ESTATE PLANNING FOR THE UNMARRIED COUPLE: UNIQUE CHALLENGES, UNIQUE OPPORTUNITIES[This paper was originally presented at Chemical Trust's Fifth Annual Trust and Probate Forum held in San Francisco, California, on October 30, 1996.]
I. Introduction.
A. Growing Trend. Unmarried couples pursuing a joint, coordinated estate plan seems
to be a growing segment of estate planning practice in recent years. The number of
continuing legal education courses devoted to this topic is evidence of this
phenomenon.
B. Terminology. The English language seems to lack adequate terms to describe these
relationships, as evidenced by this recent "Dear Abby" column (San Francisco
Chronicle, 8/1/96):
"Dear Abby: Circumstances beyond our control prevent us, a single man and
single woman, from marrying. When one of us dies, may the term
significant other' be used in the obituary to describe the surviving partner?
Or would dear friend' be better?
Longtime Reader in Florida"
What terminology do/should we use: "Domestic partners," "significant others,"
"dear friends," "non-marital partners," "unmarried couples," "cohabitants,"
"roommates," "housemates," "living in sin," "shacking up"? The phrase "domestic
partners" seems to be gaining popularity, but may imply a registered relationship
under a municipal or corporate program for health benefits.
C. Identifying this Category of Clients. In actuality, unmarried couples fall into two
broad categories:
1. Unmarried By Choice. Heterosexual couples may decide, for a variety of
reasons, to reside together in a committed relationship, but not assume the
legal obligations (or take advantage of the legal benefits) of marriage. For
these couples, marriage may be an effective tax and estate planning choice.
a. No Common Law Marriage in California. California does not
recognize common law marriage. Family Code 300. Some
unmarried couples may be cohabitating under the misconception that
California does recognize common law marriage.
2. Unmarried by Law. Even if they wanted to marry, same sex couples are
barred from doing so by state law. Accordingly, marriage as a tax and estate
planning device is not currently an option for gay and lesbian couples. (See
discussion below regarding legal challenges to state law bar on same sex
marriage.)
3. Age. Chronological age does not seem to be a factor. Domestic partnerships
of all ages, from thirty-somethings to eighty-somethings, are becoming more
common. As we approach the 21st century, the social stigma attached to
such relationships has all but evaporated (at least in California).
4. Married Couples Living Separate and Apart. Yet another category of clients,
although more rare, is the couple that wants to remain married, but live
separate and apart. Because of children or other factors, they may want a
coordinated estate plan. The issues are similar, but often viewed in reverse
when compared to planning for the unmarried couple, i.e., "would it be better
tax-wise for us to stay married?"
II. Transfer Tax Issues.
A. No Marital Deduction Safety Net. The single biggest difference in planning for
unmarried couples is the lack of the marital deduction as a fall back or safety net. In
the married context, we can rest comfortably knowing that there are no transfer tax
consequences of transmuting separate property to community to equalize estates.
Likewise, we need not worry excessively about life insurance beneficiary
designations or simple joint tenancy arrangements which pass property to the
surviving spouse because, even if it might not effectuate the best tax planning, at
least we know the marital deduction will prevent a tax imposition at the first death.
This safety net does not exist when planning for unmarried couples.
B. Gift Transfers.
1. Marital Deduction for Gift to Spouse. Gratuitous inter vivos transfers from
one spouse to the other (provided the donee spouse is a United States citizen)
are deductible in calculating taxable gifts. IRC 2523.
2. Gifts between Non-Marital Partners are Taxable. Inter vivos transfers
between unmarried partners are taxable and will consume Unified Credit or
result in gift tax payable if Unified Credit is exhausted.
a. Annual Exclusion. The first $10,000 of value transferred from one
domestic partner to the other in each year is not taxable, provided the
gift is a present interest. 2503(b).
b. Medical and Tuition Payments. Payments for medical expenses or
tuition made directly to the medical or education provider are
excluded in determining taxable gifts. IRC 2503(e). Thus, where
one domestic partner has expensive medical bills not covered by
insurance, the other partner can pay those bills directly without
generating a taxable gift.
c. Non-Citizen Spouse Compared. In effect, inter vivos gift planning
between unmarried partners is not dissimilar to planning for inter
vivos transfers to a non-citizen spouse, where there is no marital
deduction available; however, annual exclusion is $100,000 for non-citizen spouses, compared to $10,000 for unmarried partner,
regardless of citizenship. IRC 2523(i); Treas. Reg. 25.2523(a)-1.
d. Inadvertent Gifts from Commingling. One of the biggest potential
problems in planning, and a big surprise for clients, is the existence
of inadvertent, unreported taxable gifts resulting from commingled
assets real estate, bank and investment accounts, automobiles, etc.
