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Estate Planning Newsletter | April 2006 |
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The Trouble with Joint TenancyAlthough Joint Tenancy offers some short-term conveniences, in the long run it poses a host of problems that can cost you and your loved ones many times the expense and headaches you thought you were avoiding.For the vast majority of American couples, “till death do us part” also means, “till death do we hold property in Joint Tenancy.” It happens almost automatically. When you and your spouse open a checking account, buy a car, purchase a home, or acquire just about any other asset you can think of, the first — and usually only — impulse is to put the title in both your names as Joint Tenants. Married couples aren’t the only ones relying on Joint Tenancy. This ownership strategy is widely used by friends, life partners, parents and their children, among others. It’s an ownership method so pervasive, many consumers often say they know of no others. Why is Joint Tenancy so frequently employed? Ironically, otherwise well-informed consumers choose Joint Tenancy because they’ve heard it is a cost-free replacement for a Will and that it avoids probate. These consumers focus on the fact that at the death of one of the owners, Joint Tenancy — or more precisely, Joint Tenancy with Right of Survivorship — immediately passes full ownership of an asset onto the surviving Joint Tenant by operation of law. So, yes, it does circumvent probate and avoid the need for a Will. At least for the moment. What all too many Americans unfortunately overlook is the fact that Joint Tenancy only temporarily avoids probate. It also brings with it a slew of problems that more than make up for any short-term convenience it provides. In fact, Joint Tenancy can end up costing you — and your loved ones — many times the expense and headaches you thought you were avoiding. Here are just a few of its disastrous consequences:
PROBATE, AFTER ALL Frequently called the “Poor Man’s Will,” Joint Tenancy is often used as a replacement for Wills and as a tactic for avoiding probate. But this is only half the story. Joint Tenancy does alleviate the need for probate when the first owner dies. But when the second/last owner dies, the entire estate goes through the often costly, time-consuming and nightmarish probate process. After 30 years of marriage, Gene and Marjorie Cummings had accumulated the usual trappings of married life. The home they bought 25 years ago for $100,000 was now worth $500,000. When they added in the value of their autos, furnishings, and cash accounts — all held in Joint Tenancy — they were slightly amazed to discover their estate was worth $2 million. When Gene died suddenly, Marjorie immediately became the sole owner of their $2 million estate by operation of law, circumventing the probate courts. But upon her death 15 years later, the entire estate — now worth over $2.5 million — was subjected to probate. LOSING CONTROL Today more Americans are involved in second marriages than in first. And often, remarriage means that either one or both of the partners has children from a previous marriage. Whenever a parent holds property in Joint Tenancy with a spouse, children are effectively disinherited. That’s one reason why parents with children from a prior marriage should rarely, if ever, own property in Joint Tenancy with a new spouse. Instead, remarried parents should choose ownership strategies that will help them ensure their children are well provided for in the event of their death. Even when children from a prior marriage aren’t a factor, you may want to think twice about whether you want to give up total control over how the fruits of your life’s work are distributed at your death. Since many widows and widowers will eventually remarry, there’s a strong likelihood that someone your spouse may marry in the future will be the ultimate beneficiary of your estate. For some people, that’s of little concern. But most of us would rather see our assets benefit a relative, friend or favorite charity, rather than some stranger we’ve never met. Jerry and Raine Symington had been married 23 years, when Jerry died of a stroke. The Symingtons had no children, but Jerry had a niece and nephew who were dear to him. At his death, ownership of all Jerry’s assets passed to Raine, his surviving Joint Tenant. A few years later, Raine remarried a man with two children of his own. He outlived Raine, and inherited all of her assets, which his own children ultimately inherited from him. In the end, Jerry’s niece and nephew, the two people Jerry loved most next to his wife, were disinherited while his estate went instead to another man’s children whom he’d never met. THE $2,000,000 QUESTION As an estate taxation planning device, Joint Tenancy is a disaster. The federal government allows individuals to pass up to $2,000,000 of their assets estate tax-free in 2006. The exclusion is $2 million in 2006 through 2008, and $3.5 million in 2009. In 2010 the estate tax is repealed. However, in 2011 the tax returns with the exclusion back to $1 million. Married couples with