An estate planning attorney's job is to assist a client in navigating through all of these choices and decisions. This is usually accomplished by helping a client formulate and articulate his or her goals and objectives and coming up with a plan or suggestions to achieve those goals and objectives.
Sometimes during this process a dilemma arises. That is, in order to achieve the benefit of one decision, a client may have to forego the benefits of another decision. Estate planning for a married couple who own property together has traditionally created such a dilemma.
Married couples often own and want to own their property jointly. They do this for a number of reasons, including convenience. In fact, most first time married couples own property jointly without really thinking about it. When married couples own property jointly, it is typically a special type of ownership referred to as tenancy by the entirety. In addition to the convenience of owning property jointly, tenancy by the entirety property provides asset protection benefits for a married couple.
In addition, when married couples start thinking about estate planning, they often want to include a Revocable Living Trust as part of their plan once they learn the benefits that a Revocable Living Trust offers. Among other things, a Revocable Living Trust avoids probate for property placed in the trust and provides for disability protection.
It used to be that if a married couple wanted a Revocable Living Trust as part of their estate plan, they would have to sever their tenancy by the entirety property, thereby losing the asset protection benefits that this type of property ownership traditionally enjoyed.
On August 28, 2011, a new Missouri law came into effect which allows married couples to have the benefits and advantages of both a Revocable Living Trust and tenancy by the entirety property. Specifically, the new law allows a husband and wife to transfer tenancy by the entirety property to a joint revocable living trust and have that property still retain the benefits of tenancy by the entirety property for asset protection purposes.
The purpose of this issue of e-Counsel is to provide an overview of this new Missouri law. What do you need to know to understand this new law? What does the law say? What are its benefits? Who should this new law help?
Please be advised that this newsletter is only intended to be an overview of the topic under discussion and is not intended to give advice regarding any person's particular situation. As always, if you have any questions regarding this issue of e-Counsel or any other legal matter, please do not hesitate to contact us.
A Primer on Tenancy by the Entirety Property
Most married couples own their property together or jointly. In Missouri, when married couples own property together it is usually designated as tenancy by the entirety property. In fact, in Missouri, any real or personal property owned by a husband and wife is presumed to be owned as tenants by the entirety unless another type of ownership is clearly indicated.
With tenancy by the entirety property, if one spouse dies, sole ownership of the property automatically transfers by operation of law to the surviving spouse. This is true even if the deceased spouse's estate planning documents attempted to leave the property to someone else. In other words, tenancy by the entirety property trumps what might be said in a person's estate planning documents such as a Last Will and Testament or Revocable Living Trust.
Example 1. Husband and Wife own XYZ securities as tenants by the entirety. Husband has a Last Will and Testament which says that upon his death, Husband's interest in XYZ securities passes to A (and not Wife). If Husband dies, the securities automatically will transfer to Wife and not A. In other words, the attempt to pass the securities to A in Husband's Last Will and Testament will not be given any affect. The same result would be reached if Husband had attempted to pass the securities to A through a Revocable Living Trust instead of a Last Will and Testament.
One of the benefits of tenancy by the entirety property is that it provides a level of asset protection for married couples. In general (and subject to certain exceptions), a separate creditor of only one spouse may not take or levy upon any part of property owned as tenants by the entirety.
Example 2. A Husband and Wife own securities which are held as tenants by the entirety. The Husband is a doctor and gets sued by a patient for malpractice which results in a judgment above his malpractice insurance limits. The patient cannot take any part of the securities which are owned as tenants by the entirety to satisfy the judgment.
Tenancy by the entirety property does not, however, provide for comprehensive asset protection. This is because property owned as tenants by the entirety will not provide protection from joint creditors of both the husband and the wife.
Example 3. A husband and wife own rental property as tenants by the entirety. They are both sued by the tenant and the tenant gets a judgment against them. The tenant would be able to foreclose on the rental property to satisfy the judgment.
Example 4. Same facts as Example 3 except instead of getting sued by a tenant, Husband and Wife fail to make a payment on a promissory note that they both signed and the creditor (or holder of the note) gets a judgment. The creditor would be able to foreclose on the rental property to satisfy the judgment.
In addition, property owned as tenants by the entirety loses its asset protection benefits on the death of a non-debtor spouse. This is because on the death of a non-debtor spouse, the debtor spouse becomes the sole owner of the property. Since the debtor spouse now owns the property alone, his or her creditor could take or levy upon the property to satisfy a judgment.
Example 5. Same facts as Example 2, but assume Wife dies after the patient gets the judgment. The patient would now be able to get the securities because the Husband became the sole owner of the securities on Wife's death and the judgment is against Husband.
