GeriLaw | Robert Fleming, Tucson elder law attorney, and colleagues

Family Generosity and the Gift Tax

A recent New York Times article highlighted the potential gift tax implications for baby boomers who are subsidizing parents or less fortunate siblings.  Most gifts can easily fall within the donor’s annual gift tax exclusion of $12,000 in cash or other assets per donee.  There is also a lifetime exemption of $1 million ($2 million for married couples) before a 45 percent gift tax applies. 

There are several strategies that donors can use to assist family members without paying gift tax:

• Maximize use of the annual exclusion.  You can do this by writing a check, but you can also put assets (including income-producing assets such as bonds or shares of a closely held company) into trusts for the benefit of the family members.   You can also use Section 529 education savings plans to assist siblings burdened by the costs of their children’s education.

• Pay medical and educational expenses for the family members.  You do not need to use your annual exclusion to pay for these expenses, but you must pay them directly to the providers of the services.  This strategy can be helpful with regard to elderly parents.  You can pay for anything that the parents would be allowed to deduct on their income tax returns as an unreimbursed expense.  This includes home-care attendants, medically necessary home improvements, or part of the parents’ long-term care insurance premiums (up to $3,080 for someone 61 to 70 years old, and up to $3,850 if over 70).

• Employ family members.  You can employ family members to provide such things as child care, managing real estate, or handling the books, but the compensation must be reasonable (what you would pay a stranger for the same work).

• Lend and borrow money.  This requires the same formalities of a loan from a bank, but you must use the applicable federal rate.  This is a minimum interest rate set by the Treasury each month.  You could also borrow money from family members and pay them more interest than they could receive from money markets or bank certificates of deposit.  You should probably pay what a bank in your area would charge for a comparable personal loan.

• Make a family member your dependent.  You must pay at least 50% of that person’s support, but this is not available if the person’s gross income is more that $3,400 per year.  Required withdrawals from IRAs and 401(k)s count toward this income limit, but Social Security does not.  If you are able to claim a relative as a dependent, then you can deduct the dependent’s unreimbursed medical expenses above the 7.5% of adjusted gross income floor.

• Provide a safety net.  If family members are depending on you for assistance, then you may want to make sure you have life insurance in place or include them in your estate plan  just in case something happens to you.

Andrew Hook
Oast & Hook
www.oasthook.com

National Healthcare Decisions Day

Governor Timothy Kaine has signed a Certificate of Recognition, designating April 16, 2008, as Healthcare Decisions Day in the Commonwealth of Virginia.  Virginia has had its own Advance Directives Day for the past two years, and this year’s effort is part of the inaugural National Healthcare Decisions Day.  The purpose of this day is to raise public awareness of the importance of planning for healthcare decisions related to end-of-life care and medical decision-making in the event that patients are unable to speak for themselves, and to encourage the specific use of advanced directives to communicate these important healthcare decisions.

In Virginia, the Health Care Decisions Act provides the specifics of the Commonwealth’s advance directives law.  It is estimated, however, that only about 15% of all Virginians have executed an advance directive, and it is estimated that less than 50% of severely or terminally ill patients have an advance directive.  One of the primary goals of National Healthcare Decisions Day is to encourage hospitals, nursing homes, assisted living facilities, continuing care retirement communities, and hospices to participate in a nationwide effort to provide clear and consistent information to the public about advance directives.