proper planning get a double exclusion of $4 million in 2006 through 2008. But to capture these exclusions, you must plan properly. Joint Tenancy gives you no opportunity to do that. Instead, it effectively eliminates one of the two $2,000,000 exclusions a married couple would otherwise be entitled to claim. For a surviving spouse, the estate tax issue may be of little concern. Through the Unlimited Marital Deduction, the federal government lets spouses pass assets to one another at death estate tax-free. However, when the survivor dies, estate taxes can loom large, dramatically reducing the legacy the couple thought they were leaving behind. When Marjorie Cummings’ husband — and Joint Tenant — died, she immediately inherited his half of their estate, valued at $1 million. Thanks to the Unlimited Marital Deduction, Marjorie owed no estate taxes on the assets she inherited from her husband. Fifteen years later, however, when Marjorie died, her estate had grown in value from $2 million to $4 million. And estate taxes became due. Using Marjorie’s $2,000,000 exclusion, her taxable estate was reduced to $2 million. After estate taxes of $1,000,000 were paid, Marjorie’s son and sole heir inherited just $3,000,000 of the original estate valued at $4 million. With just a little planning, however, Marjorie and her husband could have sheltered up to $4 million from estate taxes. That would have reduced their taxable estate so there would be no estate taxes due. Marjorie and Gene’s son would have inherited $4,000,000 - $1,000,000 more than Joint Tenancy made available to him. When non-spouses hold property in Joint Tenancy, estate taxes take an even larger bite out of the deceased’s estate. For example, when one of the Joint Tenants dies, the entire value of the asset is included in his or her estate. If the survivor contributed to the acquisition of the asset, the survivor must prove how much was contributed, or show that the asset was acquired through inheritance or as a gift, before he or she can keep a share of the asset out of the deceased’s estate. With the entire asset included in the estate of the first Joint Tenant to die, the full burden of estate taxes must be paid by his or her estate, even though the asset now belongs to someone else. Dean Mitchell and Janine Wright decided that they would skip the formality of marriage, even though they were as committed to each other as any married couple could be. Together as Joint Tenants, they bought a home for $300,000. When Dean died several years later, the home was valued at $800,000. The full value of the home was included in Dean’s estate for tax purposes, even though Janine now owned it outright. As a result, Dean’s estate was liable for taxes on an asset it no longer owned. CAPITAL GAINS EXPOSURE Couples who live in one of the nine community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin — pay a high price when they put assets in Joint Tenancy rather than owning them as community property. In these states, using Joint Tenancy can actually expose your estate to costly capital gains taxes. Here’s how. The capital gains tax, that often-debated revenue generator for the federal government, is a tax levied against your profit when you sell an asset. To determine the amount of capital gains against which the tax will be applied, you deduct your cost basis in the asset — meaning your investment in it — from the price it fetches when you sell it. The difference is your capital gains, and that’s the sum which will be used to compute your capital gains tax. For instance, if you bought rental property for $125,000 and sell it later for $200,000, you would owe capital gains taxes on $75,000. The federal government provides a capital gains tax break on assets in a person’s estate. Called a step-up in basis, it simply means that when you die, the government will consider your heir’s cost basis in an asset to be its current market value, not your original purchase price. So, if the rental property you originally bought for $125,000 is worth $200,000 when you die, your heir’s cost basis would be $200,000. If your heir sells it for that price, no capital gains tax will be due. A very taxing situation occurs, however, when you live in a community property state but hold title to an asset in Joint Tenancy with your spouse. Instead of getting that step-up in basis on the entire sum — as your survivor would if the asset were community property or owned outright by you — the government allows him or her only half the step-up in basis. That means when the asset is sold, more of the profit will be subject to costly capital gains tax. California residents, Nick and Sandy Worthington, had an admirable art collection, with pride of place going to an acclaimed Matisse. It was one of the first pieces they bought, paying $50,000 for it several years ago. When Nick died last year, the painting was appraised at a whopping $500,000! Unfortunately, Nick and Sandy had placed ownership of the painting in both their names, as Joint Tenants, rather than owning it as community property. That meant the painting received the favorable step-up in basis treatment on only half its