Category: Alerts

Why Create An Estate Plan?

As 2013 started, the estate planning world had a new law: The American Taxpayer Relief Act of 2012 (ATRA), enacted January 2, 2013. In order to understand the current estate tax situation, we have to go back to 2001, and look at how we got to the current state of affairs.

Historical Review: The Repeal of the Estate Tax

During the first half of 2001, both houses of Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, or “EGTRRA,” and President Bush signed the Act into law. EGTRRA made changes to a wide range of tax laws, including far-reaching changes to the federal estate tax system.

It gradually increased the amount of money that people could pass on, tax-free, at death. In 2002, the amount an individual could pass on without paying estate tax was $1 million. By 2008, the amount excluded from estate tax increased to $2 million, and in 2009, the estate tax exclusion amount jumped to $3.5 million.

Finally, in 2010, the federal estate tax was repealed altogether.

Because of budgetary issues, the repeal was designed to be effective for one year only. The estate tax repeal, and EGTRRA itself, were scheduled to “sunset” on December 31, 2010. But that didn’t happen.

2011: The Estate Tax is Back

At the end of 2010, no one quite knew what, if anything, Congress was going to do about the estate tax. Initially, 2010 marked a one-year repeal of the estate tax. If Congress chose to do nothing, we were facing a return to the $1 million estate tax exclusion, with a top tax rate of 55%.

On December 17, 2010, after lengthy discussion and debate, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which became known as “TRA 2010.”

ATRA made TRA 2010 permanent and changed the rate of taxation.

In late 2017, Congress passed yet another tax law, which doubled the exemption to $10 million (adjusted for inflation from the 2011 base year).  However, after 2025, that law “sunsets” or expires, and the law reverts to the prior law’s “permanent” $5 million exemption (adjusted for inflation from the base year of 2011).

The Good News

When it comes to the estate tax, TRA 2010 made three major changes. These involve the estate tax exclusion amount, the tax rate and a new portability provision.

Federal Estate Tax Exclusion

As you know, not everyone’s assets are subject to the estate tax. Each person gets what’s called an “estate tax exclusion.” This is the amount of property that can be passed to your heirs and beneficiaries free of the estate tax at the time of your death. For the years 2010, 2011, and 2012, the temporary exclusion amount was set at $5 million (inflation adjusted). ATRA made this amount permanent and adjusted it for inflation. The 2017 law doubled the ATRA exclusion amount (temporarily). In 2018 it is 11.2 million.

Federal Estate Tax Rate

If the value of your estate exceeds your exclusion amount, and therefore ends up being subject to the estate tax, the top tax rate was 35% through 2012. ATRA increased the rate for 2013 and later to 40%.

Portability

With TRA, Congress also introduced a new “portability” provision. This is where one spouse can add their deceased spouse’s remaining estate tax exclusion to their own exclusion to shelter more from taxes. This portability provision, also known as the “Deceased Spousal Unused Exclusion Amount,” can be used to shelter the assets of the surviving spouse. However, portability only applies if the estate of the first spouse to die files an estate tax return, even if it would not otherwise be required. Further, portability does not provide remarriage protection, asset protection, or other advantages which might be available with proper planning. ATRA made portability permanent.

Federal Gift Tax

What happens to the gift tax under the new law?

Annual Exclusion

The annual exclusion amount for the federal gift tax is $15,000 for 2018, and it will be adjusted for inflation in 2019 and later years. This means the maximum value of gifts you can give to a single recipient without filing a gift tax return and without tapping into your lifetime exclusion, (discussed below), is $15,000 per year. Spouses can combine their annual gift tax exclusions and give gifts of up to $30,000 in value to each recipient each year.

Lifetime Exclusion

What if your annual gifts to one recipient are more than the annual exclusion amount? You can use a portion of your estate tax exclusion to make lifetime gifts, but then your exclusion would not be available at death. You can use your entire exclusion during life. Of course, then you would not have any available at death.

Federal Gift Tax Rate

As with the estate tax, the top gift tax rate for the years 2011 and 2012 was 35%. ATRA increased the rate to 40% for 2013 and later years.

State Estate and Inheritance Taxes

In addition to the federal estate and gift taxes, outlined above, many states have a separate state estate tax or inheritance tax. A state estate or inheritance tax typically applies to those who die when residents of the state or owning property in the state. A state estate tax typically works just like the federal estate tax. You add up your estate and then you get taxed on everything over a certain amount. An inheritance tax is similar but is based on the relationship between the deceased person and the person receiving property. The problem is that the state estate and inheritance taxes typically kick in at a much lower level than the federal estate tax. In other words, an estate which might escape without owing any federal estate tax might end up paying a significant state estate tax.