All adults in Virginia have the right to prepare an advance directive in order to put their wishes regarding medical care in writing.  There are two components to the advance directive.  The first component is the living will.  This permits an individual to state what kind of life-prolonging treatment the individual wants or does not want if diagnosed with a terminal illness and the individual is unable to express his or her wishes.  Life-prolonging treatment includes using machines, medicines and other artificial means to help individuals breathe, eat, get fluids into their bodies, have a heartbeat, and otherwise stay alive when the body cannot do these things on its own.  Medications used to keep an individual comfortable are not considered life-prolonging treatment.  Life-prolonging treatment will not help an individual recover.  Another way to look at the living will is that if an individual is in the dying process, then the individual does not want artificial means to prolong this process, but the individual might want pain-relieving medications to be administered, even if it accelerates the dying process. 
The other component of the advance directive is often called a power of attorney for healthcare.  This allows an individual to appoint an agent or agents to make medical decisions for the individual if the individual becomes incapable of making medical decisions.  The document can specifically tell the agent what kind of care the individual does or does not want.  For example, the document can give the agent the authority to work with a physician for the physician to enter a do not resuscitate order (DNR) on the individual’s behalf, but the advance directive itself is not as a DNR order.  The agent can only make medical decisions if the individual’s physician and another physician or licensed clinical psychologist examine the individual and determine in writing that the individual cannot make medical decisions for himself or herself.  As soon as the individual is capable of speaking again, decision-making authority of the agent ceases.

It is important for people to put their wishes in writing, because oral advance directives can only be created if an individual has a terminal condition and can tell his or her wishes directly to his or her physician.  Unfortunately, many terminally ill individuals may no longer be competent to discuss their wishes with their physicians.  Putting the wishes in writing reduces confusion about the patient’s desires, and also establishes clear lines of authority for decision-making.  This is important for blended families where there may be second spouses and adult children, and for younger couples where conflicts can arise between parents and spouses.  Everyone 18 years of age or over should sign an advance directive; it is not just for the elderly.  Every adult may need an agent to make medical decisions in case of a sudden illness or injury, such as an auto accident. 

Anyone 18 years of age or older can be named as an agent in an advance directive; the agent does not have to be a Virginia resident.  An alternate agent should be named in case the primary agent is unavailable to serve.  Advance directives must be witnessed by two individuals 18 years of age or older; the agents should not witness the document.  Advance directives do not need to be notarized; however, the advance directives that Oast & Hook prepares for its clients are notarized in case they need to be used in other states.  Although Virginia advance directives are designed to be valid in any state, individuals who spend a considerable amount of time in another state, should prepare an advance directive for the other state.  Advance directives can also be registered with the U.S. Living Will Registry or Docubank.

Copies of an advance directive are valid.  For this reason, Oast & Hook recommends that its clients keep the original advance directive in a secure place, and let their agents know where it is located.  They should give copies of their advance directives to their primary care physicians and all specialists.  They should also give copies to each agent, and discuss their wishes with their agents.  They should carry a copy of the advance directive in the glove compartment of their vehicles and place one on the side of their refrigerator.  It is also a good idea to take a copy of the advance directive when traveling.  Oast & Hook provides its clients with wallet cards stating that the client has executed an advance directive, and listing the names and telephone numbers of the client’s agents.  The Oast & Hook advance directive also includes a privacy act waiver, also called a HIPAA waiver, which permits the agent to talk immediately with the physicians or review medical records, even if the physicians have not declared the client incapable of making medical decisions.  This is helpful for seniors when their children do not know if they need to act as the agent for their parents and the only way they can decide is to talk with the parent’s physicians.

Andrew Hook
Oast & Hook
www.oasthook.com

Six Things To Consider When Writing a Will

Recently we read an excellent primer on preparing for your first estate planning interview written by Marta Williger, a friend and elder law attorney from Munroe Falls, Ohio. We asked her to share her suggestions with our readers. Here is Martha's contribution (and note that they apply to your periodic estate planning update as well as to the first time you consider making a will):

The first major hurdle in writing a Will is procrastination. Just thinking about death and dying makes some of us a little anxious. Once past that obstacle, there are six things that you should consider to be sure that your Will meets your needs.

1. Nonprobate Property: Remember your Will controls only property that is subject to transfer through the Probate Court. Any property that you hold jointly with someone else may be "survivorship" property that passes automatically upon your death to the other owner or owners. You may own property that is "payable on death" to another person. Insurance proceeds, annuities and IRA's usually go directly to the named beneficiary rather than passing through probate. Now is a good time to review all your assets to be sure that however they are transferred at your death, they pass according to your plan and wishes.

