Planning for Nontraditional Couples, OSB, CLE, July 29, 2004
By: Donna R. Meyer, Attorney at
Law, FITZWATER & MEYER, LLP
FITZWATER & MEYER, LLP
is located in Portland, Oregon and can be found online at http://gayfinancialadvisors.com/Oregon.htm
Transfer tax laws generally
favor married couples. There are
some ways in which the transfer tax laws have the same application for both
married and non-traditional couples. However,
in many ways the application of the laws is quite different, calling for
different and varied strategies.
TRANSFER TAX LAWS THAT APPLY THE SAME
Federal Unified Credit
The unified credit against
estate taxes of $345,800 for 2004/2005, gives each spouse or partner the ability
to exempt $1,500,000 worth of assets. The
value of the credit will be increasing over the next six years until it is
repealed in 2010 for one year. It
comes back into existence in 2011 at the exemption level of $1,000,000, unless
changed by Congress before that time. IRC
Annual Gift Exclusion
The annual gift exclusion
allows any individual to make gifts of $11,000 per person per year.
IRC §2503(b). Transfers paid on behalf of an individual as tuition to
certain educational organizations or to a person who provides certain types of
medical care to the individual are not treated as a gift transfer.
IRC §2503(e). (See below with regard to gift-splitting.)
Oregon Inheritance Tax Credit
The state unified credit (tied
to 1997 federal law levels) gives each spouse or partner the ability to exempt
$850,000 of property from inheritance tax.
The exemption threshold rises to $950,000 in 2005 and then to $1,000,000
in 2006, where it is scheduled to remain indefinitely.
Any property passing outright
to a qualified charity receives a 100 percent deduction from federal estate tax.
TRANSFER TAX LAWS THAT APPLY DIFFERENTLY
Unlimited Marital Deduction—Generally
The most significant
difference when planning for non-traditional partners rather than married
couples is the inability to use the unlimited marital deduction for gifting
during lifetime or at death. IRC
§2056(a); IRC §2523(a).
REGARDING SAME-SEX MARRIEDS: The
definition of "spouse" is controlled by the Defense of Marriage Act (DOMA),
which provides that for purposes of federal laws, marriage is defined to be a
"legal union between one man and one woman."
Defense of Marriage Act, H.R. 3396.
While on its face this may seem to be definitive for purposes of federal
law, some commentators believe that the U.S. Supreme Court will find this law to
be unconstitutional, or even that there is some interpretational wiggle room in
the Internal Revenue Code.
unmarried couples, the inability to use the marital deduction can cause a tax at
the death of the first partner to die if he/she has assets in excess of the
federal or state exemption, and makes it difficult for couples to split the
assets between them to insure each partner uses his/her unified credit. The
inability to use the marital deduction is one of the key problems in this type
QTIP trust planning, in which
one spouse gives the surviving spouse a terminable interest in property, such as
a life estate or trust, still qualifying the property for the marital deduction,
is not available for unmarried couples.
Among the requirements of a
qualified disclaimer are that the person has not accepted the interest being
disclaimed or any of its benefits, and that as a result of the disclaimer, the
interest passes without any direction on the part of the disclaimant and passes either
to the spouse of the decedent or to a person other than the person making the
disclaimer. IRC §2518(4). While an unmarried partner can disclaim outright, unmarried
couples cannot use commonly used disclaimer trust planning.
Charitable Remainder Trusts
If an unmarried partner
creates a charitable remainder trust naming his/her partner as a beneficiary, a
gift is made. This does not apply
to married couples, for which a deduction is available for the value of the
interest passing to the surviving spouse.
Unmarried partners cannot give
twice the annual exclusion to a donee by utilizing gift-splitting.
Joint Ownership with Right of Survivorship
The full value of jointly
owned property held between nonspouses (as defined for federal purposes under
DOMA) is included in the estate of the first joint owner to die, unless the
executor can produce evidence of the surviving joint tenant's consideration
toward the property in question. IRC
§2040; Treas. Reg. §20.2040-1(a)(2). Contrast
this with the rule for joint property held with spouses--only 50 percent of the
value of the property is included in the estate of the first spouse to die.
In community property states,
for married spouses the property receives a full step up in basis at the death
of the first spouse.
Chapter 14 of the Code targets
intrafamily transactions used to pass property to the next generation with a
minimum of transfer tax. Examples
are GRITs, split-interest purchases, and other transactions intended to freeze
value to the value at the time of the gift, while minimizing the value of the
gift by retaining an interest or imposing restrictions.
Unmarried partners aren't legally "family" and so are not
restricted by some of these rules.
