Estate planning is necessarily multi-disciplinary. It touches upon many aspects of law. It affects taxation, property, family, and business concerns. Marital Property rights is a critical element in legal planning. The changes go both ways — the estate planning affects marital property interests and marital property affects the planning. This is increasingly true with the social and legal changes in the definition of a family. Blended and non-traditional families have practically become the norm. Like the old joke, getting married may be the “end” of your problems, but the question is, which end.
The purpose of this article is to provide some guidance and background as to how marital property works. When we know how something works, we are better able to develop a plan for how we will deal with it in a healthy and positive manner. Today, more than ever before, planning is crucial for a marriage to succeed.
A change in marital status changes your property rights. Both before and after marriage, your actions will further change your property rights. Understanding what you have and how to work with it enables you to protect yourself. Protecting yourself cuts both ways, and is healthy for a good marriage. Both parties in a marriage should want the other one to be appropriately protected. Any other approach is not good for you or your marriage. If you don’t have your own plan to manage your marital property rights, your rights will be determined by someone else’s plan. In general, when you take charge of managing the succession of your property over time, even in marriage, you are doing what is called “Estate Planning”.
Marriage is right in the middle of the ebb and flow of federalism and the power struggle between states and the federal government. The states make rules, and the court’s interpret them. Property rights are for the most part governed by state law. Different states have different rules. In all states, husband and wife may each own their respective separate property. As for marital property, most states have either Community Property or Separate Property rules. The state’s rules governing marital property govern the resulting tax rules that apply on a federal level.
In Separate Property states, all property including marital property is owned separately. Each spouse separately owns 50% of the marital property. Earnings of each spouse are the Separate Property of that spouse. Earnings include contributions to an IRA or other retirement plan.
In Community Property states, both spouses together own 100% of the marital property as a marital community. In general, Community Property includes all property earned or acquired during the term of the marriage. Consequently, wages and earnings of each spouse during the term of marriage are Community Property. Again, this includes contributions to an IRA or other retirement plan. Absent other factors, a business started during the term of the marriage would be Community Property. Post-marriage contributions to an IRA or retirement account are community property. There are eleven Community Property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Technically, each state can only make rules for property within the borders of that state. However, some Community Property states (Arizona, California, New Mexico, and Washington) treat certain property outside the state boundaries as Community Property if it would be Community Property were it located within the state lines. This is known as Quasi-Community Property. If you are domiciled in one of these states, it can have the effect of making all of your marital property Community Property no matter where it is located. This has made these jurisdictions attractive to live in for estate planning purposes.
No matter what state are in, certain things start out as Separate Property including assets owned prior to marriage, assets acquired by gift or inheritance, and assets that spouses jointly agree will be separate. It is relatively easy to convert Separate Property into Community Property. The most common way is “co-mingling” — which occurs, for example, if Separate Property funds are deposited into a Community Property bank account and used by both spouses for marital expenses. All assets owned separately prior to marriage, no matter what state the couple resides in, are and will remain their respective Separate Property throughout their marriage if they don’t co-mingle them. This includes derivative or subsidiary assets. For example, if one spouse own an LLC as Separate Property, and that Separate Property LLC forms a subsidiary LLC during the term of the marriage, the subsidiary LLC is also Separate Property so long as there is no co-mingling of marital assets in it.
Local laws have a big impact on marital property planning, tax planning, and the associated estate and business planning. For example, states that tax estates may or may not have an exclusion for spousal property gifts. (This sometimes makes it necessary for spouses to have separate trusts.) Also, Community Property states general enable the couple to get a double step up in cost basis no marital assets. (This makes it possible to diversify assets after the first death without realizing capital gains.)
No matter what state a couple is in, if a marriage ends in divorce, each spouse gets their Separate Property and the marital property will be divided “equitably.” Most of the time this is determined by negotiation and settlement and then approved by the Court. The Separate Property and Community Property rules take different paths to calculate what constitutes “equitable” and therefore may arrive at results that are very different. For example, in Separate Property states, IRA and retirement accounts typically just go to each spouse, but in Community Property states each spouse may have a Community Property claim against contributions made during the term of the marriage.
Hopefully, with planning, marriage will be permanent. My non-scientific anecdotal observation is that couples who take their marriage seriously enough to plan their marital property interests on purpose rather than leaving it up to the politicians and courts, also take their marriage more seriously and do what it takes for the relationship to succeed long term. Whether marital property is separate or community makes a difference when you buy, sell or gift property, when you pay taxes, when you die, when you incur debt or other liabilities, if (not when) you get divorced, and if you move from one state to another.
If you are going to do what you say you are going to do and stay married forever, you must have a plan.
If you don’t have a plan for your marital property, the politicians and the courts have a plan for you. Using the default plan of whatever state or states you happen to live in is not always the best approach. A couple may at any time agree between themselves how they are going to treat their property. For such an agreement to be effective, it must be properly documented. Such documentation may take a number of forms. Adding a spouse as a joint signer on a bank account or naming a spouse as a beneficiary of an insurance policy are types of ad hoc written plans that control the disposition of property. Such an agreement will also be subject to the local laws of wherever the couple is domiciled.