2. Specific Bequests: A specific bequest is the gift of a particular thing or a particular amount of money. For example: "My wedding ring to my daughter, Katy," or "$200 to my nephew, Felix." When a specific bequest of an item is made, the law requires that item be appraised. It is then subject to inheritance tax at the appraised value. Depending on the value of the item, the appraiser's fee and tax may not be justified. Many people prefer to give gifts of sentimental value during their lifetime to share in the recipient's joy and appreciation. You might wish to make a specific bequest of cash as a token to grandchildren or a specific charity. In doing so, keep in mind that specific gifts are always paid first. Depending on how large or small your estate is at your time of death, your specific bequest may be far more or less proportionately than you intended. For example, suppose at the time you write your Will you have $500,000 in assets. You leave $10,000 to each of your ten grandchildren and the remaining $400,000 to be divided between your two children. Unfortunately, you fall ill and require nursing home care for the last years of your life. Your estate is reduced to $100,000. Your specific bequests are made first. This leaves nothing for your children whom you had intended to inherit the bulk of your estate.

3. Residual Gifts: After specific bequests are made, you need to decide who gets everything else. Generally, if more than one person is to share the residuary, each person would receive an equal share or some percentage for each person would be named. ("to my children equally, share and share alike" or "forty percent to my Uncle Joe and ten percent to each of my six nieces and nephews".) In dividing up your residuary be sure to consider what you want to happen if one of your beneficiaries dies before you. Would you want that person's share to go to her children, to the other beneficiaries, or somewhere else entirely?

4. Taxes: Estates over $338,000 are subject to Ohio Estate Tax. Those over $2,000,000 may be subject to federal estate tax as well. Consider whether you want all the tax paid out of the probate estate or whether persons receiving non-probate assets should pay a proportional part of the tax. If your tax burden appears very large, you may find a trust more suitable than a simple Will.

5. Minor Beneficiaries: If any of your beneficiaries could be under the age of 18, you may want to consider naming a trustee to hold the property until the child comes of age. The person you name may or may not be the child's parent. You may choose to be quite explicit in your instructions to the trustee or simply choose someone you find trustworthy and leave the details to his discretion. If your own children are young, you will want to name a guardian (and alternate guardian) to care for and raise your children. Your doing so can avoid much family turmoil in deciding with whom your child will live. Be sure to choose someone who's child raising ideas are similar to yours. Use care in choosing grandparents as guardians. While your 68 year old mother may seem the best choice to have your 5 year old, she may not be equipped at 78 to handle your 15 year old.

6. Fiduciaries: Your fiduciary is the person who will gather together all your assets, pay your bills, then distribute the remainder of your estate as you direct in the Will. The person you choose should be trustworthy, organized and patient. Be sure to name an alternate fiduciary in case the person you name is unwilling or unable to handle your estate. The law requires fiduciaries to post a "bond" (an insurance policy covering theft or error) unless you say in your Will that you do not require one. This is primarily protection for your other beneficiaries. The size of the bond is determined by the amount of probate assets. The cost of the bond is paid out of the estate. Your fiduciary is entitled to payment for the service he performs. The amount of compensation is determined by the Court. Fiduciaries will generally choose a lawyer to assist with the estate. As your life situation changes, your Will should be revised to suit your needs and desires. It is generally a good idea to review your Will every five years to be sure it reflects your wishes. Think about these six considerations each time you make a Will. Your individual situation may raise additional issues and considerations that your attorney can address.

Prepared by: Marta J. Williger
Williger & Peters
323 S Main St., Suite C
Munroe Falls, Ohio 44262
(330) 633-7373 Revised 2/12/07

Some late-night thoughts on advance directives

Tonight a very close friend and nationally-known elder law practitioner lies in a hospital bed, unconscious for the seventh night since his cardiac arrest. He is one of the most physically-fit men I know, and I hope like hell that his lifelong attention to fitness will be the thing that pulls him through. But that's not what I wanted to write about.