What is My Estate Worth?

To determine what your “estate” is worth (and could be taxed on), let’s break it down. You’ll need to include all of the following assets for both you and your spouse:
• Checking and Savings Accounts
• Home and Other Real Property
• Timeshares
• Cars and RVs
• 401ks and Other Retirement Accounts
• Deferred Annuities
• Pensions
• Profit Sharing Accounts
• Stocks, Bonds and Trading Accounts
• Life Insurance (full matured face values, not cash values)
• Collections
• Jewelry
• Furniture
• Antiques and Artwork
• All Other Personal Property
• Ownership in Businesses
As you can see, your combined estate value can quickly add up!

Planning and the Uncertainty

While today’s tax law provides for a substantial exclusion, we do not know what the tax law might be in the future. Just as easily as Congress passed prior laws, it could pass another law that changes the exclusion again, or otherwise upsets the apple cart that is your estate plan. That’s why it is important to review your estate plan periodically with an experienced estate planning attorney.

Those with $5.6 Million in Combined Net Worth

If you and your spouse have a combined net worth of $5.6 million or more, or if you are single and have a net worth of $5.6 million or more, having an estate tax plan in place is essential. And remember, the IRS counts assets like life insurance policies and retirement accounts; so, you may have a higher net worth than you realize.
An estate planning attorney can let you know for certain whether you need to worry about estate tax planning, and if you do (and choose not to rely on portability), he or she can help you shelter your estate tax exclusion in a Family Trust so that your hard-earned assets go to your loved ones instead of to Uncle Sam, other creditors, or a future divorcing spouse. An estate planning attorney may also be able to help you save more by using advanced estate planning methods like an Irrevocable Life Insurance Trust, a Family Limited Partnership, or a Grantor Retained Annuity Trust.

With the future of the estate tax in such a state of uncertainty, it’s essential that you stay in touch with your estate planning attorney. He or she can keep you updated on any changes in the law – and let you know if your tax planning strategy needs to change accordingly.

Those with Less Than $5.6 Million in Combined Net Worth

If your combined net worth is under $5.6 million, it doesn’t mean you are off the hook and should not put a plan in place. There are other important reasons families set up estate plans like wills or Living Trusts. Those reasons may include wanting to avoid the public and sometimes expensive process of probate, added complications of blended families and remarriages with step-children, protection from divorce (yours or your children’s) or creditor protection. Consulting with an experienced estate planning attorney can help you sort through your goals and concerns to determine which type of plan is best for your personal situation.

What Should I If I Have an Estate Plan?

As we have seen time and time again, the tax laws continue to change ― sometimes benefiting us and sometimes not. With this in mind, it is important to do regular reviews of your estate plan to make sure you are taking full advantage of all the tax savings opportunities and avoiding paying too much in taxes whenever possible. Also, if you have had changes in your family situation (births, adoptions, divorces, marriages, remarriages or deaths), your estate plan needs to evolve and change, addressing any new goals or concerns you may have.

Those with Simple Trusts

A simple trust, such as a Revocable Living Trust, may not minimize your estate taxes. Your estate planning attorney can help you find an appropriate estate planning method, like an AB Trust if appropriate, to shelter your assets and reduce your estate tax liability.

Those With Wills

A will guarantees that your remaining assets (home and other real property), regardless of their worth, will be subject to a public probate process, which many families wish to avoid. In some states, probate can be a lengthy and costly process which can hold up valuable funds while it runs through the court system. Even if you are not worried about your family having to deal with the probate process, you may want to protect them and your hard-earned assets from other everyday situations which can result in a significant loss of those assets. These asset-losing snags often come into play when you have blended families, remarriages with step-children, creditor problems, divorces (yours or your children) or if you become disabled. Will-based plans often do not provide appropriate provisions to address these common concerns. It is always good to review your will-based plan with an estate planning attorney to make sure it addresses all of your current, and more importantly, future concerns.

Estate Planning is More Than Just Tax Planning

Whether or not you think your estate will be affected by the changes in the tax law, it is essential that you have an estate plan in place. Why? Because tax planning is just one small portion of a comprehensive estate plan.