If the relationship is of long duration, tracing can be difficult if not
impossible. Commingling can result in multiple taxable gifts, in both
directions. Where simultaneous transfers occurred, perhaps the gifts
can be netted. But under what circumstances? The unscrambling of
commingled assets may simply result in generating new taxable gifts.
3. Split Gift Election.
a. Married Couple. The spouse of a married donor may elect to treat a
gift by the donor as if it were made one-half by the spouse of the
donor. IRC 2513. The election is made on form 709. Thus, even
if the gift is covered by the annual exclusion amount, a gift tax return
must be filed to split the gift. For gifts of community property, each
spouse is deemed to have made a gift of one half, and therefore no
split gift election need by made, and no return is due if the gift of
community property is less than $20,000 per donee. Of course, if the
gift of community property exceeds $20,000 to any one donee, both
spouses must file separate gift tax returns.
b. Unmarried Couple. A non-marital partner cannot elect to split a gift
made by the donor partner. Being able to do so would be useful
where, for example, the donor partner wants to maximize tax-free
gifts to his children by "doubling up" the gifts. A possible way to
circumvent this problem might be for the donor partner to transfer
assets to the other partner, who would in turn make annual exclusion
gifts to the donor's children. However, the Service could well view
this as a step transaction or treat the partner as the agent of the donor
spouse, i.e., a mere conduit. Estate of Joseph Cidulka, TC Memo
1996-149 (every time father made annual gifts of closely held stock
to son and daughter-in-law, daughter-in-law re-transferred stock to
son on the same day; held, gifts to daughter-in-law were really gifts
to son.)
4. Disclaimer Trust Planning.
a. Married Couple. A surviving spouse may retain an income interest
in a trust into which the spouse has disclaimed, thereby facilitating
optional (disclaimer) bypass trust planning. Such planning is often
employed in small to medium sized estates where the spouses are
more interested in tax planning than testamentary control and do not
want to mandate a bypass trust. IRC 2518 and Treas. Reg.
25.2518-2(e).
b. Unmarried Couple. By contrast, a domestic partner cannot retain an
income interest in a disclaimer trust, limiting planning flexibility.
C. Estate Tax.
1. Estate Tax Marital Deduction. Transfers from one spouse to the other at
death are deductible in calculating the federal estate tax. IRC 2056.
2. Unmarried Couple Compared. Transfers from one domestic partner to the
other at death are taxable and will consume available Unified Credit or result
in tax if the gross estate of the deceased partner exceeds the amount sheltered
by the Unified Credit (currently $600,000).
3. Non-Citizen Spouse Compared. Planning for an unmarried couple is not
unlike planning for a couple where one spouse is not a United States citizen,
except that there is no equivalent of a Qualified Domestic Trust (QDOT),
which can be used to defer tax. IRC 2056A. For that matter, planning for an
unmarried couple is not unlike planning for a transfer between parent and
child.
D. Generation-Skipping Tax.
1. Generation Assignment.
a. Married Couple. Spouses (and former spouses) are assigned to the
same generation, regardless of differences in their ages. IRC
2651(c)(1). The children of one spouse are treated as one generation
below the other spouse, regardless of the age span.
b. Unmarried Couple. Non-marital partners whose ages are within 12.5
years of each other are assigned to the same generation; a partner who
is more than 12.5 years but not more than 37.5 years younger than the
other partner is assigned to one generation below the older partner;
and a partner who is more than 37.5 years younger is assigned to two
generations below the older partner. Consequently, transfers from the
older partner to the younger partner are generation-skipping transfers
if more than 37.5 years separates the two partners. Moreover,
transfers to the children of a partner who is more than 12.5 years
younger than the older partner are generation-skipping transfers.
c. Example. Max, 75, and Wanda, 35, are unmarried domestic partners.
Wanda has a 5-year old child, Charlie, from a prior marriage. If Max
transfers assets to either Wanda or Charlie, it is a generation-skipping
transfer that will consume GSTT exemption and, if such transfers
exceed Max's available exemption, will result in the payment of
GSTT. If Max marries Wanda, neither the transfers to Wanda nor the
transfers to Charlie will be generation-skipping transfers.
III. Income Tax Issues.
A. Filing Joint Returns.
1. Joint and Several Liability. Married individuals may file a joint income tax
return. IRC 6013. There is deemed to be only one taxable income, but two
taxpayers. Income and deductions of both taxpayers are aggregated for the
purpose of calculating limitations based on adjusted gross income. Each
spouse is jointly and severally liable for the tax, penalties, and interest. Reg.