This man is one of the main figures in his state advocating that everyone ought to sign appropriate advance directives, and he took his own advice. I have no doubt what his intentions were when he signed the forms, and I have no doubt that they are in excellent order (though I have not seen them, and would have no reason to have reviewed them). I'm sure they name his wife as his agent, and that would be completely appropriate. She has been married to him for over 30 years, she is the mother of their two lovely adult daughters, and she is a physician. She is obviously qualified to act for him, and there could be no better choice. In fact, we should all wish we had such a perfect candidate to act as our own health care agents.

I know him well enough, and this issue has been a topic of discussion often enough, that I am pretty sure his wishes are pretty much in line with my own -- and, indeed, with those of the majority of my clients. But I'm not sure they are the right choice.

He has had a medical tragedy. His prognosis is guarded. If he recovers, he might well be permanently injured -- and I strongly suspect he would have said he didn't want that. But he has been on a respirator for two periods during the past week, and we can reasonably assume that his treatment has been more aggressive than he thought he wanted, and more aggressive than he would have approved for himself. Still, I think that aggressive treatment has been right.

Why? Because he is not the only figure in the drama. Assuming that he would have absolutely forbidden a respirator (I don't think he would have, or did, but let's assume it for a moment), the law of advance directives is clear that his wife should be bound by that uncompromising position. But it would be wrong. He might get better, and his sudden cardiac arrest deprived all of us -- and particularly his close-knit, loving family -- of the opportunity to come to grips with his mortality. Would it have been different if he had been 87 instead of 57? Perhaps, but perhaps not -- on the strength of this one personal crisis (and one glass of wine) I am not prepared yet to generalize about the issue.

Suppose his wife said "I know he would hate this, but I have to do it." Would I argue for an absolutist approach? Would I insist that the hospital ethics committee be convened, or a court proceeding initiated? No. And that makes me wonder about my own advance directive, and yours, and my clients'.

It absolutely makes a difference to me that the wife's motives are positive, that the relationship is strong and long-term, and that her self-awareness is high. But I think maybe I should soften the stridency of my advance directives, and admit of the possibility of in-crisis adjustment for the benefit of the individual, his or her agent, their families and their communities. I'm deeply glad they're still trying, and I hope it works. She's doing the right thing, and she's doing it out of love.

Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
www.elder-law.com
www.specialneedsalliance.com

Trusts and Taxes

On January 16, 2008, the U.S. Supreme Court settled a long-running conflict among federal appeals courts regarding fiduciary income taxes for trusts.  In Knight v. Commissioner, (No. 06-1286), the Court ruled in a unanimous opinion that investment advisory fees paid by a trust cannot be deducted in full for income tax purposes.  The Court held that the deductibility of such fees is limited by the 2% floor on miscellaneous itemized deductions.

The Knight case is also known as “Rudkin” because it involves a trust established under the will of Henry A. Rudkin, who, with his wife, founded the Pepperidge Farm Company.  In 2000, the trustee, Henry Knight, hired an outside firm to advise him on investing the trust’s assets.  The trust had approximately $2.9 million in marketable securities, and it paid $22,241 in investment advisory fees.  The trust deducted all of the fees, but the IRS said that the fees had to be limited by the 2% floor.  The IRS allowed the trust to deduct the investment advisory fees only to the extent that they exceeded 2% of the trust’s adjusted gross income.  The result was that the IRS said the trust owed an additional $4,448 in taxes.  The trust said that the trustee had a fiduciary duty to act as a “prudent investor” under Connecticut law and therefore was required to hire an investment professional and pay investment advisory fees.  The trust said that the fees should be fully deductible because they were unique to trusts. 

