Although statistics show that the traditional family is now the minority, the legal rights of committed couples of the opposite or same sex are evolving at a snail's pace. In May 2008, California joined Massachusetts in recognizing same-sex marriages. Other states have approved civil unions, domestic partnerships, and common-law marriages. These substitutes for marriage are intended to give a couple the same benefits, protections, and responsibilities of married couples for state law purposes. But estate planning for the nontraditional couple remains a challenge, in part because the 1996 Defense of Marriage Act prevents the federal government from recognizing same-sex marriage under its tax laws and further does not require one state to recognize the same-sex marriage laws of another state or country.
Still, though laws vary from state to state, there are basic steps involved in building a good estate plan. The following offers an overview of the process, as well as some tools and techniques for helping nontraditional couples achieve their goals.
Steps To Building A Solid Estate Plan
Determine
whether the relationship has been formalized in the couple's resident
state. Taxes aside, there is an immediate need for each partner to make
major medical and end-of-life decisions for the other. This can be
accomplished in several ways.
In states recognizing civil unions and domestic partnerships, couples normally have all the rights of spouses under state law, including hospital visitation rights and the right to make medical decisions and be appointed as guardian, as well as to inherit the partner's property without state tax. In other states, traditional estate planning documents can achieve the same result.
Ensure that basic estate planning documents are in
order. Among the basic estate planning documents for any couple are the
durable power of attorney, health care proxy, and living will:
A
power of attorney allows someone else to handle a person's financial
affairs, thus avoiding a court-ordered conservatorship.
A durable power of attorney is immediate and continues even if an individual is disabled or incompetent.
A springing power of attorney becomes effective only when an individual becomes incapacitated.
A health care power of attorney designates who can make medical decisions on someone's behalf.
A living will states wishes about artificial life support.
Other documents-often overlooked-are a hospital visitation form that instructs the hospital about who may or who may not visit an individual, a statement outlining funeral and burial wishes, and a nomination of guardian if incapacitated.
Review wills, trusts, and domestic partnership agreements. Next, review the couple's wills, trusts, relationship and business documents, asset titling, and beneficiary designations. Consider the partner's differences in wealth, children of a prior marriage, business ownership, and anticipated family inheritance. A domestic partnership agreement acts as both a will and a prenuptial agreement by outlining what will happen at death, incapacity, or break-up. The agreement should address how property acquired during the relationship will be divided upon termination of the relationship, the visitation and custody rights of children, the dependency status of the partner, what property will remain separate from the agreement, who will occupy a residence, and support after the relationship ends.
Summarize your understanding of the current plan. Draft a summary of your understanding of the current estate plan and compare it with the couple's understanding. This will lead you to identify where the current plan conflicts with client wishes or where current titling and beneficiary designations conflict with the estate plan.
A word about privacy issues. If privacy is an issue, assets held in trust avoid the public scrutiny of the probate courts. Moreover, a revocable trust is less likely to be contested by estranged relatives. Trusts can be written so that if the couple separates, the beneficial interest is shifted to the trust's other beneficiaries.
Tax-Efficient Ways To Transfer Property
Consider
establishing joint ownership. Jointly owned property with rights of
survivorship is another simple way to transfer property to a partner.
Joint ownership of assets can be tricky for estate planning. Adding a
partner to the title of the asset may be a gift for federal tax
purposes, and yet the full value of the property will be included in
the estate of the first to die unless the survivor can prove his or her
percentage of contribution. On the other hand, estate inclusion has a
silver lining in the form of a step-up in basis to fair market value.
This can prove to be a boon to the surviving partner when the asset is
sold.
Note that the establishment of a bank or brokerage account in joint names does not normally constitute a gift until the donee withdraws money. On the other hand, reregistering a house or stock in joint names is an immediate and perhaps taxable gift.
Gifting through trusts. Gifts between nontraditional partners are limited to a federal annual gift tax exclusion of $12,000 a year (2008). Gifts over $12,000 will reduce the donor's $1 million lifetime exclusion. If the couple is more than 37½ years apart in age, the generation-skipping transfer tax (GSTT) is an issue. The GSTT is a flat rate equal to the maximum estate tax rate (45% in 2008) and is imposed in addition to any other taxes due.