An estate plan brings certainty and stability to the lives of your loved ones. It gives them direction for how your assets are to be managed should you become disabled or pass away. It allows you to decide who will care for your minor children and to have a plan in place for providing for your children, even after you’re gone. Most of all, it allows you to protect your loved ones from the turmoil and uncertainty that are guaranteed if you fail to plan.

© American Academy of Estate Planning Attorneys, Inc.

According to a study by the National Center for Health Statistics of the U.S. Department of Health and Human Services, 20% of first marriages face “disruption” (defined as separation or divorce) within the first five years. One-half of all first marriages face disruption within the first 20 years of marriage.

After disruption of the marriage, most people remarry. 75% of divorced women remarry within ten years. This trend toward multiple marriages has resulted in millions of “blended” families. While each family is unique, blended families bring even more challenges for estate planning. Each spouse may have children from prior marriages and the two spouses may have children together. Spouses may come to the marriage from different financial positions.

In the traditional couple’s estate plan, the couple wants the surviving spouse to have access to all of the assets at the first spouse’s death. They typically want the assets split equally among their children at the death of the survivor. This traditional couple’s plan often does not meet the needs of blended families.

A growing number of blended families will use a combination of two trusts to gain greater flexibility. The first trust, the Family Trust, contains the first spouse’s estate tax applicable exclusion amount. The assets in the Family Trust can be used for the benefit of any of the children when the predeceasing spouse wishes to benefit. The assets can also be used for the surviving spouse. The second trust is a Qualified Terminable Interest in Property (QTIP) Trust. A QTIP Trust leaves assets in trust for the surviving spouse. All of the income goes to the surviving spouse during his or her lifetime.

However, at the death of the surviving spouse, the assets are distributed as the predeceasing spouse directed. In other words, the assets could go to the children of the predeceasing spouse if desired. The surviving spouse does not have to have the ability to alter the disposition. By leaving assets in the QTIP Trust, they qualify for a marital deduction at the death of the first spouse. This means there need not be any estate tax due at the death of the first spouse.

The assets of the other spouse can have a completely different set of beneficiaries than the assets of the predeceasing spouse. So, the husband could leave the assets in the Family Trust to the wife for her life and then to his own children. On the other hand, the wife may decide the husband has sufficient assets and leave the Family Trust directly to her own children, excluding the husband. Both the husband and wife might decide to leave assets over the estate tax exclusion amount in QTIP Trusts for each other.

Each blended family is unique. Each couple has its own set of goals to accomplish. Proper estate planning can tailor a solution to help meet those goals. A qualified estate planning attorney can help you decide upon a plan that fits your unique situation.

DIVORCE, TAXES AND YOUR ESTATE PLAN

Fortunately, some good news does exist within the arena of divorce, and it comes from none other than the IRS. Here’s the benefit. The IRS generally does not consider the transfer of assets between divorcing spouses a taxable event. This includes cash that one spouse pays another as part of the divorce settlement. There are a few restrictions to this rule, but as long as you can demonstrate that you are divorcing for legitimate reasons not related to tax savings, you and your soon-to be ex could transfer cash and assets without fear of a tax gain or loss to either party. At least, not in the short-term future.

DEPENDENCY TAX EXEMPTION FOR CHILDREN

As in most divorce settlement negotiations, you and your spouse will probably have several bargaining chips on the table. One may be the dependency exemption for your children. These exemptions mean a lot to lower and middle income taxpayers, but not as much to high income Americans as a result of the deduction phase out.
But as often happens after divorce, there may be a significant disparity in earnings between you and your spouse. And in that case, the dependency exemption may become a chip worth bargaining for.

FILING STATUS

Couples whose divorce won’t be concluded by December 31 of a given year will have to make a difficult decision regarding the filing status they choose on their tax returns. Married filing separate is the most costly filing status available. That’s why, if you and your spouse can agree to it, you may want to continue filing jointly until your divorce is final. There are two notable exceptions to this rule, however.

Exception 1: You probably shouldn’t file jointly if your spouse has incurred taxes that he or she won’t be able to pay. By filing jointly, you assume liability for your spouse’s taxes as well as your own. If the IRS can’t get satisfaction from your spouse, it will turn to you for payment.

Exception 2: You may not want to file jointly if you suspect that your spouse isn’t fully disclosing income or is falsifying deductions. Once again, you may be held liable for your spouse’s tax liability, plus associated penalties.

WHO GETS THE CAPITAL GAINS?

Let’s assume that you are your spouse own stock that has appreciated substantially since you bought it. Purchased for $50,000 five years ago, the stock is now worth $100,000. If the two of you decide to sell the shares today, the gain would be $50,000, or the difference between your original investment and the selling price.