The Court first reviewed the language of the statute governing deductions from gross income, 26 U.S.C. 67(e).  The general rule of the statute is that “[T]he adjusted gross income of [a] ... trust shall be computed in the same manner as in the case of an individual.”  This means that trusts can deduct costs subject to the same 2% floor that applies to individual taxpayers.  The statute provides an exception to the 2% floor when two conditions are met.  First, the cost must be “paid or incurred in connection with the administration of the ... trust.”  Second, the cost must be one “which would not have been incurred if the property were not held in such trust.”  The Court said that “[t]he statute does not ask whether a cost was incurred because the property is held by a trust; it asks whether a particular cost ‘would not have been incurred if the property were not held in such trust.’” The Court quoted the IRS Commissioner’s brief: “Far from examining the nature of the cost at issue from the perspective of whether it was caused by the trustee’s duties, the statute instead looks to the counterfactual question of whether individuals would have incurred such costs in the absence of a trust.”  The Court agreed with this view and the view of the Fourth and Federal Circuits that “[c]osts that escape the 2% floor are those that would not ‘commonly’ or ‘customarily’ be incurred by individuals.”  The Court said that “whether a trust-related expense is fully deductible turns on a prediction about what would happen is a fact were changed – specifically, if a property were held by an individual rather than by a trust.” 

Applying this reading of the statute to the case at issue, the Court said that it is not uncommon for individuals to hire an investment adviser, and that the “prudent investor” standard does not only apply to trustees.  The standard “looks to what a prudent investor with the same investment objectives handling the investor’s own affairs would do, i.e., a prudent individual investor.”  The Court said that it would be difficult to say that it would be uncommon or unusual for investment advisory fees to be incurred if the same property were held by an individual investor.  The Court did say that it was conceivable “that a trust may have an unusual investment objective, or may require a specialized rebalancing of the interests of the various parties, such that a reasonable comparison with individual investors would be improper.  In such a case, the incremental cost of expert advice beyond what would normally be required for the ordinary taxpayer would not be subject to the 2% floor.”  The trustee in the case before the Court did not make such an assertion, and, therefore, the Court held that the investment advisory fees were subject to the 2% floor.

This decision is particularly significant for large trusts that routinely spend substantial amounts on investment advisory fees.  Many trusts, and beneficiaries will be paying higher taxes.

Andrew Hook
Oast & Hook
www.oasthook.com

Virginia Viatical Settlements Act Upheld

The U.S. Supreme Court recently declined to rule on a case that tested whether Virginia can regulate the sale of life insurance by policyholders to investors, otherwise known as viatical settlements.  The Court’s refusal to take the case lets stand the ruling by the U.S. Court of Appeals for the Fourth Circuit that the Virginia Viatical Settlements Act is constitutional.

Viatical settlements permit life insurance policyholders to sell their policies for less than face value to third parties for an immediate cash benefit.  These third parties include investors.  The policyholders often need the funds to pay for healthcare costs for a terminal illness.  Once the policyholder (“viator’) sells the policy to the third party (“provider”), the provider assumes the responsibility for paying the premiums, and designates itself as the beneficiary of the policy.  Upon the viator’s death, the provider collects the face value of the policy, with the provider’s profit being the difference between the face value of the policy and the price paid to the viator, premiums paid to the insurance company, and administrative expenses incurred.  Providers hire independent doctors to examine the viator and the viator’s medical records prior to settlement, and monitor the viator’s health until death. 

The viatical settlements industry was an outgrowth of the AIDS crisis in the 1980s, and the market grew to include other terminal illnesses, like cancer, heart disease, and Alzheimer’s disease.  States began to regulate the industry during the early 1990s because of the power imbalance between the viator and provider, with the result that chronically or terminally ill persons may be particularly vulnerable to fraud or low prices.  The National Association of Insurance Commissioners developed the Viatical Settlements Model Act in 1993 and the Viatical Settlements Regulations in 1994, in order to guide states in regulating the viatical settlements industry.  The Virginia Viatical Settlements Act was enacted in 1997.  The core provisions of the Act ensure that providers are reliable, require full disclosures to viators, protect the privacy of viators, establish minimum prices for policies, and prohibit fraud.