Because tenancy by the entirety property does not provide for comprehensive asset protection benefits, clients often engage in more sophisticated forms of asset protection planning if asset protection is a major estate planning goal or objective. However, at its basic level, tenancy by the entirety property does provide a line of defense from creditors' claims in certain situations and subject to certain limitations.
Another benefit of tenancy by the entirety property is probate avoidance. Most, if not all, clients want to avoid probate because it is both costly and time consuming. Property owned as tenants by the entirety avoids probate upon the death of the first spouse. However, upon the death of the second spouse, the property will be subject to probate because the property is now owned solely by the surviving spouse (unless a TOD or other pay on death or beneficiary designation is utilized). Probate may not be avoided for tenancy by the entirety property if both spouses die together in a common accident. In this case, it may be necessary to have two probate estates for the tenancy by the entirety property (one for each deceased spouse).
A Primer on Revocable Living Trusts
Revocable Living Trusts have become a standard estate planning document. With a typical Revocable Living Trust, a client transfers property to his or her trust during life. The client continues to control and benefit from the property once it is in the trust in pretty much the same way the client controlled and benefited from the property before it was transferred to the trust.
As it's name implies, a Revocable Living Trust is revocable, meaning it can be changed any time prior to the death of the person who created the trust. Being revocable gives the client flexibility to change his or her estate plan in the future as a client's situation changes.
To fully enjoy the benefits of a Revocable Living Trust, property must be transferred to or titled in the name of the trust during the client's life. Property that is titled in the name of the trust will not be subject to probate. In addition, if the client becomes disabled, the Revocable Living Trust appoints other people (selected by the client in advance) to manage the assets in the trust.
Revocable Living Trusts have many other benefits which are beyond the scope of this newsletter. For a more detailed discussion on Revocable Living Trusts, please contact us and ask for our brochure titled "Understanding the Basics of Revocable Living Trusts."
One of the downsides of a Revocable Living Trust is that assets in the trust are subject to the claims of the creditors of the person who created the trust. Certain other types of trusts do provide asset protection benefits for the person who created the trust. These more sophisticated trusts can be very useful for clients whose primary objective is asset protection planning. However, for a married couple who is not as concerned about asset protection, these more sophisticated trusts tend to lack the desired flexibility that a married couple wants and can be expensive, cumbersome and impractical for many married couples.
The Typical Foundation Plan for a Married Couple
Although every client is different, the typical foundation estate plan for a married couple generally consists of the following estate planning documents:
Setting up an estate plan with these documents can achieve many goals and objectives that a client may have, including the following:
- Ensuring that property passes to intended beneficiaries at death;
- Providing guardians for minor children;
- Establishing trusts for beneficiaries, if needed;
- Avoiding probate;
- Providing for financial disability planning; and
- Providing for health care planning.
In addition to the above, another goal or objective clients have is the minimization or elimination of estate tax if there is a potential for an estate tax to be incurred upon death. Traditionally, from an estate tax perspective, this type of foundation estate plan is set up to ensure that no estate tax is due on the death of the first spouse and an amount equal to the then current estate tax exemption amount can be past to a younger generation (like children) estate tax-free. This is typically accomplished by dividing up assets between each spouse's Revocable Living Trust to ensure that the value of the exemption amount is in each spouse's Revocable Living Trust.
The estate tax law and the exemption amount has gone through dramatic changes in the past few years. In 2009, every person had an exemption amount equal to $3,500,000. This meant that a person would not have to pay any estate tax at death if the value of that person's property was under $3,500,000 (assuming no taxable gifts were made during life). In 2009, a married couple could pass up to $7,000,000 without incurring an estate tax by using each spouse's exemption (again assuming no lifetime taxable gifts).
In 2010, the estate tax was repealed for part of the year and then was reinstated with an exemption amount of $5,000,000 per individual (or $10,000,000 for a married couple). Currently for 2011, the exemption amount is $5,000,000 per individual and $10,000,000 for a married couple which is where it will be for the rest of 2011 and all of 2012. This means that for 2011 and 2012, a person would not incur an estate tax if the value of that person's property was under $5,000,000 or $10,000,000 for a married couple (assuming no lifetime taxable gifts).
Beginning in 2013, the exemption amount is scheduled to be reduced to $1,000,000 per individual or $2,000,000 for a married couple unless Congress elects to change the law. Another recent change in the estate tax law (which will expire at the end of 2012) known as "portability" has made it less important to divide up assets between spouses because the exemption amount is now portable or transferrable between spouses.
