Q: Can a Trust decide its distributions aren’t community property even when taxed as non passive K1 income & filed jointly?
In the case of divorce - Trust 1, which has a clause that names the beneficiary as spouse A & states distributions are not community property, owns an S corp (an LLC). The S corp paid distributions to spouse A, which were claimed jointly as non passive income in a community property state (AZ). The distributions went directly into trust 2 and/or businesses in the name of spouse A. Does Spouse B have any claim to these distributions? There is no prenup and this divorce is not finalized.
Unfortunately, you are asking a very difficult question. The answers hinge on the documents currently in place as well as the status of the divorce. The attorney will need to see if there is premarital agreement in place. If so, that agreement may control. We also need to look at the S Corporation By-Laws, Minutes and Buy Sell Agreements which generally discuss what to do in the event of divorce. If the S Corp is an LLC, the attorney will need to see the operating agreement.
Even so, rules change when a divorce is filed. If the divorce has already been filed, but not finalized, counsel for A and B should ask the Court to directly rule on your question. If the divorce has been finalized, I would recommend that you carefully review the dissolution documents for advice.
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