value. So, much to Sandy’s dismay, instead of a cost basis of $500,000, she now has a cost basis of only $275,000. If she were to sell the painting today, $225,000 of her profit would be subject to capital gains tax, an expense she could have avoided completely if she and Nick had titled ownership of the painting differently. JOINT TENANCY AND GIFT TAXES So far, we’ve focused primarily on the impact of Joint Tenancy and married couples. But frequently, Joint Tenancy is used as a method of ownership between non-spouses. For instance, friends often buy property together. An aging relative will often make a younger relative a Joint Tenant on property or cash accounts. Parents make their children Joint Tenants with them on everything from cash accounts to cars to the family home. Unfortunately, the government takes a dim view of these transactions, sometimes considering them to be gifts, not estate planning strategies. That’s why many Americans are shocked to discover that the step they’ve taken to avoid Wills and probate will in the long run cost them many, many times more money than it saves. Let’s look at some examples. When a non-spouse is added to the title of property as a Joint Tenant, the government deems it to be a gift. Gift taxes will become due, and the donor — the person presumably making the gift — will usually be liable for the taxes. (Under extreme circumstances, however, the donee — the person receiving the gift — may become liable.) How much gift tax is due and when it is due depends on the asset. For example, elderly relatives commonly add a younger relative or an adult child to their checking accounts, savings accounts and other cash accounts as a convenience. As long as the new Joint Tenant withdraws money strictly for the use of the original Joint Tenant, no gift taxes are due. But if he of she withdraws money for personal use, the original Joint Tenant will have to pay gift taxes on that amount. The gift tax situation is even more dire when real estate is involved. At the time a new Joint Tenant — who is not the spouse of the original Joint Tenant — is added to the title of real property, the government considers a gift to have been made. Gift taxes will then be due on the portion of the property the new Joint Tenant receives. For example, if a father decides to add his son as his Joint Tenant on his personal residence, the government will consider that the son has been given a gift equal to half the home’s value, and demand the father pay gift taxes accordingly. Of course, there are some exemptions available for gifts. Each year you may give away up to $11,000, indexed for inflation, per individual — and to as many individuals as you want — with no gift taxes due. Gifts in excess of that $11,000 are applied to a lifetime exclusion of $1 million. So, in many cases, the mere fact that you’ve added someone’s name as Joint Tenant to your checking account or real property may not actually require you to part with cold hard cash. Even if your gift falls within the exclusions described above, however, you must still report it on your federal gift tax returns. Rebecca Waters was nearing 70 and in frail health. Because she was concerned that illness might make her unable to attend to her affairs, she added her daughter Susan onto her bank accounts and home as Joint Tenant. Susan used the money for her mother’s benefit, until Susan’s car broke down and needed costly repairs. Rebecca insisted her daughter use her funds to pay for them. When tax time came around, Rebecca never thought once about reporting on a gift tax return the cash Susan withdrew for her own use or the “gift” of half Rebecca’s home. But a tax audit of Rebecca’s return a few years later uncovered these omissions. EXPOSURE TO RISK When you own property with a Joint Tenant, each of you owns half of the asset. That means you effectively lose control of half the property. Whether your Joint Tenant is your spouse or someone else, the implications of this exposure to loss are frightening. For example, half of your asset held in Joint Tenancy could be lost as a result of:
Early on we said that Joint Tenancy is so pervasive, many people are hard-pressed to think of an alternative. Fortunately, there are several. For instance, you can own property solely in your own name. Or you and another person can own property as tenants in common. If you live in a community property state, you can elect that ownership option. Or, in some states, you can seek the special creditor protection spouses receive under tenants by the entirety. Each of these options avoids some of the pitfalls of Joint Tenancy. However, none of them — and that certainly includes Joint Tenancy — is a replacement for the thoughtful estate planning that a qualified estate planning attorney can provide you. In fact, all the objectives you might try in vain to achieve through Joint Tenancy can be achieved much more effectively through an option such as a Will or Revocable Living Trust. With a Will or Revocable Living Trust, for example, you can:
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Automotive Information Council
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