1.6013-4(b).
2. Innocent Spouse Relief. A spouse who has filed a joint return may be
relieved of liability if he or she can establish that he or she is an "innocent
spouse." IRC 6013(e). The burden of proof rests with the spouse seeking
relief. See, e.g, Stevens v. Comr., 872 F.2d 1499 (11th Cir. 1989);
Sonnenborn v. Comr., 57 T.C. 373 (1971).
3. Joint Return for Unmarried Couple (?)/No Innocent Spouse Relief. In Freck
v. IRS, 810 F. Supp. 597 (M.D. Pa. 1992), rev'd on other grounds, 94-2
USTC 50,518 (3d Cir. 1994), the court deemed a joint return by unmarried
couple valid, but denied innocent spouse relief because parties were not
"spouses."
B. Basis Adjustment at Death..
1. Married Couples.
a. Community Property. Married couples may hold title to property as
community property, which receives a stepped-up or stepped-down
basis on both halves of the community property at the death of either
spouse. IRC 1014(b)(6).
b. Separate Property. The separate property of the deceased spouse
receives a full adjustment, up or down, whereas the separate property
of the surviving spouse receives no adjustment. IRC 1014(a).
c. Joint Tenancy. For spousal joint tenancy property ("qualified joint
property"), one-half the value is included at the death of the first
spouse to die regardless of the source of consideration. IRC
2040(b). One-half the value will receive a basis adjustment unless
the surviving spouse can show that the property was actually
community property nominally held in joint tenancy form.
(1) Exception for Pre-1977 Property. If joint tenancy property
was acquired by husband and wife prior to 1977, the
contribution rule rather than the qualified joint property rule
applies and the full value is included in the gross estate of the
first spouse to die in the absence of proof of contribution by
the surviving spouse. Gallenstein v. U.S. (6th Cir. 1992) 975
F.2d 286; followed in Patten v. U.S. (D.C. Va. 1996) 96-1
USTC, 60,231, and Anderson v. U.S. (D.C. Md. 1996) 96-2
USTC, 60,235. In this instance, there is no need to file a
spousal property petition to attempt to recharacterize joint
tenancy as community property.
2. Unmarried Couples.
a. Basis Adjustment for Decedent's Property. Assets held in the name
of the deceased non-marital partner, either alone or as tenant-in-common, will receive a step-up or step-down in basis. Assets held in
the name of the surviving non-marital partner, either alone or as
tenant-in-common, will not receive any basis adjustment. IRC
1014(a).
b. Joint Tenancy. For assets held in joint tenancy form, the entire value
of the property will be includable in the death tax estate of the first
non-marital partner to die, in the absence of proof of contribution by
the surviving partner. IRC 2040(a). This rule turns out to be
advantageous (at least from an income tax point of view) if the
property has appreciated and the partner who supplied all the
consideration dies first. It is disadvantageous if the partner who
supplied the consideration is the survivor, since there would be no
step-up in basis at all.
(1) Burden of Proof. Treas. Reg. 20.2040-1 provides, in part,
that "[t]he entire value of jointly held property is included in
a decedent's gross estate unless the executor submits facts
sufficient to show that property was not acquired entirely with
consideration furnished by the decedent, or was acquired by
the decedent and the other joint owner or owners by gift,
bequest, devise, or inheritance."
(2) Must Executor Submit Facts? Under the foregoing
regulation, if the executor has knowledge that the surviving
partner supplied all or part of the consideration, must the
executor report this information, or may the executor remain
silent and report the entire value on the estate tax return of the
deceased partner in order to obtain a full step-up in basis?
C. $125,000 Exclusion from Gain on Sale of Residence.
1. General Rule. A taxpayer who, at the time of sale, has attained age 55 and
who has owned and occupied real property as his or her personal residence
during 3 out of the previous 5 years, may exclude up to $125,000 of capital
gain. IRC 121.
2. Married Couple. If a married couple holds title as either joint tenancy or
community property, and the spouses file a joint income tax return for the
year of the sale, then only one spouse need satisfy the age, ownership, and
use requirements, but all requirements must be satisfied by the same spouse.
121(d)(1); Treas. Reg. 1.121-5(a)(1).
3. Unmarried Couple. Where a residence is owned jointly by non-marital
partners, each must separately satisfy the age, ownership and use
requirements to take the exclusion for their respective shares, but if they do,
they can exclude a total of $250,000 of gain ($125,000 each). Marital status
is determined at the time of the sale. Thus, two unmarried individuals who
separately satisfy the requirements of 121 and who sell their respective
residences and later marry in the same taxable year may each claim the full
exclusion, even if they file a joint return. 121(d)(6)(B); Treas. Reg.