The case at issue began when a terminally ill Virginia resident (“Jane Doe”) sold her life insurance policy to Life Partners Inc., a Texas corporation, at a deep discount to provide her with cash she needed for the remainder of her life.  After the transaction was completed, Jane Doe tried to improve the sale price of the policy by invoking the minimum pricing provisions of the Act.  Life Partners offered to rescind the transaction; Jane Doe refused, and filed a complaint with the Virginia Bureau of Insurance (“the Bureau”), which is the relevant agency under the Virginia State Corporation Commission (“SCC”).  After the Bureau’s inquiry, Life Partners commenced the initial action to declare the Act unconstitutional, and to enjoin its enforcement.  The Commonwealth defended the Act as serving a legitimate and important local interest in regulating viatical settlements with its residents.  The Commonwealth also argued that it acted properly pursuant to powers conferred on it by the McCarran-Ferguson Act.  This act authorizes states to enact laws relating to or for the purpose of regulating the business of insurance.  The U.S. District Court for the Eastern District of Virginia entered judgment for the Commonwealth, holding that the Act was constitutional.  The district court concluded that: (1) the Act did not discriminate against interstate commerce, (2) that the Act served a legitimate and important local purpose, and (3) that any burden on commerce was only incidental.  On appeal by Life Partners, the U.S. Court of Appeals for the Fourth Circuit affirmed the judgment of the district court (Life Partners, Inc. v. Morrison, No. 06-1370, 06-1371, April 30, 2007).

The Court of Appeals discussed the passage of the McCarran-Ferguson Act in 1945 when Congress declared “that the continued regulation and taxation by the several States of the business of insurance is in the public interest.”  The Act explicitly protects from a dormant Commerce Clause challenge (1) any state law that “relates to the regulation of the business of insurance,” or (2) any state law “enacted for the purpose of regulating the business of insurance.”  The court said that a viatical settlement fractures the two-part insurance contract between the insurer and insured, and creates a new “tripartite arrangement” among the insurer, the insured, and the insured’s assignee (the provider).  The Virginia Viatical Settlements Act addressed concerns of all three of these parties, as well as the interest of the Commonwealth in ensuring that its residents are not subjected to unscrupulous conduct by the providers.  The court determined that the matters regulated by the Act “relate to” the business of insurance as defined in McCarran-Ferguson, that the Act was enacted for “the purpose of regulating the business of insurance,” and that the Act “regulates directly and substantially the actual business of insurance.”  The court also said that the Act implements the licensing regime that Congress relied upon to confer tax benefits to viators under the Internal Revenue Code.  The court affirmed the judgment of the district court.

Andrew Hook
Oast & Hook
www.oasthook.com
Offices in Virginia Beach and Portsmouth, Virginia

Do I need a living trust?

It happened again today. A client (two clients, actually--a lovely couple, in their 80s) came to see me about estate planning. Their central question: "do we need a living trust?"

This couple, like many (but by no means all), had done a lot of homework and preparation. They had collected all their finances, and they showed me that they were collectively worth about $750,000. A portion (but only a small portion) of that money is in three IRAs, with two belonging to the husband and naming the wife as beneficiary, and one in the wife's name listing the husband as beneficiary.

Just over ten years ago, they had asked another local lawyer (prominent and respected in the local legal community) the same question. Their assets at the time were about a third of their worth today--but then the federal estate tax threshold was also about a third of today's $2,000,000 level. They were well below having a taxable estate then, and they remain so today.

Their first lawyer's advice: no, you don't need a living trust. Your estate is not taxable, you are not intending to put any limitations on what you leave to your children, and you already have everything held in "payable on death" or "transfer on death" accounts, or naming your children as beneficiaries.

I answered the same way: you don't need a trust. They were disappointed, on some level. They brightened up a little when I followed my own advice with "...but I wouldn't call you fools for establishing a trust, either." My basic point: the cost of establishing a living trust is modest, and there is a strong likelihood (but no certainty) that the total cost of probating the survivor's estate will exceed the cost of the living trust. But, I pointed out, the "savings" will necessarily benefit the couple's children; they will have to die to realize any savings. And that's a lousy way to save a buck.

As so often happens, though, they decided to go ahead and establish a living trust for another reason: all their friends have living trusts. I explained, candidly, that I agreed with that sentiment. A very large part of what we lawyers sell when helping with estate planning is peace of mind. If a client thinks he or she (or they) wants a living trust, it ought to be possible to have one established without feeling like the lawyer is talking you out of something. It's especially annoying (to clients) to consider the possibility that the lawyer might really be saying "your estate is too insignificant to justify the fancy planning your best friends and bridge partners have undertaken."

