Estate Planning For Unmarried Couples: How To Avoid The Non-Marriage Penalties

Transcription

1 Estate Planning News You Can Use Today Estate Planning For Unmarried Couples: How To Avoid The Non-Marriage Penalties In This Article: A Written Estate Plan is Essential for Unmarried Couples to Avoid the Effect of State and Federal Laws that May Penalize Them Failure to Plan Will Result in Disinheritance of Loved Ones, and the Inability to Make Personal Decisions Regarding Health Care and Financial Matters Tax Planning is Especially Important for Wealthier Unmarried Couples Introduction According to the U.S. Census Bureau, approximately 9.4 percent of all Michigan households are comprised of unmarried couples. People in these relationships do not benefit from numerous federal and state rules designed to protect married persons. In fact, the laws that protect married couples often have the opposite effect on unmarried partners. As a result, estate planning for unmarried individuals is more crucial than ever. In this article we will explore the different ways that unmarried couples may be penalized by current law with respect to their estate plans and how to avoid the negative effects of those penalties. Michigan Rules of Intestacy When married persons die without planning their estates, any property owned in their sole name at the time of death will be transferred under Michigan s Rules of Intestacy. These Rules are designed to ensure that a surviving spouse inherits at least a portion of his or her spouse s property. In addition to inheriting property, married spouses are also entitled to other allowances from a deceased spouse s estate to help protect them from impoverishment. However, these same protections are not in place for unmarried couples, and the Rules of Intestacy will serve to fully disinherit the surviving member of an unmarried couple. This means that a surviving spouse of a short term marriage is afforded greater protection than an unmarried partner who may have been involved in a much longer term relationship. To avoid the unintended results of the Rules of Intestacy, unmarried couples must engage in estate planning with wills or trusts to name the beneficiaries that they want to receive their property. Estate planning documents completely remove the couple s estate from being directed by the Rules of Intestacy. Joint Property Most couples find it convenient to hold property as joint owners. However, unmarried couples have fewer rights with respect to jointly-owned property. Only married couples can own assets as tenants by the entireties. This form of joint ownership prevents a creditor of only one married spouse from using property owned by both spouses as tenants by the entireties to satisfy a money judgment. Unmarried couples cannot own property as tenants by the entireties, and are limited to joint ownership of assets. The result is that their creditors may use jointly owned property to satisfy the debts of either owner.

2 Michigan law also provides certain presumptions with respect to co-owned property that may serve to protect the married couple. This occurs because property acquired during a marriage in the names of both the husband and wife is presumed to be owned by them as joint owners with full rights of survivorship. However, this presumption of joint ownership does not apply to unmarried couples. Rather, for unmarried couples, it is presumed that co-owned assets are held as tenants in common, and subject to split. Therefore, when one of the partners dies without an estate plan, his or her share of a coowned asset will be transferred to his or her next of kin by blood, and not to the surviving partner. The taxation of joint accounts can also be vexing for unmarried couples. When the original owner of a bank account adds a second joint owner to the title of the account, it is considered a gift of property by the IRS when the second owner removes funds from the account. For married couples, the impact of creating such a gift is minimized because married spouses can make unlimited gifts to each other without incurring federal gift tax. The negative consequences of co-ownership of property for unmarried couples can be avoided with proper planning to transfer property post-death to the intended beneficiary. This can be accomplished even without using a will or trust by arranging for the direct transfer of property to the surviving partner. We have outlined all of these direct transfer techniques in a guide entitled Asset Transfer Guide to Avoid Probate in Michigan. Personal Representatives and Guardians Married spouses are also protected if they fail to name a personal representative (i.e. executor) in their last will and testament because the law grants priority to a surviving spouse to serve as personal representative. On the other hand, an unmarried partner is not given any priority to serve as personal representative under Michigan law. Again, this problem can be solved easily by naming one or more specific persons to act a personal representative in a last will and testament. The lack of such documentation often places a surviving partner in conflict with his or her deceased partner s family. Similar rules apply with respect to guardians of minor children. Of course, the biological or adoptive parents of a minor child have priority to serve as guardians whether they are married or not. However, Michigan does not recognize second-parent adoptions for unmarried couples. As a result, one of the partners in an unmarried relationship will not be allowed to assume the care and custody of a minor child even if that person was instrumental in rearing the child for many years. Therefore, if the partner who is the legal guardian of the child does not nominate a successor guardian in his or her will, the surviving partner may find themselves in conflict with other family members who also desire to assume guardianship of the child. And, courts in Michigan have considered a guardian s sexual orientation when determining custody. An unmarried person who is raising children with a partner must execute a will to nominate a successor guardian to resolve these potential conflicts. Executing a will also ensures that a child who is not the natural issue of both partners will inherit property from each of them if that is their desire. Remember, the Rules of Intestacy will serve to disinherit anyone who does have a relationship by blood to a deceased person. Patient Advocates and Hospital Visitation Rights Unmarried partners may also be penalized in the context of making medical decisions for each other. Michigan law provides a formal procedure for anyone over the age of 18 to name another person in writing to make health care decisions for them in the event that they become incapacitated. These documents are known by a variety of names, including medical directives, advance directives, and patient advocate designations, among others. Even without such a document, Michigan law allows health care providers to consult with a spouse or next of kin concerning treatment options for an incapacitated person. On the other hand, it is very unlikely that medical personnel will consult with a non-family member on such matters since there is no legal authority for doing so. In addition, an unmarried person may be prohibited from visiting his or her partner since hospital visitation is frequently limited to family members. The solution to these issues is for unmarried partners to execute advance medical directives to appoint each other as a patient advocate to partici-