1.121-5(f).
D. Spousal Rollover for Qualified Plans and IRA's.
1. Married Couples. A surviving non-participant spouse who is designated
beneficiary of the participant's qualified plan may effect a rollover of plan
assets to his or her own IRA with complete tax deferral. IRC 402(a)(9)
provides "[i]f any distribution attributable to an employee is paid to the
spouse of the employee after the employee's death, the preceding provisions
of this subsection [allowing a rollover of a pension plan to an IRA - ed.]
shall apply to such distribution in the same manner as if the spouse were the
employee...." The rollover rule also applies for IRA's which on which the
surviving spouse is designated as beneficiary. IRC 408.
2. Unmarried Couples. No rollover is available for non-marital partners.
Where a non-marital partner is named as beneficiary, the usual minimum
distribution rules apply.
IV. Property Tax Issues.
A. Exclusion for Interspousal Transfers. A transfer of real property between spouses,
whether during life or at death, is exempt from reassessment for property tax
purposes. Rev. & Tax. Code 63. Interspousal transfers include transfers to a trust
for the benefit of a spouse. Rev. & Tax. Code 63(a).
B. Reassessment for Unmarried Couples. Transfers of real property between unmarried
partners during life or at death are not exempt from reassessment.
1. Joint Tenancy Exception. Under Rev. & Tax Code 65(b), if an original
owner remains on title following the creation of a joint tenancy, no change
of ownership occurs. Thus, if one non-marital partner adds the other as joint
tenant, no change of ownership occurs. If the donee partner dies first, there
is no reassessment. On the other hand, if the original owner partner dies first,
a full reassessment for the entire property will occur. Rev. & Tax. Code
65(c).
V. Statutory Probate Rights and Priorities.
A. Intestate Share.
1. Surviving Spouse. If the deceased spouse dies intestate, the surviving spouse
inherits the following share of the estate (Probate Code 6401):
a. all of the deceased spouse's share of any community property;
b. all of the deceased spouse's separate property if the deceased spouse
dies without issue, parents, brothers, sisters, or issue of a deceased
brother or sister;
c. one-half of the deceased spouse's separate property where survived
by only one child or no child, but is survived by a parent or parents
or issue of a parent or parents;
d. one-third of the deceased spouse's separate property where survived
by more than one child, or by one child and the issue of one or more
deceased children, or by the issue of two or more deceased children.
2. Surviving Domestic Partner. By contrast, a non-marital partner is a stranger
to the deceased partner as far as the law of intestacy is concerned and takes
no part of the estate, even if the deceased partner dies without heirs at law.
The State of California has a higher priority than a domestic partner, absent
a valid Marvin claim (Marvin v. Marvin [1976] 18 C.3d 660).
B. Temporary Possession of Residence.
1. Surviving Spouse. Until the filing of an inventory and for a period of 60 days
thereafter, or other period ordered by the court, the surviving spouse is
entitled to temporary possession of the family dwelling. Probate Code
6500.
2. Surviving Partner. A non-marital partner has no such rights.
C. Probate Homestead.
1. Surviving Spouse. A surviving spouse is entitled to a have property set aside
as a probate homestead. Probate Code 6510.
2. Surviving Partner. A non-marital partner has no such rights.
D. Family Allowance.
1. Surviving Spouse. A surviving spouse may petition the court for a family
allowance of the estate of the deceased spouse in an amount which is
reasonable for his or her maintenance according to his or her circumstances.
Probate Code 6540.
2. Surviving Partner. A non-marital partner has no such rights, but may be able
to sustain a "palimony" claim against the deceased partner's estate.
"Palimony" rights, established in the landmark case of Marvin v. Marvin
(1976) 18 C.3d 660, have been extended to same-sex couples. Whorton v.
Dillingham (1988) 202 Cal.App.3d 447 (The Whorton court applied Marvin
to a gay relationship without even referring to the sexual orientation of the
litigants.)
E. Omitted Spouse.
1. Surviving Spouse. A surviving spouse who married the decedent after the
execution of a will may take an intestate share against the will. Probate Code
6560.
2. Surviving Partner. A non-marital partner who enters into a relationship after
the execution of a will has no rights to the estate unless the decedent partner
updates the will to include him or her. However, a non-marital partner may
be able to sustain a "palimony" claim against the estate of the deceased
partner.
F. Appointment as Conservator.
1. Spouse's Priority. In the absence of a nomination by the proposed
conservatee, spouse, or other relative, the spouse of the proposed conservatee
has first priority for appointment. Probate Code 1812(b). If a proposed
conservatee has sufficient capacity to form an intelligent preference, the court
shall appoint as conservator the nominee of the proposed conservatee unless
the court finds that the appointment is not in the best interests of the
conservatee. Probate Code 1810. The spouse of the proposed conservatee,
or the adult child, parent, brother, or sister may also nominate a conservator.