What all these changes in the estate tax law means is that fewer people are subject to the estate tax because the exemption amount has increased (albeit more people may become subject to the estate tax law in 2013 unless Congress acts to change the schedule 2013 exemption reduction from $1,000,000). Since fewer people are subject to the estate tax, married clients are less inclined to divide up their assets between two Revocable Living Trusts. Instead, married clients would typically prefer one Revocable Living Trust - a joint Revocable Living Trust that they both can use.
Unfortunately, under prior Missouri law, if tenancy by the entirety property was transferred to a joint Revocable Living Trust, it was questionable whether that property would retain any of the benefits that tenancy by the entirety property typically enjoyed. This is because, by definition, tenancy by the entirety property had to be owned by a husband and wife. If tenancy by the entirety property was transferred to a joint Revocable Living Trust, it would no longer be owned by the husband and wife - rather, it would be owned by the trust.
New Missouri Law Creates Qualified Spousal Trusts
On August 28, 2011, a new Missouri law came into effect that allows a married couple to transfer tenancy by the entirety property to a joint Revocable Living Trust (which is referred to as a "Qualified Spousal Trust" under the new law) and have the property still retain the benefits of tenancy by the entirety property, including the asset protection benefits discussed above.
1. Executive Summary of New Missouri Law.
a. What is a Qualified Spousal Trust? The new Missouri law creates a special type of trust known as a "Qualified Spousal Trust" to be the receptacle for tenancy by the entirety property. A Qualified Spousal Trust is a joint trust where:
- The creators of the trust are husband and wife at the time the trust is created; and
- The terms of the trust provide that during the joint lives of the husband and wife, all property or interests in property transferred to or held in the joint trust are either:
- Held in the joint trust in one fund or share for the husband and the wife, and
- The trust is revocable by either or both of the husband or the wife while either or both are alive, and
- Both the husband and the wife have the right to any or all of the income or principal from the joint trust (whether mandatory or discretionary) for their joint lives or for the life of the survivor.
- Held in the joint trust in two separate shares, one share for the benefit of the husband and one share for the benefit of the wife, and
- The trust is revocable by either the husband or the wife with respect to their separate share without the consent of the other spouse, and
- Each of the husband and the wife has the right to distributions during their respective life of income or principal (whether mandatory or discretionary) from their respective separate share.
I admit that this definition is a mouthful, but it is not that complicated when you break it down.
To have a Qualified Spousal Trust, the couple must be married. Once this requirement is met, there are two alternatives. First, the property in the joint trust is treated as one fund or pot of assets with either or both spouses having the right to the assets or the ability to revoke or terminate the arrangement. Second, the property in the joint trust (although held in one trust) is accounted for by creating separate shares with each spouse, in essence, controlling his or her share by having the right to the assets in his or her share and by being able to revoke or terminate his or her share.
Let's look at a couple of examples.
Example 6. Husband and Wife are married. They own a house jointly as tenants by the entirety. They also own an investment account jointly as tenants by the entirety. They create one trust between them and transfer the house and investment account to the trust. The trust provides that during their joint lives the assets are used for their joint benefit. The trust also provides that when one of them dies, any remaining assets will be held for the surviving spouse's benefit. Upon the surviving spouse's death, the property passes to Husband and Wife's children. The trust further provides that the trust is revocable and can be changed or terminated while they are both alive or by the survivor. This trust should qualify as a Qualified Spousal Trust.
Example 7. Husband and Wife are married. They own a house jointly as tenants by the entirety. They also own an investment account jointly as tenants by the entirety. They create one trust between them and transfer the house and investment account to the trust. The trust provides that the tenancy by the entirety property transferred to the trust will be accounted for by establishing two separate shares. Husband's share consists of one-half of the house and one-half of the investment account. Wife's share consists of the other half. Husband controls his share and wife controls her share. In other words, Husband can take one-half of the property without Wife's consent and Wife can take the other half of the property without Husband's consent. This trust should qualify as a Qualified Spousal Trust.
If the above requirements are met, the new Missouri law provides that the trust can contain any other terms or provisions that are not inconsistent with the above requirements.
b. What Type of Property Can be Transferred to a Qualified Spousal Trust? Once a Qualified Spousal Trust is created, it can be the receptacle of tenancy by the entirety property owned by husband and wife. Either spouse can also transfer property that they own individually (not with the other spouse) to a Qualified Spousal Trust. The spouses can also transfer property to a Qualified Spousal Trust that they own together, but not as tenants by the entirety (such as property owned as tenants in common or as joint tenants with right of survivorship).