3 pate in medical decisions. Employee Benefits Some companies only permit an employee s spouse to be named as a beneficiary of employer-sponsored life insurance or retirement benefits. This means that the partner of an unmarried employee may not receive the same benefits as the spouse of a married employee. Even if benefit levels are the same, an employee in a same-sex relationship is often reluctant to name his or her partner as a beneficiary to prevent disclosure of their sexual orientation. As a result, many unmarried partners name their estate as a beneficiary which can have the unintended effect of disinheriting their partner if proper estate planning documents are not in place. With respect to retirement accounts, a surviving married spouse is permitted to roll a 401(k) or IRA account into his or her own qualified retirement account IRA and defer required minimum distributions for a significant period of time. No such rules apply to unmarried couples since a surviving unmarried beneficiary be required to take minimum distributions immediately. One option for unmarried couples to avoid these pitfalls is for the employee to establish a revocable living trust which can act as the beneficiary of workplace benefits such as life insurance. A revocable trust can shield the employee from revealing his or her beneficiaries since the disclosure requirements are usually limited to the name of the trust, the name of the trustee, and the trustee s powers. However, using a trust as a retirement account beneficiary may require the withdrawal of funds from the account within five years of the employee s death or over the deceased account owner s remaining actuarial life expectancy. Ending the Relationship Whether a couple is married or not, relationships don t always last, so proper planning is crucial. Again, married couples have certain built-in advantages. Michigan law automatically revokes all beneficiary designations for married couples who divorce, including life insurance designations, retirement account beneficiaries, and beneficiaries named in estate planning documents. Divorce also severs any joint ownership of property for married couples. As a result, divorced couples will not inherit property from each other even if they fail to remove a former spouse as a beneficiary of life insurance, wills, trusts, or other documents. Unmarried couples do not have similar protections, and must modify all of their account designations, and estate planning documents to prevent unintended transfers of property. This is also true with respect to joint ownership. Unfortunately, rescinding joint ownership may require the consent of all owners. Unmarried couples are also at a disadvantage when it comes to dividing assets upon a break-up. For divorced spouses, federal tax rules provide that no gain or loss is recognized on the transfer of property to a spouse or ex-spouse if it is made within one year from the date that the marriage is terminated. In addition, transfers to a former spouse are considered to be for full consideration and are therefore not deemed a gift. For unmarried couples, no such rules exist to prevent recognition of gain when assets are partitioned. Transfers of property to facilitate a break-up between unmarried partners may create taxable gifts and taxable income to be recognized by the donor. Planning For The Taxable Estate Married spouses also have several built-in advantages when planning to avoid estate taxes. First, they have an unlimited marital deduction which allows complete deferral of estate taxes until the death of the second spouse. Second, married spouses can gift an unlimited amount of property to each other without gift tax. In addition, married couples enjoy portability of their estate tax exclusions, which allows them to double their exemption from estate taxes. Unmarried couples do not have this right. Therefore, without proper planning, they may not be able to fully utilize their federal estate tax exemptions. Fortunately, there are ways to shift property to avoid the limitations imposed by gift tax, and without giving up too much control over the assets. Limited Liability Companies One approach to shift assets to avoid estate tax is for a donor-partner to transfer property to a Limited Liability Company (LLC), and then gift partial in-