For the high-net-worth couple, the key is to maximize both the annual and lifetime exclusions through discounting. While the IRS scrutinizes any attempt to take discounts for gifts made to family members, these rules do not apply to nontraditional couples. Thus, grantor retained trusts (GRTs), split-interest gifts, limited partnerships, and other estate freeze techniques are all available. These techniques can also help overcome the biggest impediment to making gifts, that is, the loss of an asset that is generating income for the donor.
If property is retained until income is no longer needed, the value of the asset may be substantially greater. Delaying the gift only aggravates the tax problem. Instead, the property owner can give away the asset while retaining the right to the income. This is similar to selling land but retaining the oil rights. The value of the land is reduced by the value of the oil rights. With estate freeze techniques, the value of the gift is established immediately and is reduced by the present value of any interest retained by the donor.
There are two popular types of GRTs: the grantor retained interest trust (GRIT), which pays all income to the grantor, and the grantor retained annuity trust (GRAT), which limits the income to an amount established at the time the trust is created. In both cases, the wealthier partner retains the right to the trust's income for a term of years. If he or she survives the term, the trust's assets are removed from his or her estate. The gift tax value is reduced by the present value of the anticipated income. After the term ends, the other partner receives the trust's income or is transferred the asset outright.
A GRT that holds a residence is called a qualified personal residence trust (QPRT). A QPRT allows the donor to live in the house until the end of the term and to rent it thereafter from the ultimate beneficiary, the other partner. Like the GRT, the gift to the other partner is reduced by the economic value of occupying the residence during the term. Or the grantor can purchase the house back before the end of the term with cash. The house comes back into the estate and receives a step-up in basis at death while the couple was able to shift a sizable amount of cash in trust.
Family limited partnerships and limited liability companies are ways to jointly own property without giving up complete control, and, if set up correctly, the gift can be discounted for lack of marketability and control. The donor, as general partner, makes all management decisions, while the limited partner can receive income from the business entity. Though this type of entity does not have to be a business in the usual sense of the word, it is recommended that it has a "business purpose" in order to be recognized by the IRS. Merging the couple's investment portfolios to get economies of scale and central management may be a suitable business purpose.
Setting up a life estate. Like traditional couples in a second marriage, couples with children from another relationship are often torn between sharing a home with their partner and preserving the family estate for their children. This can be solved with a life estate, which is a type of split-interest bequest. For example, a homeowner can give a partner the right to live in the home for life; at the partner's death, the house reverts to the ultimate beneficiaries.
Charitable remainder and charitable lead trusts. For the couple without children or close family, one partner can create a life estate for the other while at the same time making a charitable bequest. While most charitable remainder trusts (CRT) are established during life in order to defer income taxes on a highly appreciated asset, CRTs can also be created at death to provide a means of support for the surviving partner. Only the present value of the beneficiary's income stream is included in the deceased's estate. The donor's estate is credited the difference as a charitable estate tax deduction.
The older the survivor's age at the trust's inception, the greater the charitable deduction and the smaller the estate tax. CRTs are a less effective estate reduction technique for the younger beneficiary. The younger the beneficiary, the greater the present value of the income stream, and the smaller the charitable bequest. In order for the CRT to be valid, the charitable beneficiary must have an expectation of receiving 10% of the trust's value as determined at the creation of the trust. Note, since any resulting estate taxes cannot be paid from the CRT assets, it is important that the estate has enough liquidity to pay the taxes.
A charitable lead trust (CLT) is another planning strategy to facilitate the transfer of property from one partner to another in a tax-efficient manner. Basically, this works just the opposite of the CRT, in that the income beneficiary is initially the charity and the remainder beneficiary is the other partner. Even though the gift is delayed, the value of the gift to the partner is determined immediately. If the trust assets grow significantly between the date of the gift and the end of the term, there is an opportunity to pass this excess without additional gift taxes.
In The End, The Simplest Solution May Be Best
Finally,
the simplest solution is sometimes the least obvious. Trust-owned life
insurance can solve a lot of problems by creating liquidity to pay
estate and income taxes or providing the surviving partner with a
source of support and perhaps lessen family conflict.
As relationships and laws evolve, the key to the estate plan for the nontraditional couple is listening to their goals, understanding family dynamics, anticipating contests by hostile family members, and understanding how these can be meshed with gift and estate tax-reduction techniques.
Tere D'Amato is the vice president of advanced planning at Commonwealth Financial Network in Waltham, Mass. She can be reached at [email protected].