c. What Happens to Property in a Qualified Joint Trust When One Spouse Dies? Upon the death of either spouse while property is held in a Qualified Spousal Trust, the new Missouri law provides that the property shall be held and/or distributed as set forth in the trust. If the first spouse to die had his or her tenancy by the entirety property accounted for in a separate share, that separate share may be passed into an irrevocable trust with asset protection provisions for the benefit of the surviving spouse. Interestingly, the ability of a first to die spouse to direct that his or her separate share passes to an asset protection trust for the surviving spouse is different than pure tenancy by the entirety property held outside of a Qualified Spousal Trust because property held simply as tenants by the entirety automatically passes to the surviving spouse and is therefore subject to claims against the surviving spouse.
d. Asset Protection Benefits of a Qualified Spousal Trust. Tenancy by the entirety property that is transferred to a Qualified Spousal Trust will remain protected from claims of the separate creditors of one spouse just like the property was when it was held outside the trust as tenants by the entirety. Property that was not owned as tenants by the entirety before it was transferred to the trust will not obtain those asset protection benefits. Therefore, from a planning perspective, a married couple who has a Qualified Spousal Trust may want to ensure that property is owned by them as tenants by the entirety (as opposed to individually) before any such property is transferred to a Qualified Spousal Trust.
Example 8. Husband and Wife own ABC securities which are held as tenants by the entirety. Husband also owns XYZ securities in his individual name. Husband and Wife establish a Qualified Spousal Trust. Husband and Wife transfer the ABC securities to the trust and Husband transfers the XYZ securities to the trust. Husband is a doctor and gets sued by a patient for malpractice which results in a judgment above his malpractice insurance limits. The patient cannot take any part of the ABC securities which are owned in the trust because it was tenancy by the entirety property before it was transferred to the Qualified Spousal Trust. The patient would be able to take or levy upon the XYZ securities.
The new Missouri law does provide limitations on the asset protection benefits which a Qualified Spousal Trust enjoys. For example, both the husband and wife must be alive. If one spouse dies, the asset protection benefits of a Qualified Spousal Trust are lost. In other words, this limitation pretty much puts the asset protection benefits of a Qualified Spousal Trust on par with the asset protection benefits of a husband and wife owning property as tenants by the entirety, which was the intent of the law.
2. Who Should Consider a Qualified Spousal Trust. A Qualified Spousal Trust can benefit many married estate planning clients. For a first time married couple that has a net worth under $1,000,000 and that would otherwise own their property as husband and wife as tenants by the entirety, a Qualified Spousal Trust offers additional estate planning benefits without offsetting detriments. An exception to this would be for a client where asset protection planning is a primary concern and more sophisticated asset protection planning tools are needed.
The reason I put the $1,000,000 limit above is because of a conservative estate tax concern. Currently, the estate tax exemption is at $5,000,000 (or $10,000,000 for a husband and wife) and we have portability which makes asset division between spouses less important then it has been in the past. However, this current estate tax law expires beginning in 2013 when the exemption amount is scheduled to decrease to $1,000,000. Congress may act to change the law prior to 2013 and maintain the exemption at $5,000,000 or they may further increase or decrease the exemption. At this time, we do not know what will happen. I used the $1,000,000 limit for the possibility that the exemption may actually go down to $1,000,000 and the portability provisions will be allowed to lapse. If the exemption amount remains at $5,000,000 for 2013 and beyond, a Qualified Spousal Trust may make sense for higher net worth clients for the above reasons, although I have found that as net worth increases, so does the need for more sophisticated asset protection and estate tax planning tools.
A Qualified Spousal Trust may not work as well for clients who are in a second marriage and intend to leave property to children by a prior marriage. Certainly, a Qualified Spousal Trust that uses only one fund or pot would be inconsistent with this type of distribution scheme. It is possible that separate shares in a Qualified Spousal Trust could work in a second marriage situation, but the accounting and tracking of the separate shares could be difficult and problematic.
Conclusion
We hope this newsletter gave you a basic understanding of Missouri's new law regarding Qualified Spousal Trusts. It certainly is something that married couples should at least consider when they are implementing or reviewing their estate plan.
As always, if you have any questions or comments regarding the contents of this issue of e-Counsel, please do not hesitate to contact us.
CIRCULAR 230 DISCLOSURE
Under U.S. Treasury Department guidelines, we are required to inform you that (1) any tax advice contained in this communication is not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or by any party to market or promote any transaction or matter addressed herein without the express and written consent of Helfrey, Neiers & Jones, P.C. and the Law Office of Richard C. Petrofsky, (2) Helfrey, Neiers & Jones, P.C. and the Law Office of Richard C. Petrofsky imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein, and (3) any fees otherwise payable to Helfrey, Neiers & Jones, P.C. or the Law Office of Richard C. Petrofsky in connection with this written tax advice are not refundable or contingent on your realization of federal tax benefits from the advice contained herein.