Probate Code 1811.
2. Unmarried Partner. If one non-marital partner wants his or her partner to
serve as conservator, a written nomination must be executed. This is often
done as part of a power of attorney for property management and/or health
care. In the absence of a nomination, virtually every relative of the
conservatee will have priority over the conservatee's partner.
G. Appointment as Administrator.
1. Spouse's Statutory Priority. The surviving spouse has first priority for
appointment as administrator of a decedent's estate if the decedent dies
intestate or if there is no person named in decedent's will to serve as executor
who is available or willing to serve. Probate Code 8461.
2. Non-Marital Partner. Following the surviving spouse, in order of priority, are
children, grandchildren, other issue, parents, brothers and sisters, etc.
"Domestic partner" or "significant other" is nowhere on the list. Last on the
list, after creditors, is "any other person," which is where a non-marital
partner would presumably fall.
H. Standing to File Petition Regarding Power of Attorney. Court proceedings regarding
powers of attorney is one of the areas where "friend" or "other interested person" has
standing to file a court petition concerning the principal's affairs. Probate Code
4940(l).
I. Summary Probate Proceedings.
1. Married Couples. As the name indicates, only a surviving spouse may use the
streamlined spousal property petition procedure to facilitate the transfer of
assets at death, regardless of the value of the estate. Probate Code 13500 et
seq.
2. Unmarried Couples. For unmarried couples, the estate of the first partner to
die would have to go through probate even if the will devises the entire estate
to the surviving partner, unless the estate qualifies for small estate affidavit
treatment (less than $60,000 in value). Probate Code 13100.
3. Transfers on Dissolution.
a. Married Couples. Ironically, one of the advantages of marriage is
that transfers of property to a spouse or former spouse incident to a
divorce are non-recognition events for income tax purposes. IRC
1041(a); 408(d)(6) (IRA accounts).
b. Unmarried Couples. Transfers in settlement of a dissolution of a non-marital relationship are taxable.
4. Limitation on Transfers to Drafters. The only place in the Probate Code that
equates married to unmarried couples is 21350, dealing with the invalidity
of donative transfers to, among others, the drafter of an instrument or a
person who is related by blood or marriage to, "is a cohabitant with," or is an
employee of, the person who drafted the instrument.
J. Duty of Support.
1. Married Couple. Each spouse has a legal duty to support the other spouse.
Family Code 4300, 4301. As a consequence, the separate property of one
spouse must be used to support the other if there is insufficient community
property.
a. Medi-Cal Planning. This rule has a significant impact on Medi-Cal
planning. Where one spouse ("institutionalized spouse") moves to
a nursing home, the spouse who remains at home ("community
spouse") is limited to a set-aside of non-exempt assets, called the
Community Spouse Resource Allowance ("CSRA"). Remaining
non-exempt assets must be "spent down." Distinctions between
community and separate property are ignored for this purpose; in
other words, the separate property of the community spouse is
considered an available resource of the institutionalized spouse.
2. Unmarried Couples. Unmarried couples do not have a legal duty to support
each other, subject to the ability of one partner to make a claim for palimony.
Unmarried couples have an advantage in Medi-Cal planning because the
community partner's resources are not considered at all in determining the
qualification of the institutionalized partner, i.e., they are not available
resources. Thus, the absence of a legal marriage is an advantage in this
context. Divorce thus becomes a planning option for married couples,
especially a late in life marriage where the community spouse has substantial
separate property.
K. Fiduciary Duties.
1. Married Couples. Married couples are subject to statutory fiduciary duties
to each other in the conduct of their financial relationship. Family Code 721
provides in part:
"...in transactions between themselves, a husband and wife are subject
to the general rules governing fiduciary relationships which control
the actions of persons occupying confidential relations with each
other. This confidential relationship imposes a duty of the highest
good faith and fair dealing on each spouse, and neither shall take any
unfair advantage of the other. This confidential relationship is a
fiduciary relationship subject to the same rights and duties of
nonmarital business partners...."
2. Unmarried Couples. Family Code 721 does not expressly apply to
unmarried couples, but one might argue that the general fiduciary rules
applicable to business partnerships may apply. See Corp. Code 15021;
Ragsdale v. Haller (9th Cir. 1986) 780 F.2d 794, applying California law
(partners are trustees for each other).
