Increase in Value of Remainder Interest in Irrevocable Trust

The Balanson case has taken a very prominent role in Colorado domestic law. One of its many significant contributions is its holding that a remainder interest in an irrevocable trust is, in fact, property and increased value during the marriage of a separate property remainder interest is marital property subject to equitable division. In re Marriage of Balanson, 25 P.3d 28 (Colo. 2001) reversing in part In re Marriage of Balanson, 996 P.2d 213 (Colo. App. 1999). That increased value must be determined for the court to fashion a property division scheme, so that a valuation needs to be done as of the date of acquiring the separate property interest or date of marriage, whichever is later, and as of the date of the permanent orders.

Valuation of such property interests is still being developed and fine tuned, and there is no one endorsed valuation method. Case law has provided direction, though. See Beach v. Beach, 56 P.3d 1125 (Colo. App. 2002), reversed on other grounds 74 P.3d 1 (Colo. 2003); In re Marriage of Mohrlang, 85 P.3d 561 (Colo. 2003); In re Marriage of Dale, 87 P.3d 219 (Colo. App. 2003). For example, risks of forfeiture or depletion must be considered in the valuation process. In re Marriage of Mohrlang, 85 P.3d 561 (Colo. 2003). Additional factors to be considered in any valuation include actuarial information about the life expectancy of any beneficiary whose death triggers payment of the remainder interest, as well as the probability of the trustee invading the corpus. Id.

Irrevocable Trust – Basic Concepts

An irrevocable trust is a trust that can’t be modified or terminated without the permission of the beneficiary. The grantor, having transferred assets into the trust, effectively removes all of his or her rights of ownership to the assets and the trust. The main reason for setting up an irrevocable trust is for estate and tax considerations. The benefit of this type of trust for estate assets is that it removes all incidents of ownership, effectively removing the trust’s assets from the grantor’s taxable estate. The grantor also is relieved of the tax liability on the income generated by the assets.

Possible trust interests include an income beneficiary and a remainder beneficiary. These interests also are known as successive interests. An income beneficiary is an individual who is entitled to the income for the assets, rather than the trust corpus or principal. A remainder beneficiary is a person or entity entitled to receive what remains of the trust corpus or principal after a life interest has terminated, or upon other schedules events such a attainment of a certain age.

Remainder Interests in Irrevocable Trusts – Basic Valuation Methodology

A basic valuation methodology is the Subtractive Method, which is utilized by the Internal Revenue Service. This method incorporates present value factors (either by age or by number of years) which are provided in IRS publications. The value of the remainder interest of a trust is determined by multiplying the current value of the trust assets by the remainder interest factor. The remainder interest factor is determined by subtracting the income factor (as provided by the IRS) from one.

Remainder Interests in Irrevocable Trusts – Complex Valuation Methodology

In re Marriage of Mohrlang, 85 P.3d 561 (Colo. App. 2003), advises that the net present value of a vested remainder interest should be determined. The “valuation of such an interest should be accomplished by using an approach similar to that taken when valuing pensions.” The factors to be considered in determining whether the trust interest should be discounted by an appropriate rate are as follows:

• The life expectancy of the settler or current beneficiaries, if the vested interest is subject to the contingency of survival to a future date;
• The risk of forfeiture if the vested interest is inaccessible before a distant date and terminable upon the beneficiary’s death;
• Relevant information concerning the likelihood that the trust corpus would be invaded by the trustee in the future, and;
• Other contingencies.

The net present value method applied to the determination of a remainder interest value begins with a projection of the future value of the trust based upon an expected growth rate. The calculated growth rate should be consistent with the underlying assets of the trust. A provision for contingencies is included and can be treated as an adjustment to the discount rate and/or as an adjustment to the projected value. Finally, the calculated amount after a provision for contingencies is discounted to present value. The determination of the discount rate should be commensurate with the growth rate.

This method embraces sound financial theory. It is simple to understand and flexible. It also appears to fulfill the guidance regarding discounting in Mohrlang. There are weaknesses though, which include virtually unlimited contingency possibilities and subjective judgment. Additionally, this methodology has not been specifically embraced by the courts and despite one's best intentions, the results can be inaccurate.

Disclaimer:  Views expressed in these written materials do not necessarily reflect the professional opinions or positions that the author would take in an actual valuation, or in providing valuation services in connection with an actual litigation matter. Nothing contained in these written materials shall be construed to constitute the rendering of valuation advice; the rendering of a valuation opinion; the rendering of an opinion as to propriety of taking a particular valuation position; or the rendering of any other professional opinion or service. Valuation services are necessarily fact-sensitive particularly in a litigation context. Therefore, the author urges readers to apply their expertise to particular valuation fact patterns that they encounter, or to seek competent professional assistance as warranted in the circumstances.