TRANSFER TAX TECHNIQUES FOR NON-TRADITIONAL COUPLES
Credit Shelter Trust
A credit shelter trust can be
used to hold assets in the amount of the exemption equivalent for the benefit of
the surviving partner. The credit
shelter trust works to prevent the assets of the first partner to die from
doubling up in the surviving partner's estate, similar to its use for married
partners. It has the additional
effects of creditor protection and insuring that any assets remaining at the
second death are distributed back to the family of the first partner. The exemption equivalent can be tied to federal or state
levels, depending on the overall goals of the client, and any excess could be
distributed to charity. Further,
provisions can be made to allow distributions from the credit shelter trust to
children or other family.
Oregon QTIP for Same-Sex Marrieds
Oregon inheritance tax is
"tied" to the federal tax calculation so that federal deductions are
allowable for Oregon inheritance tax purposes, including unlimited
marital/charitable deductions. ORS
will the definition of spouse be controlled by state or federal law? See
ORS 118.007: "Any term used in
[the Oregon inheritance tax statutes] has the same meaning as when used in a
comparable context in the laws of the federal Internal Revenue Code relating to
federal estate taxes, unless a different meaning is clearly required or the term is
specifically defined in the [inheritance tax statutes]."
Does the interpretation of the Oregon Constitution allowing same-sex
couples to marry clearly require a different interpretation of the word spouse?
If so, Oregon same-sex spouses should receive the same privileges as
federal spouses in the context of inheritance tax.
REGARDING CIVIL UNION: If same-sex
marriages do not survive the upcoming ballot measure or court challenge, it is
still possible that civil unions will be formalized, giving same-sex partners
many of the same rights under Oregon law as married couples.
It remains to be seen if the result will be that same-sex couples are
treated as if federal tax law
recognizes a civil union. This is
the Vermont solution for purposes of income tax law.
same-sex married couples in which one spouse has assets in excess of the Oregon
exempt amount, it may be wise to include an Oregon QTIP trust in the planning to
be effective only in the event the exemption at the state level is available.
This is the approach used by some Massachusetts estate planners for
same-sex married couples.
in the Amount of the Annual Exclusion and for Medical and Educational Expenses
Nontraditional couples can use
the same gifting techniques available to all individuals for gifting to third
parties. In addition to gifting in
the annual exclusion amount, the wealthier partner can also pay directly for any
medical or educational expenses qualified under IRC §2503(e). The goal is to equalize the estates and bring both partners
under the tax thresholds. This is
particularly true for those couples whose combined estates fall in between the
Oregon and federal tax thresholds. Because
Oregon does not tax lifetime transfers of property, it may be possible to
transfer property between partners to bring both partners under the Oregon
threshold level with no tax consequences. Gifts must be to individual title; gifts into joint names
will not work because full value of asset (not one-half) will be included in
first partner's estate. Reg.
It may be difficult to transfer enough wealth through annual gifting to
successfully split the assets to minimize tax, but annual gifting can help
minimize growth in the estate of the wealthier partner.
Freeze and Discount Techniques
Traditional freeze and
discount techniques may be appropriate for unmarried partners. Further, several benefits that are not available to married
couples may be available to nontraditional couples, because Chapter 14 rules,
enacted to curb abuses in intrafamily transactions, do not apply.
In addition to benefiting partners, each partner can benefit the children
or nieces and nephews of the other partner without triggering the intrafamily
rules. Techniques include grantor
retained interest trusts (GRITs), grantor retained annuity trusts (GRATs),
valuation freezes, split-interest purchases, and other traditional freeze
Examples of freeze and discount techniques include the following:
Gifting fractionalized interests in property to obtain valuation
discounts. Each partner can own a
fractionalized interest as tenants in common of the property, perhaps achieving
marketability discounts on some assets (real estate).
Or a properly drafted joint revocable living trust could provide that all
property transferred is deemed to be held as 50 percent tenants in common.
(This technique is available to married couples as well.)
Transfers of closely held business interests, such as an interest in a
corporation or partnership.
Nonfamily member grantor retained interest trusts (GRITs).
The GRIT is a method for making discounted gifts and removing future
appreciation of assets from the maker's gross estate.
It "is particularly useful if the domestic partners function as an
economic unit because the gifted property will provide an income stream to the
partners during the retained trust term and the principal will remain within the
economic unit at the expiration of the term."
The trust should be funded with assets that produce high appreciation
Grantor retained annuity trusts (GRATs).
A grantor retained annuity trust is a popular form of retained interest
transfers used to limit gift tax exposure.
The grantor transfers assets to the trust, and retains the right to
receive fixed payments for a specified term.
At the termination of the term, trust property passes to the remainder
beneficiaries. The taxable gift is reduced by the value of the grantor's
If the donor is unlikely to survive the term, an outright gift may be the
Qualified personal residence trust (QPRT) and "house GRITS."
