The Bus List

by Keith Dorney

Community Property States

  Community property states handle the concept of the spousal share quite differently than common law states.

  Community property states presume all assets acquired during a marriage are owned fifty-fifty between spouses, regardless of what the legal title says or who paid for it. Individual assets owned before a marriage stand the chance of becoming a community asset if commingled with other community property.

  Example C: John and Sally are married and reside in a community property state. John makes $400,000 a year. Sally pursues many interests but does not have income. John buys a rustic fishing cabin near his home town in the mountains for his sole and separate use several times a year with friends and family. He takes title to the property in his name only. Even though Sally has never visited the cabin and has no intention of ever doing so in the future, she legally owns one half of it.

  Example D: A spouse enters into a marriage as sole owner of a home they both end up occupying after the marriage. Mortgage payments, insurance premiums, and capital improvements are paid for from a joint checking account. Individual ownership of the home eventually reverts to community property where each spouse is a 50-50 owner despite what the title says.

  There are three exceptions to the community property rules:

  - Property owned before the marriage that is kept separate

  - Gifts intended for one spouse

  - An inheritance intended for one spouse

  Even these assets, if commingled with community assets, can become community property over time.

  These community property rules are used for both estate planning purposes and divorce proceedings. Determining each spouse’s share of property is less subjective than in common law states. Except for assets attained through one of the three exceptions or an overriding agreement or trust, property is considered owned 50-50 by each spouse.

  Community Property with the Rights of Survivorship

  When it comes to taking title to real estate, community property states afford an ownership option for spouses not available in common law states. Community property with the rights of survivorship is very similar to joint tenancy with the rights of survivorship with one very important difference.

  Joint tenancy with the rights of survivorship, and in some states tenancy by the entirety, are the only undivided ownership options with survivorship rights available to spouses in common law states. When a spouse dies and property is vested with one of these options, only the deceased spouse’s half of the property gets stepped-up: The surviving spouse’s half retains its original basis.

  This could cost the surviving spouse big time capital gains taxes if they decide to sell, especially if it is a highly appreciated asset.

  In community property states, assuming title is taken as community property with the rights of survivorship, when the first spouse dies, both spouses half of the property enjoy a stepped-up basis. This can save the surviving spouse a ton in capital gains tax if the asset is sold before their death.

  Example E: A couple owns a home with a market value of $1 million dollars as joint tenants with the rights of survivorship. The property was acquired many years before for $80,000.

  $20,000 of capital improvements were made over the years. These costs are added to the original purchase price, giving the couple a basis of $100,000. Subtract the basis from the future selling price to determine the capital gain.

  When the first spouse dies, only the deceased spouse’s half of the property (market value $500,000 with a basis of $50,000) gets stepped-up to $500,000. The surviving spouse’s half (market value $500,000 with a basis of $50,000) remains at $50,000.

  Let’s assume the widow later sells the house for $1.25 million. The surviving spouse won’t incur any tax on the deceased spouse’s portion of the house, but will incur a hefty capital gains bill on a $450,000 capital gain, despite the home capital gains exclusion of $250,000:

  Deceased Spouse’s Part

  $500,000 minus $500,000 [stepped-up from $50,000 to market value ($500,000) at time of death] equals zero.

  Surviving Spouse’s Part

  $500,000 plus $250,000 of appreciation since spouse’s death minus $50,000 basis = $700,000

  $700,000 minus $250,000 (home capital gains exclusion amount) = $450,000

  If his scenario instead occurred in a community property state, and the couple had taken title to the house as community property with the rights of survivorship, the tax bill would be zero.

  No tax is owed since the surviving spouse’s half of the property got stepped-up in addition to the deceased spouse’s half, and the quarter million dollars of appreciation since the first spouse’s death is taken care of by the home capital gains exclusion.

  $1.25 million (selling price) minus $1 million (basis) = $250,000

  $250,000 minus $250,000 (home capital gains exclusion) = $0

  If you live in a community property state and own your home with your spouse, check the title to see how it is vested. If you can’t find a copy of your title, more than likely it’s recorded at your county recorder’s office and you can get a copy there.

  If it is vested as joint tenants with the rights of survivorship instead of community property with the rights of survivorship, consult with an attorney licensed in your state of residence and inquire about changing it.

  Deciding how you want to “take title” to real property, or whether you want to change your current ownership designation for estate planning purposes, are important decisions. Unless you’re fully versed in all the ownership options available in your state and clearly understand all the ramifications, it’s best to consult with an experienced attorney licensed in your state of residence on these matters.

  Should You Hire an Attorney?

  I recommend using an attorney licensed in your state of residence to help draw up your will, durable powers of attorney, beneficiary deeds, as well as addressing any concerns as to how to take title to real property. If a trust is in your plans, I doubly recommend using an attorney that specializes in trusts. This insures your documents are legal and done right.

  Make sure you interview several candidates for the job, check credentials, and follow up with their references. Discuss the price of drawing the initial document(s) as well as the cost of adding amendments and maintenance of the trust.