L. Disposition of Remains; Funeral.
1. Surviving Spouse Has Priority. The right to control the disposition of
remains of a decedent, absent instructions by the decedent, vests in the
surviving spouse, if any, and if none, the surviving child or children, and if
none, the surviving parent or parents. Thereafter, the right to control
disposition of remains follows the laws of intestate succession. Health &
Safety Code 7100.
2. Non-Marital Partner Has No Authority. Absent instructions by a deceased
nonmarital partner granting his or her partner the right to dispose of remains,
the surviving nonmarital partner has no right to control disposition. Such
authority may be granted in a power of attorney, will or other document.
3. Nonmarital Partner Could Be Excluded from Funeral. The right to dispose
of remains includes the right to determine the timing and manner of burial
and funeral services, and the right to include or exclude certain persons. Ross
v. Forest Lawn Memorial Park (1984) 153 Cal.App.3d 988 (mother of 17-year-old decedent, who had first priority under H & S 7100, had cause of
action against cemetery which failed to follow her instructions to exclude
punk rockers from daughter's funeral, which was disrupted). "The one in
whom the right to control vests by statute has the right and the power to
dispose of the remains without services, with public services, or with services
attended by invited guests only. Friends or family members who are
uninvited have no right to be present." 153 Cal.App.3d at 994 (italics
supplied). Thus, a parent or child could not only dispose of the decedent's
remains in a manner contrary to the wishes of the nonmarital partner, but
could legally exclude the non-marital partner from the funeral.
VI. Planning Ideas
A. Marriage.
1. Heterosexual Couples. If the benefits of marriage outweigh the burdens, a
heterosexual couple can marry.
2. Same Sex Couples. The marriage option presently does not exist for same
sex couples.
a. Same Sex Marriage.
(1) Hawaii Supreme Court. A case out of Hawaii, Baehr v.
Lewin, involves a constitutional challenge (under the Hawaii
Constitution, not U.S.) to the state's rejection of marriage
applications submitted by three same sex couples. The
applications were rejected on the sole ground that the couples
were of the same sex. The trial and intermediate appeals
courts upheld the administrative ruling. The Hawaii Supreme
Court (852 P.2d 44, May 1993), reversed and remanded the
case to the trial court for a factual determination whether there
was a rational relationship between the administrative
decision to reject same sex marriage applications and a
legitimate state concern. While upholding the appellants
equal protection claims, the Court rejected the claim that the
couples had a constitutional right to marriage arising out of
the right to privacy. (For the full text of the Hawaii Supreme
Court opinion, see the following World Wide Web site:
http://www.cs.edu/afs/cscmu/user/scotts/domestic-partners/baehr-v-lewin.html.")
(2) Recent Developments. The trial on remand was concluded on
September 30, 1996. The state, bearing the burden of proof
to establish a compelling reason for the rejection of same sex
marriage applications, focused on the alleged connection
between same sex marriage and the "optimal development of
children." The plaintiffs focused on the fact that marriage is
not limited to the facilitation of procreation, and that there are
other aspects of marriage which are not unique to
heterosexual relationships. At this writing, no decision has
been rendered by the trial court. (For a synopsis of the recent
trial, visit the World Wide Web site of Hawaii Equal
Rights Marriage Project ("H.E.R.M.P.").)
(3) Effect on Estate Planning. Anticipating the possibility of
legal recognition of same sex marriages within the lifetimes
of our clients, query whether estate planners should be
drafting documents with built in contingencies in case such
unions become legal in the future ("if married, then....; if not
married, then....").
(a) Draft trusts which will qualify for marital deduction?
(b) Disclaimer planning?
(c) QDOT for non-citizen partners?
B. Non-Marital or Cohabitation Agreement. Non-marital partners may execute a
cohabitation or non-marital agreement dealing with issues of property, title, rights of
partition, and rights on "dissolution" of the partnership, such as a waiver of
"palimony" rights (Marvin v. Marvin, supra) waiver of partition for property held as
co-tenants, etc.
1. Contract for Prostitution Not Enforceable. Agreement regarding support or
property in exchange for providing sexual services is a contract for
prostitution and is not enforceable.
2. Consideration Independent of Sexual Services. However, cohabitation
agreements are enforceable if supported by adequate consideration
independent of sexual services.
a. In Whorton v. Dillingham (1988) 202 Cal.App.3d 447, a case
involving a same sex couple, the plaintiff had made an oral agreement
whereby Whorton was to provide Dillingham with services as
chauffeur, bodyguard, secretary, and business partner, in addition to
services as lover and companion, in exchange for promise of support
and other property interests. The parties had expressly agreed that if
any portion of the contract was not legally enforceable, such
provisions were severable from the rest of the contract. Citing
Marvin, the Court stated (202 Cal.App.3d at 451):
"Adults who voluntarily live together and engage in sexual
relations are competent to contract respecting their earnings
and property rights. Such contracts will be enforced unless
expressly and inseparably based upon an illicit consideration
of sexual services.'"
