But that’s where I found one yesterday. And if it exists under California law, it may exist where you practice as well.
A testamentary trust paying some current income to a prospective client sent me to the cases. I needed to know
- did the trust have a spendthrift clause
- if so, was the income stream exempt
- does the corpus come into the estate if the trust terminates within 180 days of the filing of the bankruptcy
What I found is case law holding that under state law, the exemption created by the sprendthrift provision protects 75% of each income distribution. The remaining 25% is subject to levy in the hands of the beneficiary. That mirrors the exemption provisions for levies on wages.
But the probate code went further: the 25% that creditors, and therefore the trustee, can reach is a cap, and under state law, any part of that 25% that is necessary for the support of the beneficiary or his dependents is also exempt.
Behold the marvelous operation of the intersection of state law and bankruptcy law. This probate exemption is nowhere found in the two sections of the California Code of Civil Procedure that identify the alternative exemption systems. Yet it holds out the prospect of reserving unto the debtor all of the stream of income flowing from the spendthrift trust.
By the way, I found that even if the death that will terminate this trust occurs within 180 days of the commencement of the bankruptcy case, the corpus does not become property of the estate by reason of §541(c).
Another time, let’s talk about some of the other issues that trusts, intervivos, testamentary and spendthrift, raise when a bankruptcy is in prospect.
In the mean time, see what the law of your state provides on spendthrift trusts and the vulnerability of income distributions to claims of creditors.
Image courtesy of Wikimedia and the US Forest Service.