  If you are unable to ascertain your prospective attorney’s approximate fees during this initial interview, consider their vagueness a red flag and move on to the next candidate.

  If you’re a do-it-yourselfer, there are lots of choices. One option is using estate document-generating software specific to your state of residence that is provided by a reputable vendor. Type “will maker software” into your favorite web browser and peruse the multitude of choices. Be sure and choose a reputable vendor, follow instructions implicitly, and make sure you answer all questions correctly.

  Many states have rules that allow you to execute legal documents from scratch, but your margin for error increases even more. Laws regarding what is legal and what is not vary from state to state, so be extra careful if you take this route.

  Remember, if there is any doubt as to an estate planning document’s authenticity, it may be declared invalid upon your passing.

  Here’s wishing you a long, healthy, and happy life.

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  Glossary

  AB Trust - An AB Trust is actually two trusts that are used in marital estate planning to utilize the state estate and gift tax exemption amount for the first spouse to die. With few exceptions, AB Trust planning at the federal estate tax level is no longer necessary since the passage of the American Taxpayer Relief Act of 2012, which makes the first spouse to die’s exemption portable to the surviving spouse. Except for Hawaii residents, no such portability is afforded for state estate and gift taxes, making AB Trust planning still relevant for wealthy couples. When the first spouse dies, the decedent’s living trust or will directs the B trust or Bypass Trust to be funded with assets eq
ual to the state’s estate tax exemption amount, with the reminder going to the A Trust or Marital Trust. This arrangement effectively utilizes the state exemption amount of the first spouse to die.

  ABC Trust - If you haven’t already, read about an AB Trust above. An ABC Trust was utilized for decedents who lived in a state with an estate and gift tax. Before the federal estate tax exemption of the first spouse to die became portable (thanks to the American Taxpayer Relief Act of 2012), ABC Trusts were needed for wealthy couples to utilize both the federal and state exemptions for the first spouse to die. Since the federal exemption became portable, utilizing the state exemption can be accomplished with an AB Trust

  Administrator - Term used in some states to describe a court-appointed executor. If you don’t name your executor in a will, the probate court appoints one on your behalf.

  American Taxpayer Relief Act of 2012 – This comprehensive piece of legislation included provisions making it much easier to preserve the exemption amount of the first spouse to die for the benefit of the surviving spouse. This effectively doubles the surviving spouse’s exemption. Two things are required for legal portability of the first spouse to die’s exemption: An estate tax return must be filed on behalf of the first spouse to die’s estate and assets must be bequeathed to the surviving spouse.

  Beneficiary - The recipient of assets. In estate planning it implies the recipient acquired assets through your death. Beneficiaries can be named through wills, trusts, TODs, PODs, and contracts with beneficiary statements.

  Beneficiary Deed – A will substitute that allows the transfer of real property without the expense and rigmarole of probate or the potentially high price of a trust. Not available in all states.

  Bequeath - To give to someone else through a will or will substitute.

  Brain Donation Registry - The Brain Donation Registry at Boston University’s School of Medicine accepts donations of brain and spinal tissue from registered individuals who were subjected to repetitive head trauma during their lives in an effort to find out more about chronic traumatic encephalopathy (CTE). Currently, the disease can only be detected and verified postmortem. Visit their website at https://www.bu.edu/cte/our-research/brain-donation-registry/.

  Bypass Trust - Bypass trusts are used primarily by married couples who live in a state that has a state estate and gift tax to utilize the first spouse to die’s state estate and gift tax exemption. Please see AB Trust and ABC Trust here in the glossary for more information on bypass trusts.

  Corpus - A legal trust has five elements (grantor, beneficiaries, trustee, terms of the trust, and corpus). The corpus or trust property is what is transferred into the trust by the grantor. It is then legally owned by the trust, not the grantor, and avoids probate upon the grantor’s death.

  Community Property - A term relative to married couples who live in a community property state. Property acquired during the marriage is considered community property, with 50-50 ownership rights. Property owned separately previous to a marriage can become community property over time unless kept separate, which is best done through a nuptial agreement or trust.

  Community Property with the Rights of Survivorship - There is a whole section on this earlier in the book. See Community Property with the Rights of Survivorship.

  Dead - Synonyms: answered the call, at room temperature, belly up, bought the farm, bit the dust, chillin’, deader than a doornail, expired, extinct, endsville, fettuccini al deado, flatlined, gone fishin’, grateful dead, home to stay, Hotel California, joined one’s ancestors, kicked the can, knocking on heaven’s door, left the building, Morrison hotel, motel deep 6, muerte, out of business, pushing up daisies, rottingham, splitsville, stairway to heaven, street pizza, toe’s up, walked the plank, worm farm, zombie playground.

  Decedent - A nice way to say any of the above.

  Durable Power of Attorney - A power of attorney is a legal document that gives another the power to act on your behalf. The term durable means the power of attorney is valid during your lifetime, even if you are legally declared mentally incompetent. Durable powers of attorney should be drawn for healthcare decisions (healthcare brain) and financial management (financial brain).

