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The Ins and Outs of Community Property

Couple with house planMany married couples living in the U.S. own assets that are deemed legally separate. This may include a business or real property purchased in one person’s name alone. The reason for this designation is that the laws of most states treat married individuals as financially unrelated to their spouse, except for joint accounts and those assets specifically mentioned in a will. However, there are some states called community property states that have different laws on this issue.
As a result, it’s important to know about community property laws in the event you move to one of these jurisdictions or already live in one.
Barron’s article, “How Community Property States Are Different,” explains that Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are the states in which everything you acquire during a marriage is considered legally owned by both spouses. For example, their state statutes view a couple as the co-owners of a business with a 50-50 partnership.
Here are a few other issues to consider.
Premarital assets. Typically, any wealth acquired before the marriage and any inheritances acquired at any time by one spouse are not the property of the other spouse. If you intend to keep them separate, leave them out of your community accounts created after the marriage. If you want to join finances, an estate planning attorney can help you with pre- and post-marital agreements and community property agreements to pool assets.
Estate plans. In most states, a married couple’s assets are divided evenly in life, and the same is true when one dies. One half the couple’s assets become part of the estate, which can make for major taxes in some situations. If a couple buys a home for $1 million, which then appreciates to $5 million, half of the value of the home—or $2.5 million—becomes a part of the decedent spouse’s estate. It’s given a step-up in basis—a readjustment of the value of the home to the market price over what was initially paid. But the surviving spouse keeps the original cost basis of $500,000. If that spouse wanted to sell the property upon the death of the spouse, he or she would have a cost basis of $3 million (the $500,000 cost basis plus the adjusted basis of $2.5 million) amounting to a $2 million capital gain.
Community property states are a plus in this case because they give a step-up in basis to the entire home. In this example, the surviving spouse will also get a step-up in basis, which means if he or she sells the home there would be no capital gains tax owed. However, the step-up in basis can complicate wealth transfer planning.
Gifting. In community property states, both spouses have to agree on gifts from joint funds. No one can make a gift of your property without your consent, and without that consent, the spouse who didn’t make the gift can revoke the gift at a later date. It’s best to make sure it’s in writing—even when it’s a gift to each other.
Life insurance. Talk with an experienced estate planning attorney before you create an irrevocable life insurance trust. For example, a husband creates an irrevocable life insurance trust to benefit his wife, and the trust buys a $10 million life insurance policy on his life. He will need to be certain that any gifts made to the trust and used to pay the premiums are paid for from a non-community property account—payments cannot come from a joint account. Otherwise, it places a portion of the trust into the estate of his wife, which defeats the purpose of having an irrevocable life insurance trust in the first place and subjects it to an estate tax. Sign a transmutation agreement, which makes the gifts to the trusts entirely one person’s.
It’s important to remember that when community property laws are advantageous to your situation, you can carry community property over with you when you move to a new state. An agreement can preserve the community property state of already-acquired assets and conserve joint trusts to save them from getting comingled with assets in the new state.
Be sure to consult with a qualified estate planning attorney who understands community property law.
Reference: Barron’s (June 28, 2016) “How Community Property States Are Different”

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Tax Free Giving

Bigstock-Money-Box-2428389While many people would prefer to wait until after death to give an inheritance to their heirs, others might prefer to give while they are still alive to see the benefits of their gifts. There are ways to give money now and avoid any tax consequences.

Traditionally, wealth is transferred from one generation to the next through inheritances. However, if an elder family member has more money than he or she needs and younger family members are in need, then it is often preferable to transfer the wealth while the elder person is still alive. In fact, that affords the older generation an opportunity to witness the impact of their generosity.

When it comes to giving methods, there are many ways to skin the cat. This was the subject of a recent article in the Columbus Dispatch, "Guide to Life: Pros and cons of leaving inheritances to relatives." Nevertheless, some of those giving methods are more tax savvy than others.

The article mentions three such ways:

  • Cash – A single person can give an individual $14,000 a year without tax consequences for the person receiving the gift. A married couple can give $28,000. This amount can be given to as many people as desired so long as no one individual is given more than the limit by the person giving the gift. Moreover, the giver must be sure not to have given more than his or her lifetime limit on "taxable" gifts (i.e., gifts made in excess of the annual gift exemption). That number is currently $5.43 million for a single person and $10.86 million for a married couple.
  • Student Loans – When you pay off a loved one's student loan debt, that does not count against the $14,000 annual limit on gifting. Caveat: This only works if the money is given directly to the educational institution.
  • College Savings – Money invested in a 529 college savings plan accumulates tax free and can be withdrawn tax free for qualified expenses.

These are just a few of the ways to make tax savvy gifts. Your estate planning attorney can help you with other techniques to benefit your family and favorite charities.

For more information about estate planning, please visit my estate planning website.

Reference: Columbus Dispatch (October 16, 2015) "Guide to Life: Pros and cons of leaving inheritances to relatives"

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Estate Planning Options for High-Wealth Individuals

AdvancedEP1346While the federal estate tax exclusion is currently larger than it has ever been at $5.43 million for individuals and $10.86 million for couples because of the portability of unused exclusion amounts, some families still face the challenge of reducing their estate to minimize or eliminate estate taxes. Because the top estate tax rate on amounts above the exemption is 40 percent, you can see why those with large estates are concerned.

The Marietta Daily Journal’s recent article, titled“Estate reduction ensuring wealth transfer to heirs,”says first and foremost, families in this situation should work closely with an experienced estate planning attorney for high-net worth individuals. “While a financial adviser is helpful in planning asset transfers to heirs, an expert in estate tax law is key for ensuring documents are structured properly.” Estate and gift tax laws are subject to change.

An easy move for wealthy families is gifting. Individuals can gift up to $14,000 per year, per individual without incurring a gift tax. The amount doubles for spouses. There’s an informational gift tax return to be filed, but there’s no tax due if the gift is under the annual exclusion limit.

Another option is paying for medical care, insurance premiums, and education costs. These do not count against the $14,000 limit, but must be paid directly to the institution or service provider.

You can also “power-fund” a 529 College Savings Plan. The Plans allow you to contribute a lump sum (up to $70,000 per beneficiary) and then elect to treat the contribution as if it were made over five years for gift tax purposes. Those assets immediately leave your estate.

Older heirs might do well with a Grantor Retained Annuity Trust. You’ll need to work with an estate planning attorney to set this up.  

A GRAT allows you to transfer rapidly appreciating or income-producing property to heirs while retaining an interest in the property over a set term, from two to 20 years. As the grantor, you are making an irrevocable, taxable gift to the beneficiaries, and the gift’s value is discounted by your retained interest.

Taxes owed on the gift to a GRAT can be partially or fully offset by the grantor’s applicable lifetime gift tax exclusion amount.

The trust pays the grantor a taxable income from the assets, based on an interest rate set by the IRS. The assets in the trust hopefully will grow at a higher rate than the annuity stream, and the excess growth will pass to the remainder beneficiaries without any gift taxes.

An estate planning attorney can create strategies that will work best for your circumstances and should be able to accommodate any changes in law.

For more information about estate planning, please visit my estate planning website.

Reference: The Marietta Daily Journal (June 5, 2015) “Estate reduction ensuring wealth transfer to heirs”

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