If you decide you’d like to keep the stock, and pay your spouse $50,000 (half the current market value) for full ownership, your total investment becomes $75,000. However, if you sell the shares, the cost basis used to determine your capital gains taxes won’t be the $75,000 you’ve actually invested in the stock. Instead, the government will look at your original cost basis – $25,000 – and your spouse’s original cost basis – also $25,000 – and deem that your actual cost basis is just $50,000! Therefore, the $50,000 cash you paid your ex-spouse for the stock goes to him or her tax free, while you are left with a hefty capital gains tax.

WHICH ESTATE PLANNING STRATEGY IS BEST?

Fortunately, all the problems described above can be neatly countered with a well-designed tax and estate plan. If you already have an estate plan in place, your main concern will be having it updated as a result of the new changes that your divorce has introduced into your life. For most, these estate planning issues are of greatest concern during a divorce:

• Controlling to whom, when and how assets are divided today, and how they will be distributed after death
• Capturing every tax break available during the divorce transition
• Maintaining control and management of certain assets
• Renaming beneficiaries

Here are three estate planning strategies that may help you achieve these objectives:

The Revocable Living Trust

This popular estate planning tool is unlike a will in that it allows you to avoid probate which brings on potential delays, expenses and public exposure. Instead, upon your death, your designated Successor Trustee assumes responsibility for management and distribution of your assets, which are owned by your Revocable Living Trust. Your trustee will follow the directions you have provided in your trust documents, including when you want assets distributed, to whom and by what means.

The Children’s Trust

Another estate planning strategy popular among parents is the Children’s Trust. It allows you to set aside funds which may be used at a later time to pay for college education or purchase a first residence.

The Irrevocable Life Insurance Trust

The Irrevocable Life Insurance Trust, or ILIT, accomplishes several important objectives. First, it lets you remain in control of the distribution of your life insurance policy’s proceeds long after you’re gone. As with the Children’s Trust, the ILIT disperses policy proceeds to your beneficiaries when and how you want. Because the trustee of the ILIT is your designee, you also ensure the proceeds remain out of your ex-spouse’s reach.

GETTING HELP

Any of these solutions, or a combination of all three, may help you achieve the tax advantages and control you seek. Equally important is the peace of mind you’ll gain when you know that, come what may, your children will be well provided for. ecause your goals and your family’s situation are unique, seek out the counsel of an attorney who concentrates on these estate planning strategies. Only he or she will be able to show you how you can best employ them for your children’s benefit.

© American Academy of Estate Planning Attorneys, Inc.

Just what is probate? Living probate is a legal process that determines your fate when you cannot, generally because you’ve been disabled by injury, illness, or mental incapacity. Death probate is the process that disposes of your estate after you die. Having a will virtually guarantees that your estate will go through probate. While probate attorneys might be happy with these definitions, trust attorneys would draw your attention to all the problems that come with probate: red tape, expense, publicity, delay, loss of control, and in the case of living probate, potential for personal humiliation.

THE IMPACT ON SENIORS

Way back in 1989, the American Association of Retired Persons (AARP) decided to look carefully at probate and its impact on seniors. As the organization reported in its study, Probate: Consumer Perspectives and Concerns, probate is a special concern for older Americans.
The study found that 90% of all probate cases involved the disposition of property owned by people 60 years of age or older. Because the chances of becoming incapacitated increase dramatically as we age, living probate is also much more likely to involve seniors.

AARP went on to reveal that consumers nationally spend as much as $2 billion or more each year on all probate-related expenses, with attorneys’ fees alone representing more than $1.5 billion of that amount. The study noted that attorneys’ and executors’ fees could consume as much as 20% of small estates, and as much as 10% of even uncomplicated estates . And that’s only the beginning. Add to these fees such expenses as court costs and appraisers’ fees, and your heirs could end up with a legacy that’s considerably less than you intended.

HOW PROBATE AFFECTS SENIORS’ FAMILIES

AARP found that probate usually comes into play after the surviving spouse of marriage dies. Most couples own property jointly. So, at the first death, much if not all of their property immediately becomes the sole possession of the survivor. When the survivor dies, however, their property will have to go through probate before it can pass on to their heirs. Since few couples take into consideration probate costs, many would be saddened to learn how big a dent it will make in their intended gifts.