  Estate and Gift Tax - Tax levied on the estate and lifetime gifts of a decedent at the federal level, state level, or both.

  Estate Tax Exemption Equivalent - The estate tax exemption equivalent ($11.58 million in 2020) is the gross amount of a decedent’s estate that won’t be subject to estate tax. Assuming no estate tax deductions, it is calculated by taking ever increasing amounts of the estate’s taxable income to the tax tables, calculating the tax, then subtracting the unified estate tax credit for the year. Think of it this way. If you were to plug in $11.58 million to the Estate and Gift Tax Schedule for 2020, you’d start calculating tax owed first from the 18% bracket, which covers the first $10,000 of the taxable estate. After slogging through the next 11 brackets (ranging from 18% - 40%), adding those amounts together, and then subtracting the unified credit, the answer would be zero. Any amount larger than $11.58 million starts to generate estate tax. Unified means the credit, as well as the estate tax tables, are used to calculate both estate and gift tax. The unified credit, and subsequently the gift and estate tax exemption equivalent, are indexed for inflation and can change year to year.

  Executor - A person or persons you appoint to take care of things after you’re gone. Name your executor (executrix if female) in a will. Once confirmed, they can act on your behalf after you’ve passed. Duties include inventorying and appraising assets, securing and managing probated property, communicating with the assigned probate judge and beneficiaries, and filing final income and estate tax returns.

  Executrix - Female version of executor.

  Fiduciary - One who holds a responsibility to a third party that is above and beyond the norm. Executors and trustees, two brains you may name as you write your Bus List, act as fiduciaries in regard to your beneficiaries. The best interests of the beneficiaries must be paramount when making decisions.

  Fiduciary Duty - One that requires due diligence above and beyond the norm. The best interests of the party being represented must be considered and paramount to any decisions made on their behalf.

  Financial Brain - This brain, along with your healthcare brain, are in charge of things if you are ever unable to take care of things yourself. You appoint them through properly prepared and executed durable powers of attorney. Your financial brain handles the money end of things, which includes paying bills, making deposits, and managing assets.

  Generation-Skipping Transfer Tax - Be aware if you’re planning on gifting or bequeathing assets to an unrelated someone who is 37.5 years younger than you, or relatives more than one generation removed (i.e. grandchildren and great-grandchildren), there could be an additional tax owed. The generation-skipping transfer tax has been overhauled by Congress many times the last few decades. The current rendition includes a $3.5 million dollar exemption, so unless you’re planning on gifting or bequeathing more than that to your grandchildren, there is no tax.

  Gift Tax - See Gift Tax Exclusion and Gift Tax Exemption below

  Gift Tax Exemption - The gift tax exemption ($11.58 million in 2020) is the dollar amount of gifts one may give away during one’s lifetime that won’t be subject to gift tax. Amounts gifted in excess of the gift tax exclusion amount for the year ($15,000 in 2020) counts against this gift tax exemption and must be reported via a gift tax return in the year of the gift. This same gift tax exemption amount carries over and becomes your estate tax exemption when you die. In other words, gifts made over the yearly gift tax exclusion erode both your gift tax and estate tax exemption, which are one in the same. For gifts between spouses, there is an unlimited marital deduction, meaning one spouse can gift an unlimited amount of assets to the other spouse without incurring any federal or state estate or gift tax liability.

  Gift Tax Exclusion - The amount ($15,000 in 2020) that can be gifted to an individ
ual in a calendar year without eroding (or owing tax if the exemption is used up) your gift and estate tax exemption ($11.58 million in 2020). Amounts gifted in excess of the yearly gift tax exclusion must be reported on a gift tax return (IRS form 709) that is required to be filed along with your other tax paperwork. The gift tax exclusion, as well as the estate tax exemption, are indexed for inflation and can change from year to year.

  Grantor - A legal trust has five elements (grantor, beneficiaries, trustee, terms of the trust, and trust property). The grantor is the person who created the trust for the benefit of the beneficiaries, and who during their lifetime funded the trust with trust property. In a living trust, the grantor typically assumes the additional role of trustee during their lifetime and appoints a successor trustee to take over after that.

  Healthcare Brain - This brain, along with your financial brain, are in charge of things if you’re ever declared mentally incompetent. You appoint them through properly prepared and executed durable power of attorneys. This enables your healthcare brain to make healthcare decisions on your behalf when you are not able.

  HIPAA - Acronym for the Health Insurance Portability and Accountability Act of 1996. This sweeping legislation better protects the security of your health information, whether written, electronic, or orally communicated. It also protects individual rights to health insurance in regard to pre-existing conditions and those seeking continued coverage.

  Home Capital Gains Exclusion - My favorite piece of legislation ever! It allows a taxpayer to exclude the first $250,000 of capital gain on the sale of their personal residence. Married taxpayers get to exclude double that amount, or $500,000. The law states in order to qualify, the dwelling had to be lived in as your personal residence for two out of the last five years. There are no age restrictions (other than being old enough to own real property), and a taxpayer can take advantage of the exclusion multiple times during their lifetime.