How Community Property Affects Estate and Tax Planning

In most states, spouses can purchase and own property separately from one another. However, in certain states – called community property states – if one spouse purchases property, it is considered the property of both spouses. How marital property is owned has implications for both estate and tax planning. 

There are currently nine community property states. They are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A few other states (for example, Alaska) allow couples to opt into community property arrangements. 

Community property is property acquired by a husband and wife during marriage. In community property states, property held in only one spouse’s name can still be community property. For example, the paycheck that a spouse brings home every week is community property even though only one spouse’s name is on the check. If that check is used to buy an asset, then that asset is community property, regardless of whose name is on the account or the asset. 

Property that is not community property is property that one spouse brings to the marriage, inherits, or is gifted. A spouse can turn separate property into community property by putting an asset owned by one spouse into both spouses’ names. 

Depending on the state, partners may be able to change whether property is separate or community via pre-nuptial agreement, post-nuptial agreement, or exceptions in the law. Changing community property into separate property may be appropriate in second marriages or when one spouse is bringing significant separate property into the marriage. For example, if, at the time of the marriage, one spouse receives significant income from owning a business, the spouses may decide that it is appropriate that the business remain that spouse’s separate property and the income from that property will remain that spouse’s separate property. 

One advantage of community property is with regard to capital gains taxes. If one spouse dies, the cost basis of the community property gets “stepped up.” The current value of the property becomes the cost basis. This means that if, for example, the couples’ house was purchased years ago for $150,000 and it is now worth $600,000. The surviving spouse will receive a step up from the original cost basis from $150,000 to $600,000. If the spouse sells the property right away, he or she will not owe any capital gains taxes. In non-community property states, if one spouse dies, only the deceased spouse’s interest (usually 50 percent of the value) is stepped up. 

When estate planning in a community property state, it is important to fully review assets to determine which assets are community property and which are separate property. A surviving spouse in a community property state is entitled by law to half of the community property, regardless of what the spouses may have wanted to do with the property (such as pass it on to children). Community property can be a factor even in non-community property states if the couple owns property in a community property state. 

If spouses move from one type of state to another, it is especially important that they have their estate plan reviewed by an attorney in the new state to make sure the plan still does what they want. Find an attorney near you.

Issues When Gifting Unequal Shares to Children

As a strong recommendation that I consistently encourage clients to adopt, parents overwhelming choose to leave their children equal shares of their estate, but due to personal circumstances this is not always the case. If you plan to provide more (or less) for one child in your estate plan, understanding the consequences is key. 

It is natural for parents to want to treat their children equally in their estate plan. However, there are special circumstances in which a parent might choose to leave children unequal shares. For example, if one child is providing caregiving of an elderly parent in lieu of pursuing a career, a parent might understandably want to compensate that child for their lost income earning potential. Alternatively, if one child is overwhelmingly financially better off than another child, then the parent might want to provide more for a child who has a greater need for the funds. 

In a different context, the decision of how to allocate funds amongst a parent’s children may be due to one child having special needs or if there is a family business that one child has adopted as a career and wishes to succeed their parents after they are gone. It’s also possible that the parents have already provided more for one child during their lifetime, perhaps by advancing funds to pay for higher education or providing funds to assist with the purchase of a house. 

Whatever the reason for leaving your children unequal shares, the important thing is to discuss your reasoning with the children. Sit down with them and explain your decision-making process. If you feel like the conversation could be difficult and contentious, you could hire a mediator to help facilitate the discussion. These circumstances can frequently result in misunderstanding and feelings of favoritism or jealously by children who have been provided less. The classic example is the caretaking child who stays with mom or dad and provides full time care as parents age, and non-caretaking children assume theft or self-dealing is occurring due to the regular interaction with an aging parent. And even more unfortunately, these accusations, true or not, can frequently cause lifelong estrangement of the affected children.

In an ideal situation, your children may be understanding of your decision, but if you are concerned about certain children disagreeing and/or potentially suing to challenge your estate plan after you die, you may want to take additional steps: 

• Draft your will and estate plan with the assistance of an attorney and make sure it is properly executed. Find an attorney near you. To avoid accusations of undue influence, do not involve any of your children in the process.

• Explain in detail your reasoning in your estate planning document and make it clear that it is your decision and not the influence of the child who is receiving more.