The usual qualified personal residence trusts are available to unmarried
partners. However, because partners
are unrelated and thus not subject to many of the prohibitions described in Regs
§§25.2702-5, a "house GRIT" can be established outside the usual
§2702 valuation rules that apply to qualified personal residence trusts (QPRTs).
The partner who establishes the trust may purchase the residence from the
trust just prior to the expiration of the retained term so that cash or other
assets pass to the remainder partner, if that is desirable.
This may also be useful if the remainder beneficiary is the child or
other relative of the partner.
Form a family LLC, transferring substantial interest in the property to
the donee partner but retaining a voting membership interest.
The gift thus lacks control and marketability and should be valued at a
discount. The agreement could also
contain terms for buyout in the event of a breakup.
Charitable Gifting Techniques
In the absence of the marital
deduction, many unmarried partners take a more careful look at the charitable
deduction. Many of the usual
charitable techniques are available. However,
with many of these techniques, a reportable gift will be made.
Leave the exemption equivalent at the first partner's death to the
surviving partner, either outright or in trust, with the excess to charity.
Disclaimer to charity. The
client can provide that all property would pass to the surviving partner but
that any property disclaimed by the surviving partner would pass to a qualified
charity. This would allow the surviving partner the flexibility to
analyze the estate taxes existing on the date of the decedent partner's death
and decide whether to pay estate taxes (if any) by keeping the property or
reduce/eliminate the taxes by directing a portion of the property to charity.
Testamentary charitable remainder trust, benefiting the surviving partner
for his/her lifetime.
A nongrantor charitable lead trust, especially when the donee partner is
significantly younger than the donor partner.
Life estate to the partner, with remainder interest to charity.
Charitable remainder trusts and gift annuities.
Life insurance is often even
more important for unmarried partners.
First, there may be a transfer tax at the death of the first partner.
Second, the surviving partner will not be able to draw on the decedent
partner's Social Security record. If
the higher earning partner dies first, the survivor may not have sufficient
income to cover his/her needs. Also,
the surviving partner may not benefit from pension or health insurance benefits
that a surviving spouse may have received in the same situation.
Gifts of life insurance policies to the other partner can avoid
taxability at the
death of the first
partner, if made three years before death.
This will not, however, shield the insurance from taxability at the death
of the second partner to die. Also,
the interpolated terminal reserve value of the policy will be considered a gift
to the other partner at the time of the transfer.
Irrevocable life insurance trust (ILIT) may be preferable to an outright
transfer for several reasons. It
can shield the assets from taxability at the death of both partners, it
insulates the proceeds from creditor claims, and it avoids questions about
whether the beneficiary has an insurable interest in the insured.
Again, transfer of an existing policy into an ILIT will trigger a gift to
the trust beneficiaries.
Tax Apportionment Clause
With the higher risk of
transfer tax, it is even more important than usual to carefully review the tax
apportionment clause in estate planning documents.
For a helpful chart and summary discussion of the similarities and
differences in the estate planning tools for married versus unmarried
partners, see Chris Yates, The
Unmarried Penalty: Gift, Estate
And Other Planning Considerations for Unmarrieds, Planned Giving Design
See, e.g., Joseph Wetzel, "Current Considerations in Tax Aspects
of Divorce," Chapter 7, OSB CLE Materials, Family
Law, April 30, 2004.
IRC §§2701, 2702, 2703, 2704.
For detailed discussion, see "Freezes and Discounts,"
Chapter 14, Part IV, C, Estate Planning for the Unmarried Adult (813-2nd), Estates, Gifts,
and Trusts Portfolio Listing, BNA Tax Management.
See also Cynthia Barrett's
materials from her February 19-21, 2004, ALI-ABA seminar, "Domestic
Partner Life and Estate Planning."
For a good discussion of both discount techniques and charitable
gifting, see article by Andrew R. Lee, Trusts
& Estates, January 2002.
See detailed discussion at
BNA Tax Management, supra note 3.
See detailed discussion at BNA Tax Management, supra note 3; see also
discussion and forms at Robert A. Esperti and Renno L. Peterson, IRREVOCABLE
TRUSTS, Warren, Gorham & Lamont.
For detailed discussion, see "Life Insurance," Part V, Estate
Planning for the Unmarried Adult (813-2nd), Estates, Gifts, and Trusts
Portfolio Listing, BNA Tax Management.
Donna R. Meyer, Attorney at Law, FITZWATER & MEYER, LLP
FITZWATER & MEYER, LLP
is located in Portland, Oregon and can be found online at http://gayfinancialadvisors.com/Oregon.htm