The Court in Whorton distinguished Jones v. Daly (1981) 122
Cal.App.3d 500, on the ground that in that case the non-sexual
services were not severable from the sexual services.
3. Cohabitation as Prerequisite. In Bergen v. Wood (1993) 14 Cal.App.4th 854,
Bergen claimed that she had entered into an agreement with Wood whereby
she would serve as social and traveling companion, hostess, and confidante,
in exchange for financial support. However, the parties maintained separate
residences and never cohabitated. The trial court awarded Bergen $3500 per
month for 48 months, holding that the services in question were not
meretricious, were severable from the sexual relations, and were adequate
consideration to support the agreement. The Court of Appeals reversed,
holding that services as social companion and hostess are the type not
normally compensated and were "inextricably intertwined" with the sexual
relations. 14 Cal.App.4th at 859-860. Moreover, the Court found that
cohabitation was a prerequisite to a Marvin claim:
"Since Marvin, case law has held recovery by an unmarried partner
under Marvin requires a showing of a stable and significant
relationship arising out of cohabitation."
The Court was clearly sensitive to opening the floodgates of litigation:
"... if cohabitation were not a prerequisite to recovery, every dating
relationship would have the potential for giving rise to such claims,
a result no one favors." (Id. at p. 858.)
a. Action for Partition Distinguished. The Court distinguished the case
of Milian v. DeLeon (1986) 181 Cal.App.3d 1185, which involved
a non-cohabitating couple, on the grounds that it dealt solely with
property rights arising from an action for partition, and not support.
C. Revocable Trust. For the same reason that revocable living trusts are used in the
married context, they may be used in the unmarried context to allow for creation of
bypass trust for a partner without probate.
1. Joint vs. Separate Trust. Some non-marital partners may prefer a joint trust
for psychological reasons, i.e., as evidence of each partner's commitment to
the relationship. However, separate trusts are easier to administer, create
fewer legal and tax complexities, and present fewer problems on dissolution.
If joint trust is formed, it should create two separate sub-trusts, one for each
partner, with each partner being sole trustee of his or her respective trust.
What we have is really two separate trusts under one document, but this may
satisfy the couple that wants one trust as evidence of committment or so that
they can be just like their married friends.
a. Gift Tax Problems in Joint Trust. Unless ownership of all assets
contributed to the trust is equal, formation of a single joint trust by
non-married couple may result in taxable gifts from one partner to the
other, or in both directions, unless assets are somehow segregated
into separate shares.
b. Income Tax Problems in Joint Trust. Since the trust will be a grantor
trust, income tax will be reportable by the grantors on their individual
returns. Income from separate shares would presumably be reported
by respective partners; if shares not separate, and income reported
equally, either gifts have occurred or income has been misallocated.
Assets held in the name of the trust, as one joint trust, must use only
one tax identification number. Whose number will be used? If an
EIN is obtained for the Trust and a 1041 filed, allocations and
adjustments will have to be made to properly report income.
c. Partnership Compared. Because of the income tax reporting
problems, partnership may be a better model than joint trust. (See
discussion below.)
2. Potential Challenges. Potential litigants include children from former
marriages/relationships, intestate heirs, domestic partner (e.g., palimony
claim), and creditors. In general, it is harder to challenge a living trust than
a will, although not impossible. For example, only beneficiaries of the trust
need be informed of the trust and its assets, and not heirs at law. Contrast
probate proceeding where heirs at law must be given statutory notice of
petition for probate, even if they are not named as beneficiaries. See
Barringer and Lawrence, "Beware: All Fiduciary Law is not Created Equal,"
17 CEB Est. Plan. Rep. 136 (Apr. 1996), for a further discussion of the
differences between trust and estate litigation.
D. Non-Family Partnerships.
1. Valuation Discounts. Valuation discounts for minority interest and lack of
marketability may be easier to obtain in non-marital setting because Service
cannot argue family attribution should its current position change. (See, eg.,
Rev. Rul. 93-12.) Therefore, consider forming a "non-family limited
partnership" to leverage annual exclusion gifts between unmarried partners
to equalize estates.
2. 1034 Issue. Caveat concerning loss of IRC 1034 rollover treatment if
personal residence transferred to a partnership.
3. Management Vehicle. Formal partnership may also serve as more effective
management vehicle for non-marital assets than trusts, but consider costs of
maintaining entity: partnership tax returns, California minimum franchise tax,
accounting issues, tax treatment of formation and dissolution.