Seniors aren’t the only ones who may be blind-sided by probate. Their children and grandchildren may feel the bite as well. A study by American Demographics Magazine revealed that many Baby Boomers are so financially strapped today that they are deferring an important financial goal: saving for retirement. Instead, they are counting on their inheritance from Mom and Dad to help pad their meager retirement funds.

So, the higher the probate fees, the less of a legacy they will receive, and the harder it will be for them to retire.

WHAT THE AARP HAS TO SAY ABOUT PROBATE

Unreasonable expenses aren’t probate’s only drawbacks. There’s also the time involved.
AARP’s study found that probate frequently lasts longer than a year. Having a will seemed to make no difference in the time required. In fact, it could drag the process out even longer.

Now, add to the expenses and delays of probate these problems: a loss of control over one’s affairs and the publicity it requires. You can see why AARP declared that:

Probate as it is generally practiced in the United States is anachronism… and, to the extent that the probate system is unreasonable, attorney’s fees in connection with the probate work are unreasonable.

WHY ATTORNEYS DISAGREE ABOUT PROBATE

AARP’s edict sums up the reason for so much rancor between pro-probate and pro-trust attorneys. It’s a matter of money, and lots of it. The AARP study noted that attorneys often build lucrative practices focused solely on probate. Many use cheap wills as a “loss leader.” According to AARP:
This marketing practice may set a costly trap for consumers. Attorneys lay the groundwork for their probate practice by writing wills. Some write wills cheaply as a way to generate other business, prompting the companion to loss leader discounts in retail trade. When the client dies, the same attorney, or other member of the firm, probates the will at a high fee enough to recover any money lost on the earlier discount.

But not all attorneys have been happy with the status quo and escalating consumer dissatisfaction with probate. A growing number, such as the members of the American Academy of Estate Planning Attorneys, would rather spare their clients the expense, delay, publicity, inconvenience and potential for public humiliation that can be such an integral part of the probate process.

IS PROBATE EVEN NECESSARY?

“Death Probate” has these primary functions:

• It verifies the validity of your will.
• It inventories and establishes the value of your significant assets.
• It provides your creditors with the opportunity to make claims against your estate.
• It gives disgruntled family members a forum for challenging your will.
• Lastly, when all these steps have been completed, it transfers the title to your property to your heirs, as you’ve instructed in your will.

Do you really need probate to accomplish these tasks? AARP says no. Instead, it recommends alternatives such as the Revocable Living Trust.

HOW TO AVOID PROBATE WITH A LIVING TRUST

Whether you die with a will or without one, probate will be required if you owned any property in your own name. A Living Trust makes probate unnecessary by changing the way you own your property. Although you still have absolute control over all your assets, just as if you owned them directly, you do not own property in your own name. Instead, your Living Trust owns your property. And you own your Living Trust.

At first blush, that can sound like a scary proposition. But it isn’t, because you are the trust maker, the trust owner and trust beneficiary. So you and you alone control your trust and the assets it owns. You can buy, sell, trade, derive income from, mortgage and give away your trust assets, just as before. You can change your trust, add to it, or even revoke it any time you want. Bottom line: the fact that your trust owns your property has little, if any, impact on the way you live and conduct business each day.

But what a difference the trust makes when you die. Then, the person you’ve chosen to take charge of your trust, your successor trustee, steps in and follows your direction for the disposition of your estate. Because you owned no property in your own name, there’s no need for probate. So there’s no publicity and, compared to probate, very little expense, delay or inconvenience for your family.

Living Trusts are also indispensable for avoiding the indignity of living probate, the court proceedings that determine who will oversee your affairs in the event of your disability. A Living Trust helps you ensure that your physical and financial needs are handled as you would want them to be.

The Living Trust isn’t exactly a new idea. Its origins date back hundreds of years. More importantly for Americans, the concept has been used in the U.S. since 1765 when Patrick Henry drafted a trust for Robert Morris, governor of the Colony of Virginia. During this century its many proponents have included John F. Kennedy, William Waldorf Astor, John D. Rockefeller, H. L. Hunt, Bing Crosby and Frank Sinatra. As consumers become better educated about the pitfalls of probate, all signs point to Living Trusts becoming even more popular in the years ahead.

JUST FOR THE WEALTHY?

Now that you know all the problems that probate entails, it’s probably the last thing you’d want to bequeath your loved ones. But is it a strategy worth pursuing only if you’re a Rockefeller or Vanderbilt?
Absolutely not. Even if your estate is valued at no more than $100,000, you should probably have a Living Trust to avoid death probate. And regardless of how much your estate is worth, you should definitely have a Living Trust if you want to avoid living probate.

