Have It My Way
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By Yunna Barats |
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By Joseph Bayewitch Director Tax Services jbayewitch@rbz.com |
| Publication Date: Fall 2007 | |
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Estate Planning Opportunities for Unmarried Couples
Estate planning, including creation of a will and/or trust, is important for all families. For unmarried couples it’s an absolute necessity.
If you’re married and you die without a will or living trust, your state’s succession laws will generally provide for your wealth to be divided as you may have desired that is, among your surviving spouse, children or other family members. But if you’re unmarried and wish to leave assets to a life partner, you must have a plan because state succession laws will generally not cause such transfers to happen.
Marriage offers several estate planning advantages. One of the most important is the marital deduction, which allows spouses to make unlimited tax-free gifts to each other. Therefore, many estate planning strategies for married couples focus on leveraging this deduction.
To overcome this disadvantage, unmarried couples should begin planning early to take advantage of their annual gift tax exclusions and $1 million lifetime gift tax exemptions. Keep in mind that one partner’s payment of the couple’s living expenses may be considered a taxable gift.
Another advantage of marriage is the ability, in many states, to own real property as tenants by the entirety. This form of ownership is similar to a joint tenancy, but offers additional asset protection benefits. For example, the property is protected against claims by an individual spouse’s creditors.
Unmarried partners can hold property as joint tenants with survivorship rights. This ensures that, when one partner dies, ownership automatically passes to the survivor. For real estate, the impact of gift taxes also needs to be considered if the partners’ contributions and mortgage liabilities are in different proportion to their respective ownership interests.
A variation on joint tenancy is joint purchase of a property, from securities to rental real estate, where one unmarried partner can purchase the current interest in the use/ownership of the property while the other partner purchases a residual interest. The value of the interests are calculated following IRS rules and at the termination of the current interest by death or term of years the property interest will pass to the other partner free of transfer tax. In fact, this approach is not available to members of the same family.
However, for unmarried partners, purchasing property jointly has a significant disadvantage in that once you transfer title it can’t be undone without transfer tax consequences. A will or living trust can be a more effective estate planning vehicle, because it can be changed at any time without incurring a transfer tax.
In some states, registered domestic partners can obtain certain benefits, but the laws typically provide little or no assistance when it comes to federal estate and gift tax rules. This is particularly true in California where starting in 2007 the State will treat registered domestic partners in the same manner as married couples. However, because they are not recognized as “married” under federal law there are major conformity issues to be dealt with related to estate and gift taxes which are yet to be fully understood by anyone.
In particular, federal tax law defines “marriage” as a legal union between one man and one woman as husband and wife, and the word “spouse” refers only to a person of the opposite sex who is a husband or a wife. Consequently, registered domestic partners are not “spouses” for federal tax purposes and cannot file a joint return. They also cannot utilize certain advantages afforded to spouses by the Internal Revenue Code and are in fact treated under federal tax law as single individuals.
Using Trusts
A trust is one of the most effective and flexible tools available for passing your wealth to your loved ones. And in the case of one type of trust—the grantor retained income trust (GRIT)—unmarried couples actually have an advantage over married couples.
In the late 1980s, lawmakers were concerned about potential abuses of GRITS and other estate planning vehicles. So Congress eliminated their tax benefits when used to transfer assets to family members as discussed above for direct joint purchase of assets. But a GRIT remains a powerful tool for transferring property to nonfamily members.
To take advantage of a GRIT, transfer real estate, investments or other assets to an irrevocable trust. You retain the right to receive the trust’s income during its term, after which the assets are transferred to your partner or other nonfamily beneficiaries. You also reserve a “contingent reversionary interest,” which means that the assets will be pulled back into your estate if you die before the end of the trust term. For this strategy to work, you must outlive the trust term.
Transferring Wealth
When you create a GRIT, you make a taxable gift to your beneficiary, but by retaining income and reversionary interests in the trust, you can minimize its value for gift tax purposes. The gift tax value is the initial value of the trust assets minus the value of your retained interests. And because the value of those interests is discounted to present value using a conservative applicable federal rate (AFR), a GRIT may allow you to transfer substantial amounts of wealth at a minimal tax cost.
For example, Stanley, age 50, transfers real estate worth $1 million to a 20-year GRIT for the benefit of his partner, Stella. At the time of the transfer, the AFR is 5%, which means that the trust is assumed to earn $50,000 per year, regardless of whether it actually produces any income.
Using IRS tables, the present value of Stanley’s retained income interest is about $579,000 and the present value of his contingent reversionary interest is approximately $129,000. So the GRIT’s value for gift tax purposes is roughly $292,000 ($1 million – $579,000 – $129,000).
Suppose that, at the end of the trust term, the property has appreciated in value to $3 million. Assuming that Stanley survives the term, Stella will receive $3 million in wealth at a gift tax value of only $292,000.
Health Care Issues
Aside from tax, gift and estate issues, in the area of health, spouses generally can make health care decisions for each other without a medical directive or health care power of attorney, though it’s still a good idea to have one to make your wishes clear.
However, an unmarried person without such documentation typically has no right to participate in the health care of a partner who becomes incapacitated because of an injury or illness. In most states, an unmarried life partner has the same legal status as a complete stranger.
Unmarried couples should also have a durable power of attorney, which allows one partner to manage the other’s assets in the event he or she becomes incapacitated due to an injury or illness.
Overcoming the Obstacles
When it comes to estate planning, unmarried couples have some disadvantages over married couples. But by planning carefully and taking advantage of GRITs and other tools, they can overcome the obstacles and ensure that their wishes are carried out—and in a tax-efficient manner.