4. Other Entity Forms. In addition to partnership form, do not ignore S
corporation or limited liability company as possibilities, which have added
benefit of limited liability. Limited liability company may have advantage
over S corporation because of ability to achieve basis step-up through 754
election.
E. Bypass Trust Planning.
1. More Important for Unmarried Couples. Standard "A-B" trust planning is
not just for married couples; in fact, it may be even more important for non-marital partners, at least where the total combined estate of both partners
exceeds the amount that can be sheltered by the Unified Credit of one partner.
Thus, bequests to a partner should almost always be in trust, rather than
outright. This will avoid "wasting" Unified Credit and avoid a potential
"double" estate tax.
2. Example. Terry and Pat are not married. Terry has no children. Pat has one
child, Dolores, whom Terry has participated in raising and treats as Terry's
own child. Terry has an estate of $500,000. Pat has an estate of $700,000.
They have kept their assets separate. Neither has consumed any Unified
Credit. If Pat dies first leaving everything to Terry, there will be estate tax
of $37,000, and Terry's estate will increase to $1,163,000. If Terry then dies
leaving everything to Dolores, there will be another tax of $219,830, for total
estate taxes of $256,830 (ignoring PPT Credit). If instead Pat had left the
$700,000 estate in trust for Terry for life (for example, with an income
interest and principal invasion on an ascertainable standard, and perhaps a
nongeneral power of appointment), with remainder to Dolores, there would
still be a $37,000 tax on Pat's death, but no further tax on Terry's death,
resulting in a tax savings of $219,830.
F. Life Insurance.
1. Policy Ownership.
a. Existing Policies.
(1) Outright Transfer. Consider outright transfer of ownership
from insured partner to other partner for existing policies, at
interpolated terminal reserve value, using annual exclusion
and even consuming some Unified Credit, rather than waiting
until death where full death proceeds will be a taxable
transfer. Three year rule applies. IRC 2035(b)(2).
(2) Irrevocable Trust. Consider transferring existing policies to
an irrevocable life insurance trust that will continue to pay
income and/or principal to non-marital partner for life,
remainder to children or other beneficiaries. This will
eliminate death proceeds from taxable estate of both partners.
Crummey power provisions could be included to make
ongoing contributions for premium payments present interest
gifts which qualify for the annual exclusion. Take care in
avoiding incidents of ownership because there is no back-up
marital deduction as there is for married couples.
2. Beneficiary Designation. Whereas simply designating marital partner as
beneficiary results in a transfer that qualifies for marital deduction,
designating non-marital partner as beneficiary is a taxable transfer which will
consume Unified Credit or be subject to tax at the full value of the death
benefits payable to the non-marital partner. Except in small estates,
therefore, life insurance proceeds should either be payable on death to a trust
for the benefit of the surviving partner or, even better, transfer policies to an
irrevocable trust at least three years prior to death.
G. Charitable Deduction in Lieu of Marital Deduction. Charitable bequests may be
more acceptable to a non-marital partner who has no children as long as the needs
of the surviving partner can be met. Even where there are children, a so-called
"wealth replacement trust" (irrevocable life insurance trust holding policy to replace
the "lost" value passing to charity) may satisfy both goals: supporting surviving
partner for life as well as providing inheritance for children.
1. Charitable Remainder Trust. Although the marital deduction is not available
for unmarried couples, consider using charitable deduction as a substitute for
the marital deduction by creating testamentary charitable remainder trust
with life income interest in the surviving partner. Only the value of the life
(non-charitable) interest is includable in the net taxable estate of the deceased
partner, since the remainder (charitable) interest is deductible for estate tax
purposes. IRC 2055(e)(2).
2. Outright Charitable Bequest. Another alternative would be a formula bequest
to charity of an amount necessary to reduce the remaining non-charitable
bequest to the surviving partner to the amount that can pass free of estate tax
(i.e., $600,000).
3. Example. Pat, 67, and Terry, 65, are domestic partners. Pat dies with an
estate of $1,000,000. If Pat leaves the entire estate to Terry, the estate tax
will be $153,000. If instead Pat leaves the entire estate in a testamentary
charitable remainder trust paying Terry a 6% annuity for life (assuming an
applicable federal rate of 8.0 %), Pat's estate will be entitled to a estate tax
charitable deduction of $415,440, leaving a net taxable estate of $584,560,
which would be covered by the Unified Credit exemption equivalent. Estate
tax savings on Pat's death: $153,000. (Note: in addition, if Terry did not use
any of the principal received at Pat's death during life, Terry's estate will also
have an estate tax burden, which is avoided by the CRT.)
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