In the United States, there are two very different types of property law for married couples: common law and community law. There are many variations in the details of these ownership styles across many states, but some general rules apply in each case. Any state that is not a community-owned state is a common law state.
Community-owned states offer a separate tax advantage for couples’ assets when one of the spouses dies. But if you live in a common law state, there is some good news: Several states have passed statutes that allow married couples living in any common law state to establish a community-owned trust with a qualified trustee. The advantage they can get is an increase in the cost base with each death, something not previously available in common law states.
First, let’s briefly discuss what “community property” means. Nine states – Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin – operate under community property laws, as does Puerto Rico. Under common property law, each member of a married couple owns half of the entire property, with all property rights. It is usually assumed that all assets acquired during a marriage are the property of the community, with the exception of assets acquired by gift or inheritance. But the law varies greatly between community of property states regarding some important matters, for example, whether one spouse can identify a property as community property without the other spouse’s consent and whether an unsecured creditor can claim against any property. of the community if both spouses have not signed the guarantee.
Under the Federal Income Tax Act, IRC § 1014 (b) (6), all community property (including both half the deceased’s interest in the community property and half the surviving spouse’s interest in the community) receives a new basis upon the death of the first spouse equal to its fair market value; in other words, the cost base is strengthened and the assets can be sold without recognizing a capital gain.
The property in the sole name of the second spouse to die may receive a second increase based on, but there is no second increase for those assets that were placed in irrevocable trusts prior to the second death (such a trust may be needed to protect the assets in the scope of exemption from life inheritance tax or to qualify assets for unlimited marital deduction, commonly referred to as AB trust planning).
States of common law
Under common law, married couples generally own assets jointly or individually. Upon the death of the first spouse, the assets in the name of the deceased spouse, or in the name of a revocable trust, are increased. Assets held in conjunction with death only receive an increase based on half the ownership. And the single-name assets of the surviving spouse are not strengthened. However, when the surviving spouse dies, the assets held in his sole name can get a basic increase. Again, this does not apply to assets placed in irrevocable trusts prior to death.
With the portability of the lifetime inheritance tax exemption, most couples seek fiduciary planning for financial organization and professional asset management. AB trust planning can be helpful in protecting assets that are expected to grow substantially after the death of the first spouse or when the first spouse to die wants to bind those assets for his or her descendants in the event that the surviving spouse remarries and could decide to favor a second family.
Common law states that offer mutual funds of ownership
So far, five common law states have passed community-owned trust statutes that authorize a married couple to convert common law ownership into community property. I’m:
- South Dakota
The purpose of community-owned trusts is to enable married couples living in the resident state and others living in common law states to also obtain an enhanced foundation for all assets they own on first death, just like in the states. owned by the community. Residents living in a common law state that does not offer this trust solution can still execute a community-owned trust in one of the community-owned trust states, but must appoint a qualified trustee in that state.
Tennessee Community Property Trust
As I am a consultant for a trust company founded in Tennessee, I can only talk about the ins and outs of a community-owned fund: the Tennessee Community Property Trust. However, understanding how this trust works will generally prepare residents of other common law states to consider this strategy.
The Tennessee Community Property Trust Act (TCPTA) of 2010, Tennessee Code Annotated, Section 35-17-101, et seq, allows married couples to convert their individual assets into community property. Each spouse is believed to own one-half undivided stake in each asset of a community-owned fund. Therefore, IRC § 1014 (b) (6) (described above) applies in the same way as community-owned states to provide an increase in the death date value base for the entire community-owned fund at death of the first spouse to die.
According to the TCPTA, a community-owned fund can be voluntarily funded with some or all of the couple’s assets, without the assets being marital property. Grantors may transfer any property jointly or exclusively owned by one of the parties to the trust. Grantors will determine their rights and obligations in the trust assets, regardless of when and where the property was acquired or located, the disposition of those assets in the event of dissolution, death or other event, and any other matter relating to the ownership of the trust. that does not violate public policy.
To qualify under the TCPTA, a community-owned trust must follow a few rules:
- Both spouses must be grantors.
- The trustee must be a qualified Tennessee trust company, bank, or resident, including one or both spouses residing in Tennessee.
- The trust must divide the assets equally in the event of a divorce or must include terms that address the division in the event of a divorce.
- The trust will be subject to the claims of creditors, but only half of the assets are subject to the creditors of each spouse.
- Grantors must be able to distribute or remove fiduciary assets at any time and those assets will no longer be the property of the community.
Grantors can jointly modify or revoke a community trust at any time. An individual grantor can modify the trust to change how that grantor’s assets will be disposed of in the event of death and can revoke the entire trust without the consent of the other grantor. The trust can be written to preserve other purposes which can be changed.
On the first death, the trust’s assets must be divided into a survivors’ share and a deceased’s share. These shares can then fund a surviving irrevocable trust and an irrevocable marital trust for the benefit of the surviving spouse. Both of these trusts will get an additional base increase on the death of the surviving spouse if properly drafted. They will therefore avoid federal capital gains taxes on trust assets sold by a surviving spouse and, once again, avoid federal capital gains taxes when the assets are sold by the beneficiaries of the surviving spouse’s trust.
In addition, lifetime exemptions from the couple’s joint estate tax can be applied to protect the trust’s assets from estate tax if certain strategies are employed. The surviving spouse may be given general naming power in the survivor’s trust and may have an unlimited right to withdraw all the assets of the survivor’s trust. The surviving spouse may also choose to have all or part of the marital trust treated as a qualifying marital deduction trust or as qualifying terminal interest property (QTIP).
Applying these strategies will result in the survivor’s trust and marital trust being included in the surviving spouse’s taxable property for income and inheritance tax purposes, subject to exemption from lifetime inheritance tax (plus any unused deceased spouse exemption) and will allow for a base increase to be desired upon his or her death.
Senior Vice President, Argent Trust Company
Timothy Barrett is a senior vice president and trustee advisor of Argent Trust Company. Timothy is a graduate of the Louis D. Brandeis School of Law, 2016 Bingham Fellow, board member of the Metro Louisville Estate Planning Council, and is a member of the Louisville, Kentucky and Indiana Bar Associations and the University of Kentucky Estate Planning Committee for planning Institute program.