• Include a no-contest clause (also called an "in terrorem clause") in your will. A no-contest clause provides that if an heir challenges the will and loses, then he or she will get nothing. You must leave the heir enough so that a challenge is not worth the risk of losing the inheritance.

Learn more about how to prevent a will contest.

The "Problem Child": Estate Planning Techniques to Minimize Post-Death Disputes

It’s the unfortunate, but common reality that not all families get along.

For the purposes of this article, we’re focusing on children and problems that can arise with certain children in your life where the parent-child relationship is strained or estranged. Whether problems with one or more of your children arises from personality conflicts, political or cultural differences, drug or alcohol abuse, love addictions or ongoing untreated mental illness some clients make the difficult decision to curtail gifts or remove an affected child as a benefactor of their estate. While these situations are invariably sad for family harmony, these situations are more common than the public realizes; however, there are several strategies for dealing with an estranged child in your estate plan. In contrast, this article does not address estate planning strategies for children who have certain involuntary conditions, whether mental or physical, that may be able to benefit from strategies that ensure they do not become ineligible for legitimate public benefits.

Irrespective of the reasons for the estrangement, the following are some common approaches for customizing your estate plan to reflect methods to deal with an estranged or troubled child in your estate plan:

• Outright disinheritance. If you have come to the conclusions that your relationship with you child and/or children is permanent and beyond repair, you can legally disinherit the child through provisions in your estate plan. Commonly, if you are leaving a child nothing, their disinheritance needs to be specifically mention the specific child in the will or trust and state in no uncertain terms that you are disinheriting him or her; failing to do so could make it easier for him or her to challenge the will. (It is also recommended that you specify whether you are disinheriting that child’s descendants if the estrangement from the children extends to their children or other descendants.)

However, disinheriting a child comes with a risk: First, on a personal level this may cause substantial harm among other child who were included, and may result in lifelong severance of family relationships. Second, from a legal perspective, the affect child or children may sue to contest the validity of the will or trust in court, which can cost your estate time, heartache and money. There are steps you can take to try preventing a will contest, including making sure your will or trust is properly executed, perhaps writing a letter to the estranged child to explain your reasoning, and removing any appearance of undue influence by third parties. Granted, there is no guarantee that this will persuade a scorned child from pursuing legal recourse, but awareness of these issues and consultation with a qualified attorney can help to mitigate these issue to the maximum extent possible. Irrespective, while some children may be indifferent, it should be expected that a disinherited child will experience common human emotions, often similar to stages of grief - but in my experience, most likely anger

• Smaller inheritance. If you don’t want to disinherit your child entirely or wish to make it less likely the estranged child will contest the will or trust, you may want to leave them an inheritance that is unequal when compared to other beneficiaries. Leaving a child a reduced inheritance may influence a child to avoid contesting the estate plan, especially if you include a no-contest clause (also called an “in terrorem clause”) in the estate plan. A classic no-contest clause provides that if an heir challenges the will and loses, then he or she will get nothing rather than the amount gifted. Ideally, it is smart to leave the heir enough so that a challenge is not worth the risk and costs of litigation versus the complete loss of the inheritance.

  Notwithstanding these clauses, several states, Arizona and California included, have provided the ability to contest these clauses so long as the child has “probable cause'“ to do so - however, the intent of the inclusion of these clauses is to dissuade (i.e. scare) dissatisfied children from attempting to contest a will or trust by putting their inheritance at risk if they indeed do not have probable cause to contest the terms of the estate plan.

• Put the inheritance in a restrictive trust. If the reason you do not want to leave your child an inheritance is because you are worried about how they will use the money, you can leave the child’s inheritance in an irrevocable trust managed by a third party trustee that will have unlimited discretion to make distributions as they see fit rather than allowing the child themselves to make distributions decisions. Additionally, you can provide suggestions to the trustee on when and how the trustee should disburse the funds in the trust, or make such distributions contingent upon certain achievements being met by the child. More simply, you can instruct the trustee to disburse the money in small increments or only if the child meets certain conditions, like staying drug or alcohol-free or obtaining and maintaining a full-time job.

Figuring out how to treat an estranged child in your estate plan is complicated and emotional. As Leo Tolstoy wrote in Anna Karenina, "Happy families are all alike; every unhappy family is unhappy in its own way." If this sounds like an issue present in your family, don’t hesitate to call Ganser Law Offices at (480) 930-5859 to discuss.