For a couple about to be married, the most common and comprehensive written plan to consider is a pre-nuptial agreement. Technically, a couple may enter into such an agreement either pre-nuptial or before marriage (“pre-nup”) or post nuptial or after marriage (“post-nup”). Because such agreements may take place at any time, the term “marital agreement” refers to both pre-nups and post-nups. The timing for a marital agreement makes a difference. A pre-nup in anticipation of marriage is more common because it is clears things up in advance and eliminates the no-agreement time period of marriage prior to a post-nup. A marital agreement is not always necessary, but it is almost never wrong.
A marital agreement is often mistakenly thought of as just a blue print for divorce. I think this view is mistaken. In a healthy relationship, a marital agreement should be viewed and made to function as a plan for success. Working through the issues to make such an agreement requires the couple to ask tough questions, make candid disclosures, talk things over, and agree upon a road map for how they are going to work together. Even if you decide not to actually sign a pre-nup, going through the process necessary to develop one will make your relationship stronger, and set the stage for long term success. You will either deal with these issues in advance and on purpose in a kind and loving way, or you will deal with them as they arise in your marriage when they are imposed upon you perhaps at a time of stress. You never escape the issues. You get to choose when and how you are going to deal with them.
One of the functions of a pre-nup is for a couple to decide what they want instead of deferring to the default plan imposed by the state. For example, even though a couple lives in a Community Property state, they may want to treat their wages (or retirement accounts) as Separate Property. Typically, a marital ageement will have three schedules to identify property that is his, hers and ours. A marital agreement may also handle situation specific issues such as how to treat a marital residence owned by just one of the spouses. (A couple may agree to contribute a house to the marriage or in lieu of rent the couple may pay the mortgage with Community Property funds even though the house remains Separate Property of one spouse.) It may be as general or as specific as the couple wishes. The couple may detail household budgets, who contributes how much, who does the dishes and takes out the trash, and whether or not you have weekly dates. Such provisions are, of course, optional. Older couples entering into second or third marriages tend to be much more specific and detailed than younger couples entering into a first marriage. This is partly because older couples often have children from prior relationships. If your situation is uncomplicated and fresh, a marital agreement can be fairly simple.
A marital agreement can vary significantly in cost. Celebrities and high net worth couples can spend enormous sums on them. Fees for a marital agreement can be based on hourly services or fixed or a blend. It is typically strongly advisable or necessary for both spouses to have their own separate counsel. Separate attorneys are important to prevent defects on the basis of inadequate representation, and in the end it makes the final product better. In my experience, no matter how well crafted the initial draft, the other attorney will always make changes.
Your advance preparation can greatly reduce the cost of a marital agreement. Here are some things that will help:
• Make a list of your preliminary thoughts, concerns and what you want the document to accomplish
• Typically one of the attorneys will provide the couple with a draft based on the information they provide. The draft will generally include typical provisions used by other couples, and may have choices for the couple to select from.
• The couple should then talk and work together to edit and red-line the draft, making choices, and filling in information, then they will return the red-lined draft to their legal counsel.
• The lawyer’s job is to put the client’s edits and information in appropriate legal terminology and then explain what the document is doing.
• The couple and their respective legal counsel should edit the document as long as it takes until it does exactly what they want.
• There will almost certainly be some back and forth between the attorneys, who will each consult with their respective client during this process.
• When the final version is acceptable to both parties and their attorneys, everyone signs it. In some instances, the attorneys also sign it to acknowledge that the couple had separate legal counsel.
• Then, as a couple, they each live with it. With any marital agreement, the couple can still change the nature or their property either by accident through co-mingling or on purpose by making a deliberate gift to a spouse or choosing to ignore the agreement. If the marital agreement is going to be operative over time, the couple must act in compliance with it.
One of the issues every married couple has to deal with as part of the marital planning process is what is going to happen with their stuff when they are done with it. If a couple chooses to have children, they are the natural object of their bounty. If they choose not to have children, it is natural to consider other family members as potential beneficiaries. In such situations, it is also very common for part or all of the estate to go to charity. There are a number of very powerful tools that enable a couple to receive and enjoy the tax benefits of such charitable giving while they are still here to enjoy them, rather than timing such benefits to occur only after they are gone.
Initially, the simplest way to deal with financial accounts is to name beneficiaries. A couple may name each other, other persons, a trust, or a charity. Such Pay On Death beneficiary designations trump everything else. Even if a person has a will or a trust that provides otherwise, financial accounts will always go to the designated beneficiary.
When a couple is ready, it will be important to implement their own estate planning on a higher level than merely naming beneficiaries. Through documents such as wills, powers of attorney, and one or more trusts, a couple is able map out what will happen in the event of death or incapacity, and the succession of control and beneficial enjoyment of both their separate and marital properties. Sometimes a joint trust alone is enough. Other times separate trusts are appropriate. A couple may also need to coordinate with and take advantage of any planning their parents or grandparents have put in place. If individuals you have wills and other documents prior to marriage, they will need to be up-dated. A change in marital status renders a will and other documents like powers of attorney either void or voidable.
While you read this article, a thought came to you of something you should do. Do it. You will be glad you did.