Did my clients really need a living trust? No. They had actually done a pretty good job of establishing beneficiary designations on all their assets, so the cost and hassle of probate was not going to be an issue in any event. But they came in wanting a trust, they felt like maybe they were missing out on something by not having one, and the cost of getting a trust was way less than, say, the big-screen LCD television they might well have decided they want--no, need.

Are living trusts oversold? Absolutely. Would today's clients have been fine with new wills and powers of attorney, plus a little advice about beneficiary designations? Absolutely. Did they need a living trust? Absolutely not. Will they benefit from having a living trust? Absolutely.

Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona
www.elder-law.com

Community property law

The notion of "community property" remains oddly foreign to most lawyers from states outside the few which recognize the Spanish/French concept. Actually, though, the idea is hardly foreign at all--it is consistent with the way I believe most married couples think of their assets. It is also consistent with what most states mandate upon divorce--the assets acquired during the marriage will usually be divided, and usually equally divided, in a divorce setting.

The Fleming & Curti, PLC, website has several articles discussing community property, including this week's (October 1, 2007) Elder Law Issues. In fact, there is an abundance of information over at the Fleming & Curti website.

So what's the big deal? Well, the community property states handle things differently in a number of ways. First, there is the issue of stepped-up income tax basis. In a nutshell, it works like this:

1. If you die owning property in your own name, your heirs (spouse or otherwise) receive it from your estate with an income tax basis set at its fair market value at the time of your death (there are lots of caveats, qualifiers and exceptions, but we're going to ignore those for now). That means that if your heirs sell the property shortly after your death, they will pay no (or very little) income tax on the sale. If they hold it for later sale, they will pay income taxes only on the appreciation in value between your death and that later sale.
2. If you die owning a piece of property in joint tenancy, generally speaking your joint tenant will receive your share with a stepped-up basis, but will retain their share with its original basis. That means that if, say, you and your brother buy a $100,000 parcel of land as joint tenants, and it is worth $250,000 on the day you die, your brother will pay capital gains taxes only on the $75,000 of gain realized on his 1/2 interest. The same principle is true if the joint tenant is your spouse.
3. If you die owning that same property as community property (which may, depending on your community-property state, also include a "with right of survivorship" qualifier), your spouse will receive a 100% step-up in the basis on your death--and vice versa. This may not make logical sense, but it gives a significant tax benefit to property held as community property. That's the good news. The bad news, of course, is that one of you must die before the survivor receives the benefit.

Community property rules are also responsible for another issue that mystifies many non-lawyers. Why do some estate planning attorneys prefer to create two separate trusts for a husband and wife, while others usually create a single joint trust? The division is mostly along community property / common law property lines; lawyers in community property states generally favor joint trusts, and common law state lawyers more often prefer to establish two separate trusts.

That can lead to unnecessary confusion; if your joint living trust was drafted in a community property state and you move to a common law property state, you may well be advised to create two trusts and separate your jointly-held assets. Conversely, your new lawyer in a community property state might well advise that you collapse your separate trusts into a single trust. Both types of advice may be based more on the lawyer's familiarity and comfort level than on any real legal difference.

Which states use the community property approach to assets acquired during the marriage? Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are the community property states, with the last two having come to the concept relatively recently. Alaska permits property in a trust to retain its community property character, but does not authorize creation of new community-property interests outside a trust.

Is all of this enough reason for you to sell everything you own and move to, say, New Mexico? Probably not. We tend to think that your personal happiness, health and well being are actually more important than the tax bite at your death. There are also other issues to consider, including state estate, income and property tax rates, state protections against creditors and other, less legal items. But if you are resolved to move to New Mexico (to continue the example), the somewhat favorable treatment of community property might well be the proverbial cake's icing.

Robert Fleming
Fleming & Curti, PLC
Tucson, Arizona