Irrevocable Dynasty Trusts: A Tax Efficient Generational Wealth Strategy

If you want to pass money to future generations without having it subject to gift and estate taxes, then a dynasty trust may be right for you. A dynasty trust allows trust assets to be used for the benefit of multiple generations while keeping the assets out of the grantor’s and the beneficiaries’ taxable estates. 

The main benefit of a dynasty trust is the avoidance of estate and gift taxes over many generations. In 2022, federal estate tax exemption is $12.06 million ($24.12 million for couples). Estates valued at more than the exemption amount will pay federal estate taxes, at a rate of between 18 percent and 40 percent. The lifetime gift tax exclusion – the amount you can give away without incurring a tax – is also $12.06 million in 2022. Note that you can give any number of people up to $16,000 each per year (in 2022) without the gifts counting against the lifetime limit. In addition, the generation skipping transfer (GST) tax affects assets passed to grandchildren. The tax is imposed even when property is left in trust for a grandchild. The GST exemption is the same as the estate and gift tax exemptions. If you transfer more than the GST exemption, the tax rate is 40 percent. 

Assets transferred to a dynasty trust are subject to estate, gift, and GST taxes only when initially transferred and only if they exceed federal exemption thresholds. While estate and gift tax exemptions are currently very high, in 2026 the exemption is set to drop to the previous exemption amount of $5.49 million (adjusted for inflation).

Another benefit of a dynasty trust is that the assets in the trust are protected from the beneficiaries’ creditors or in the event a beneficiary divorces. If the trust is properly structured, creditors cannot go after trust assets to pay the beneficiaries’ debts. 

How a dynasty trust works
A dynasty trust is an irrevocable trust, which means once it is created it cannot be changed. Funds transferred into the trust will be taxed if they exceed the lifetime gift tax exclusion. However, once funds are transferred to the trust, beneficiaries of the trust can pass assets to the next generation without those assets being subject to estate, GST, or gift taxes. In addition, the assets placed in the trust are removed from your estate and can grow outside of it. 

The trustee of the trust can be a beneficiary, but because the trust is designed to last for generations, it may make sense to have a professional fiduciary, such as a bank or other financial institution, serve as trustee. The trustee manages and distributes the assets in the way you set forth in the trust agreement. Usually, the trust provides for the beneficiaries’ support during their lifetimes. For example, it could direct the trustee to pay out income regularly, make periodic principal distributions, or make distributions contingent on the beneficiary’s need. 

The length of time the dynasty trust can continue to exist depends on state law. Some states allow trusts to run for hundreds of years or indefinitely, while others place limits on how long the trust can operate. Traditionally, the rule against perpetuities states that a trust can last 21 years past the death of the last beneficiary. However, many states, have opted out of the rule, allowing trusts to continue for many generations - in Arizona this period lasts for 500 years under Arizona state law. 

The general consensus regarding the downside of dynasty trusts is that they are inflexible. And while it’s true that once the trust is created, you lose access to the assets because they have been permanently gifted away, Arizona law provides the ability to modify irrevocable trusts through multiple methods, namely by utilizing a process called decanting, or through the use of a non-judicial settlement agreement. However, because dynasty trusts can potentially last for generations, they require specialized attention due to the sophisticated nature of their design to include considerable flexibility to ensure that they remain workable vehicle far after your death. 

Dynasty trusts are sophisticated instruments that must be designed correctly in order to provide benefits. Contact Ganser Law Offices to determine if a dynasty trust is right for you. 

Proposed Inheritance Tax Changes Under the Biden Administration

A new administration usually means that tax code changes are coming. While it remains unclear exactly what tax changes President Biden’s administration will usher in, two possibilities are that it will propose lowering the estate tax exemption and eliminating the stepped-up basis on death. The first would affect only multi-millionaires, but the second could have an impact on more modest estates and their heirs.

In 2017, Republicans in Congress and President Trump doubled the federal estate tax exemption and indexed it for inflation. For the 2021 tax year, the exemption is $11.7 million for individuals and $23.4 million for couples. As long as your estate is valued at under the exemption amount, it will not pay any federal estate taxes, and the vast majority of estates do not owe any tax. President Biden has expressed an interest in lowering the estate tax exemption. It could be more than halved to $5 million or even reduced to the previous exemption of $3.5 million for individuals.

