Living Trusts: Should Couples Use Joint or Separate Trusts? (Part I)

March 25, 2011
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We have previously discussed the choice between wills and living trusts as your primary estate planning document.  However, if you opt for the living trust route, there is another important choice to make if you are married or have a significant other you wish to plan with.

The question is whether you both should create one joint living trust or separate living trusts for each of you.  Here, we provide general guidelines to help you decide, but always remember to seek legal counsel for your particular situation.

To make this determination, you first need to calculate your joint anticipated estate value.  Take into consideration all of your assets and liabilities, including savings and investment accounts, as well as the value of your home, the face amount of your insurance policies, and your retirement plans.

Once you have figured this out, the ultimate decision is mainly based on your answers to the three following questions:

  1. Under federal and/or state law, are you married to your partner – Yes or No?
  2. Do you live in a Community Property or Separate Property State?
  3. Will your anticipated estate potentially be subject to estate taxes – Yes, No, or Maybe?

Over the remainder of this post and in a follow-up post, we will discuss the options for all possible combinations of answers to these questions.

You and Your Partner are Unmarried (including non-traditional couples and aged siblings)

This section discusses what you might do if you are unmarried, regardless of your answers to the other two questions.  If you are in a non-traditional relationship, choosing separate living trusts is the less complicated choice and is generally recommended, due to these intricacies under federal law:

  • Taxable Gifts – Your relationship does not currently qualify for the unlimited marital deduction, so you cannot give all of your assets to your partner tax-free.  As a result, unless you both contribute equal amounts, a joint trust could result in taxable gifts between you.
  • Separate Accounts – Alternatively, while a joint trust could be constructed to contain separate shares that account for each individual’s contribution, this would essentially have the same effect as if you had created two separate trusts.
  • Filing Income Taxes – Your income tax reporting is much more complicated with a joint trust, since you will not be able to file jointly.  You would each have to report your income from your separate shares of the trust.

On the other hand, if these kinds of complexities do not concern you and/or you look at the joint trust as a symbol of solidarity as many do, then such a trust can certainly be considered.  However, keep reading, as other factors below might also affect your decision.

You are Married and Living in a Community Property State

This section covers what you might do if you are married and living in a community property state, regardless of the value of your estate.

There are presently nine community property states:  Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.  A tenth state, Alaska, also allows some community property advantages.  If you don’t live in one of these states, then you live in a separate property state.  If you do live in one of these states, you would most likely choose a joint trust.  Here’s why:

  • Retaining “Community Property” Status – A properly drafted trust will allow community property to remain as such once it is transferred into the trust.
  • Double Step-Up in Basis – Any community property receives a full step-up in tax basis (also known as a “double step-up”) to the asset’s full fair market value after the first spouse dies.  In separate property states, generally only the decedent’s half gets this adjustment.
    • Example:  A & B together buy a stock for $10.  Later, A dies when the stock is worth $50.  In community property states, if B sold the stock for $50 thereafter, B would owe no capital gains tax on the sale ($50 sale value less $50 “double step-up”  value = $0 gain).
    • For separate property, B would owe tax on $20 of capital gains because B’s basis would  equal the original cost plus A’s half of the increased value ($50 sale less $10 cost less $20 for A’s half of increase = $20 gain)

The double step-up could potentially save the surviving spouse many thousands of dollars in capital gains tax, depending on how much your assets have grown in value through the years.  A split of community property into separate trusts risks the loss of this significant tax advantage.

However, let’s briefly muddy the waters a bit here, to show an example of why we lawyers have disclaimers, don’t make guarantees, or commit to answers in a blog format.  As pointed out by CA lawyer Robert J. Mintz on his Asset Protection Law website, assets held as community property are subject to the creditors of either spouse.  If there are credit problems in the relationship, keeping your property separate could very well protect an innocent spouse from liability and thereby supersede our tax concerns.

Part II

In Part II, coming soon, we will conclude this discussion by analyzing the options if you are a married couple living in a separate property state.

 Living Trusts: Should Couples Use Joint or Separate Trusts? (Part I)
 Living Trusts: Should Couples Use Joint or Separate Trusts? (Part I)

Scott

Scott R. Zucker, Esq. is the owner of The Zucker Law Firm PLLC, located just outside the Capital Beltway in Annandale, within five miles of the City of Fairfax, the county seat of beautiful Fairfax County, Virginia. The firm focuses mainly on estate planning services for Virginia, Maryland and Pennsylvania clientele, and seeks to do so in an affordable and approachable way. People interested in learning more can contact Scott by phone or email.

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