Who should you turn to for help with your Living Trust? The American Academy of Estate Planning Attorneys recommends that you start with an attorney who concentrates on this area of the law. That’s the best way to ensure that your legal professional has invested the time and energy to providing you with the most current estate planning techniques.

But be wary. Remember that wills and probate are also estate planning tools. So make sure your attorney focuses on the Living Trust, rather than wills.

GETTING THE MOST FROM YOUR LIVING TRUST

Once you’ve worked with your estate planning attorney to draw up your Living Trust, don’t stop there. Taking advantage of everything this powerful estate planning tool has to offer requires these final steps:

• Make sure you fund your Living Trust. Remember that it only works if the title to your property has been transferred to the trust. If you keep your property in your own name, you’ve defeated its purpose. These days, most financial advisors are experienced in funding Living Trusts, so be sure to turn to your advisor for help if you need it.
• Keep your Living Trust current. As you acquire new property, be sure that you transfer title to these assets to your Living Trust.

Ideally, a Living Trust is a living, breathing document, and a plan that will serve you for many years to come. That means, however, that you’ve got to take the time to have it updated as your family’s situation, your goals, and your needs change. A good estate planning attorney will stay in touch with you over the years to ensure your Living Trust continues to serve you well.

Yes, it is true that a Living Trust will cost you more up front than a “discount” will. But in estate plans, as in all other areas, you get what you pay for. The bargain you buy today might just cost you or your heirs a fortune – your fortune – down the road.

© American Academy of Estate Planning Attorneys, Inc.

Although Joint Tenancy offers some short-term conveniences, in the long run it poses a host of problems that can cost you and your loved ones many times the expense and headaches you thought you were avoiding.

It happens almost automatically.  When you and your spouse open a checking account, buy a car, purchase a home, or acquire just about any other asset you can think of, the first — and usually only — impulse is to put the title in both your names as Joint Tenants.

Married couples aren’t the only ones relying on Joint Tenancy.  This ownership strategy is widely used by friends, life partners, parents and their children, among others.  It’s an ownership method so pervasive, many consumers often say they know of no others.

Why is Joint Tenancy so frequently employed?  Ironically, otherwise well-informed consumers choose Joint Tenancy because they’ve heard it is a cost-free replacement for a will and that it avoids probate.  These consumers focus on the fact that at the death of one of the owners, Joint Tenancy — or more precisely, Joint Tenancy with Right of Survivorship — immediately passes full ownership of an asset onto the surviving Joint Tenant by operation of law.  So, yes, it does circumvent probate and avoid the need for a will.  At least for the moment.

What all too many Americans unfortunately overlook is the fact that Joint Tenancy only temporarily avoids probate.  It also brings with it a slew of problems that more than make up for any short-term convenience it provides.  In fact, Joint Tenancy can end up costing you — and your loved ones — many times the expense and headaches you thought you were avoiding.

Consequences include:

• Joint Tenancy may avoid probate at the first death.  But upon the death of the surviving Joint Tenant, the entire estate will have to pass through probate.
• Joint Tenancy means that the first person to die loses all control over to whom or how his or her assets will ultimately be distributed.
• With Joint Tenancy, spouses effectively lose their right to a double federal estate tax exclusion.
• Depending on the state in which you reside and the state in which the joint tenancy property is located, Joint Tenancy may expose assets to capital gains taxes that otherwise could have been avoided.
• When the Joint Tenants aren’t husband and wife, gift taxes may be due.
• Joint Tenancy exposes one Joint Tenant to the financial risks, liabilities, and other potential problems created by the other Joint Tenant.

Let’s take a closer look at each of these areas and how they may affect you.

PROBATE, AFTER ALL

Frequently called the “Poor Man’s Will,” Joint Tenancy is often used as a replacement for wills and as a tactic for avoiding probate.  But this is only half the story.  Joint Tenancy does alleviate the need for probate when the first owner dies.  But when the second/last owner dies, the entire estate goes through the often costly, time-consuming and nightmarish probate process.

After 30 years of marriage, Gene and Marjorie Cummings had accumulated the usual trappings of married life. The home they bought 25 years ago for $100,000 was now worth $500,000. When they added in the value of their autos, furnishings, and cash accounts — all held in Joint Tenancy — they were slightly amazed to discover their estate was worth $1.5 million. When Gene died suddenly, Marjorie immediately became the sole owner of their $1.5 million estate by operation of law, circumventing the probate courts. But upon her death 15 years later, the entire estate — now worth over $2 million — was subjected to probate.

