compel distributions.

While apparently in practice, Mrs. Savoy has only made distributions primarily to herself, and as a trustee, she has a fiduciary duty to all beneficiaries. As a beneficiary, she has no more power to compel the trustee to make distributions than can her children and grandchildren.

Second, the Court makes the common mistake of misinterpreting the HEMS language, also known as an “ascertainable standard.” It finds

This standard, in essence, requires the wife to distribute principal to herself “with an eye toward maintaining [her] standard of living in existence at the time the trust was created.”

That’s simply inaccurate. The HEMS standard is a restriction on trustee discretion which has been accepted by the Internal Revenue Service as sufficient so that even if the trustee and beneficiary are the same person, the trust assets will not be considered to be owned for tax purposes by that individual. It is not a requirement that the trustee pay for the beneficiary’s health, education, maintenance, and support. Instead, it means that the trustee may only make distributions to pay for such purposes. In this trust, there are no such restrictions on distributions to other beneficiaries, since none is necessary to keep them from being deemed the owner for tax purposes.

But What About the Trust’s History?

While the Court is clearly in error with respect to the trust, the facts of the case may still bode ill for Mrs. Savoy. Unlike the situation in the Phannenstiehl case, she is the trustee of the trust in question. And she has a practice of dipping into it for her own needs. The question is whether those circumstances in effect outweigh the Phannenstiehl rule in rendering the trust assets subject to marital division. Both could reduce the certainty for planning to protect assets for future generations.

With respect to the trustee, does it matter whether the spouse is the sole trustee or whether he is currently the trustee? Could Mrs. Savoy resign her trusteeship and appoint someone else? If so, by when must that happen for the trust assets to be protected? Would doing so the day prior to filing for divorce do the trick?

With respect to trust distributions, there’s even less of a bright line possible. Presumably, the divorcing spouse could receive some benefits from the trust and still have it protected, but how much and how exclusively? Would it matter whether or not she was the sole beneficiary? Certainly, a court could set out a number of factors that would influence its decision, but without those, estate planners and trustees are left with significant uncertainty.

We Need SJC Guidance

Mrs. Savoy has asked the Supreme Judicial Court to review this decision. We can hope that they will take on the case, correct the misinterpretation of the trust provisions and provide guidance on whether and how the actual administration of the trust should or should not affect the results.

 

Related Articles:

In Pfannenstiehl Case, MA SJC Affirms Use of Asset Protection Trusts

How to Tailor Your Asset Protection Trust

7 Reasons to Use a Professional Trustee

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