4 terests in the LLC to the donee-partner. The Operating Agreement for the LLC may contain restrictive covenants and buy-sell provisions to restrict the donee-partner s access to the assets of the LLC. This approach provides protection in the event of breakup, and prevents misuse of funds. The donor-partner may also be able to claim discounts on the gifts for lack of control and marketability. Discounts for lack of control and marketability are based on the idea that property owned by an entity which is controlled by 2 or more persons is worth less than assets owned individually. This type of valuation discounting may allow the donorpartner to transfer more assets to an LLC at a lower gift-tax cost than he or should would be able to do directly. For example, if a donor shifted $1.2 million directly to his or her partner, then the donor would owe gift taxes of $82,000. However, if the donor took a discount of 25 percent based on reduced marketability and control in the LLC, then the value of gift would be reduced to $900,000, thus reducing the overall gift and estate tax impact on the donor. Estate Freeze Techniques There are a variety of planning strategies that can be employed to shift assets to a non-family member while allowing the donor to retain certain tax benefits. These are commonly known as estate freeze techniques because they have the effect of insulating the donor s gross estate from future appreciation (i.e. freezing its growth). The general idea is to shift assets now to reduce the size of the estate, and inhibit its future growth, and thereby reduce estate taxes. Three common estate freeze strategies are known by the acronyms GRIT, GRAT, and QPRT. A Grantor Retained Income Trust (GRIT) can be used to leverage the value of gifts to a non-family member. For example, if a 55-year-old donorpartner transferred $1.2 million in assets to his partner through a 10-year GRIT when the applicable IRS interest rate was 5.8 percent, the gift would be $605,628 rather than $1.2 million. The actual size of the gift for tax purposes is a function of the IRS 7520 Rate which is established by the IRS to determine the present value of gifts. If interest rates rise, the use of GRITs can be even more favorable because as rates rise the gift becomes smaller. Under the illustration above, for example, if the 7520 Rate were 8.2 percent, the gift would be valued at only $483,936. Through the use of a Qualified Personal Residence Trust (QPRT), a donor-partner can transfer all or part of his or her residence to his or her partner. A QPRT works exactly the same way as a GRIT, but the trust is funded with the donor s residence. A Grantor Retained Annuity Trust (GRAT) is similar to a GRIT, except that a distribution has to be made annually to the GRAT s creator. Like both the GRIT and the QPRT, the age of the donor, the term of the trust, and the current interest rate all affect the size of the gift. Unlike the QPRT and the GRIT, however, the donor can also determine the gift by deciding how much the fixed annual annuity from the GRAT should be. Planning for the taxable estate is especially complex and requires careful consideration. Almost every technique that produces tax savings will also result in a trade-off with respect to the control and use of property. Always consult a tax planning professional before transferring assets to avoid estate tax. Conclusion Many legal protections are granted only to married couples. But, through proper estate planning, unmarried partners may also achieve favorable tax treatment, distribution of property to loved ones, and the appointment of suitable persons to act on their behalf.

5 John Tamboer concentrates his practice in the areas of estate planning and probate. Please visit our website for more information about these areas of law, and our office Corporate Exchange Blvd. Grand Rapids, MI Phone: Web: Estate Planning for Families and Business Owners This newsletter, or any other publication, is not a substitute for legal advice. Do not proceed with any strategy outlined in this article without consulting a qualified professional. Feel free to send us your comments and suggestions regarding future editions of this newsletter. This publication is a copyrighted service of the Law Offices of John Tamboer, PLC, and may not be reprinted without permission. However, you may feel free to pass it on to your friends, family, and colleagues.