LOSING CONTROL

Today more Americans are involved in second marriages than in first. And often, remarriage means that either one or both of the partners has children from a previous marriage. Whenever a parent holds property in Joint Tenancy with a spouse, children are effectively disinherited. That’s one reason why parents with children from a prior marriage should rarely, if ever, own property in Joint Tenancy with a new spouse. Instead, remarried parents should choose ownership strategies that will help them ensure their children are well provided for in the event of their death.

Even when children from a prior marriage aren’t a factor, you may want to think twice about whether you want to give up total control over how the fruits of your life’s work are distributed at your death. Since many widows and widowers will eventually remarry, there’s a strong likelihood that someone your spouse may marry in the future will be the ultimate beneficiary of your estate. For some people, that’s of little concern. But most of us would rather see our assets benefit a relative, friend or favorite charity, rather than some stranger we’ve never met.

A TAXING ISSUE

As an estate taxation planning device, Joint Tenancy is not optimal. As the death of the first tenant, there may be little concern. Through the Unlimited Marital Deduction, the government lets spouses pass assets to one another at death estate tax-free. However, when the survivor dies, estate taxes can reduce the legacy the couple thought they were leaving behind. Why? At the death of the survivor, the value of the entire property is included in the survivor’s estate. If the sum of all of the survivor’s property is less than the amount that can be passed free of estate tax, this may not be a problem. This amount is $5 million for federal tax purposes, indexed for inflation. However, many states have a separate state estate or inheritance tax which kicks in at a much lower level.

CAPITAL GAINS EXPOSURE

Couples who live in one of the nine community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin — pay a high price when they put assets in Joint Tenancy rather than owning them as community property. In these states, using Joint Tenancy can actually expose your estate to costly capital gains taxes. Here’s how.

The capital gains tax, that often-debated revenue generator for the federal government, is a tax levied against your profit when you sell an asset. To determine the amount of capital gains against which the tax will be applied, you deduct your cost basis in the asset — meaning your investment in it — from the price it fetches when you sell it. The difference is your capital gains, and that’s the sum which will be used to compute your capital gains tax. For instance, if you bought rental property for $125,000 and sell it later for $200,000, you would owe capital gains taxes on $75,000.

The federal government provides a capital gains tax break on assets in a person’s estate. Called a step-up in basis, it simply means that when you die, the government will consider your heir’s cost basis in an asset to be its current market value, not your original purchase price. So, if the rental property you originally bought for $125,000 is worth $200,000 when you die, your heir’s cost basis would be $200,000. If your heir sells it for that price, no capital gains tax will be due.

A very taxing situation occurs, however, when you live in a community property state but hold title to an asset in Joint Tenancy with your spouse. Instead of getting that step-up in basis on the entire sum — as your survivor would if the asset were community property or owned outright by you — the government allows him or her only half the step-up in basis.  That means when the asset is sold, more of the profit will be subject to costly capital gains tax.

California residents, Nick and Sandy Worthington, had an admirable art collection, with pride of place going to an acclaimed Matisse.  It was one of the first pieces they bought, paying $50,000 for it several years ago.  When Nick died last year, the painting was appraised at a whopping $500,000!  Unfortunately, Nick and Sandy had placed ownership of the painting in both their names, as Joint Tenants, rather than owning it as community property.  That meant the painting received the favorable step-up in basis treatment on only half its value.  So, much to Sandy’s dismay, instead of a cost basis of $500,000, she now has a cost basis of only $275,000.  If she were to sell the painting today, $225,000 of her profit would be subject to capital gains tax, an expense she could have avoided completely if she and Nick had titled ownership of the painting differently.

JOINT TENANCY AND GIFT TAXES

So far, we’ve focused primarily on the impact of Joint Tenancy and married couples.  But frequently, Joint Tenancy is used as a method of ownership between non-spouses.
For instance, friends often buy property together.  An aging relative will often make a younger relative a Joint Tenant on property or cash accounts.  Parents make their children Joint Tenants with them on everything from cash accounts to cars to the family home.

Unfortunately, the government takes a dim view of these transactions, sometimes considering them to be gifts, not estate planning strategies.  That’s why many Americans are shocked to discover that the step they’ve taken to avoid wills and probate will in the long run cost them many, many times more money than it saves.  Let’s look at some examples.

When a non-spouse is added to the title of property as a Joint Tenant, the government deems it to be a gift.  Gift taxes will become due, and the donor — the person presumably making the gift — will usually be liable for the taxes.  (Under extreme circumstances, however, the done — the person receiving the gift — may become liable.)  How much gift tax is due and when it is due depends on the asset.

For example, elderly relatives commonly add a younger relative or an adult child to their checking accounts, savings accounts and other cash accounts as a convenience.  As long as the new Joint Tenant withdraws money strictly for the use of the original Joint Tenant, no gift taxes are due.  But if he or she withdraws money for personal use, the original Joint Tenant will have to pay gift taxes on that amount.

The gift tax situation is even more dire when real estate is involved.  At the time a new Joint Tenant — who is not the spouse of the original Joint Tenant — is added to the title of real property, the government considers a gift to have been made.  Gift taxes will then be due on the portion of the property the new Joint Tenant receives.  For example, if a father decides to add his son as his Joint Tenant on his personal residence, the government will consider that the son has been given a gift equal to half the home’s value, and demand the father pay gift taxes accordingly.

Of course, there are some exemptions available for gifts.  Each year you may give away up to “pre-determined dollar amount”, indexed for inflation, per individual — and to as many individuals as you want — with no gift taxes due. Gifts in excess of that amount reduce the gift and estate tax exclusion. The gift and estate tax exclusion is $5 million, adjusted annually for inflation.

So, in many cases, the mere fact that you’ve added someone’s name as Joint Tenant to your checking account or real property may not actually require you to part with cold hard cash. Even if your gift falls within the exclusions described above, however, you must still report it on your federal gift tax returns.

EXPOSURE TO RISK

When you own property with a Joint Tenant, each of you owns half of the asset. That means you effectively lose control of half the property. Whether your Joint Tenant is your spouse or someone else, the implications of this exposure to loss are frightening. For example, half of your asset held in Joint Tenancy could be lost as a result of:

• Your Joint Tenant’s bad debts, back taxes or bankruptcy
• Your Joint Tenant’s divorce
• Lawsuits or damage awards filed against your Joint Tenant

More than exposure to risk, Joint Tenancy also deprives you of the day-to-day autonomy and control in managing your own asset. Consider, for example, that property is held in Joint Tenancy with someone else:

• You may have to obtain your Joint Tenant’s consent before you sell, pledge as collateral or engage in any other transaction involving your property.
• You may have to obtain the approval of your Joint Tenant’s spouse before you can dispose of your property.
• Your asset may fall under the jurisdiction of your Joint Tenant’s living probate, if your Joint Tenant becomes incapacitated through illness or injury.
• If your Joint Tenant is a child, your shared property may be the subject of guardianship hearings.
• If your Joint Tenant is a child, you run the risk that his or her financial inexperience, emotional immaturity, or the inevitable mistakes that are part of the growing experience, may have a disastrous financial impact on your shared asset.\
• Liquid assets — such as cash accounts — can be depleted by your Joint Tenant without any safeguards to protect you.

ALTERNATIVES TO JOINT TENANCY

Early on we said that Joint Tenancy is so pervasive, many people are hard-pressed to think of an alternative. Fortunately, there are several. For instance, you can own property solely in your own name. Or you and another person can own property as tenants in common. If you live in a community property state, you can elect that ownership option. Or, in some states, you can seek the special creditor protection spouses receive under tenants by the entirety. Each of these options avoids some of the pitfalls of Joint Tenancy.

However, none of them — and that certainly includes Joint Tenancy — is a replacement for the thoughtful estate planning that a qualified estate planning attorney can provide you.  In fact, all the objectives you might try in vain to achieve through Joint Tenancy can be achieved much more effectively through an option such as the Revocable Living Trust.  With a Revocable Living Trust, for example, you can:

Control exactly how your estate is distributed — including who your beneficiaries will be, when they will receive your legacy and how they will receive it. Ensure that children from another marriage — or children who have special needs — will receive fair treatment from your estate.

• Reduce your estate taxes or eliminate them completely.
• Take advantage of all other tax breaks to which you might be entitled.
• Retain complete control over your assets while you live.
• Put your legacy out of the reach of your heirs’ predators, creditors and others seeking a piece of your estate.
• Choose when, where and how you will make gifts to friends, family and worthwhile organizations.
• Enjoy peace of mind in the knowledge that you can make provisions for your care should injury, illness or some other incapacity make you unable to do so for yourself.

© American Academy of Estate Planning Attorneys, Inc.