Another possible tax change is to how property is valued when it is passed on at death. "Cost basis" is the monetary value of an item for tax purposes. When determining whether a capital gains tax is owed on property, the basis is used to determine whether an asset has increased or decreased in value. For example, if you purchase a stock for $10,000, that is the cost basis. If you later sell it for $50,000, you will have to pay taxes on the $40,000 increase in value.

Under current law, when a property owner dies, the cost basis of the property is "stepped up." This means the current value of the property becomes the basis. For example, suppose you inherit a house that was purchased years ago for $50,000 and it is now worth $250,000. You will receive a step up from the original cost basis from $50,000 to $250,000. If you sell the property right away, you will not owe any capital gains taxes.

According to an article in the New York Times, the current administration may propose to eliminate the basis step-up rule. In the past it was difficult to determine the original cost basis of some property, but in the digital age that information is more easily gathered. The change could result in tax increases for some people inheriting property that has risen significantly in value.

Another question is whether either of these changes will be made retroactively. It is unlikely, but possible, that if Congress changes these rules later in the year, they could be made retroactive to the first of the year.

If you are concerned about these rules changing, a trust may be a good way to protect your estate. Property in a trust passes outside of probate, and there are specific types of trusts that are designed to protect assets against estate taxes and capital gains. Talk to your attorney to determine if a trust is right for you. To find an attorney near you, click here.

Tax experts agree that while changes to the tax code are likely, they probably won’t happen right away. The coronavirus pandemic and the recession it has triggered mean that Congress has other priorities at the moment.

Fundamental Differences Between a Revocable Trust and an Irrevocable Trust

Trusts can be useful tools to protect your assets, save on estate taxes, or set aside money for a family member. But before you commit to adding a trust to your estate plan, make sure you understand the differences between revocable (also called “living”) and irrevocable trusts because each offers advantages and disadvantages, depending on their purpose. 

While the two main types of trusts differ in how they are structured and taxed, both types of trusts are tools for setting aside assets and distributing them according to specific wishes and instructions. They can protect one’s property, safeguard a family’s financial future, and provide tax-saving strategies.

Structure
As the name suggests, an irrevocable trust, once established, can’t be canceled or revoked. The person creating the trust, sometimes called the “grantor” or “trustor” transfers assets into the trust and permanently gives up all claim to them. A trustee is appointed to carry out the instructions spelled out in the trust. No changes to the terms of the trust can be made without the consent of the trust’s beneficiaries.

In contrast, a revocable trust offers more flexibility. The grantor of a revocable trust still owns and controls the assets and can make changes at any time. A revocable trust also has a trustee, someone who would take over management of the trust if the owner is no longer capable of doing so.

Taxes
Both types of trusts offer tax advantages, although these differ in key ways. An irrevocable trust is considered a separate entity and must have its own tax returns filed annually under its tax ID number. Irrevocable trusts can incur additional costs if a CPA is needed for tax preparation. Because it is a trust and not an individual, the irrevocable trust can’t qualify for the various deductions and exemptions that individuals can claim on their returns. Also, higher rates apply at lower income levels. For example, an irrevocable trust is subject to the highest federal tax rate of 37 percent if its income exceeds $12,500, a much lower ceiling than for individuals.

Conversely, assets within a revocable trust are still considered the property of the trust owner. Any income earned from this trust is filed along with the owner’s other income. Also, the assets of the trust belong to the owner’s estate and are taxed accordingly on the owner’s death. For this reason, wealthy families may choose to transfer a portion of their assets into an irrevocable trust to keep the value of their estate below federal and state exemptions.

Protecting Assets in the Future
One key advantage of irrevocable trusts is that their assets are protected from lawsuits and creditors. A revocable trust offers no such protection, because the trust assets are still part of the owner’s property. 

A revocable trust is an option for someone who doesn’t need all the layers of protection but still wants to set up some provisions for the future.  A revocable trust works well to set aside assets in the event that the grantor becomes unable to manage his or her finances in the future, due to illness or old age. With a revocable trust, the grantor controls the property while he or she is competent, but a trustee can take over this function if the grantor loses this capacity.

If there are other considerations, such as estate tax planning, protection from creditors, or providing for a special needs family member, an irrevocable trust might be the better way to go. Your planner will have the best answers for your particular circumstances.

Keep in mind that this is general advice only and that specific situations may be treated differently. Contact your attorney for advice on how your specific situation will be handled using different types of trusts.

Essential Estate Planning Tools for Unmarried Couples

While estate planning is important for married couples, it is arguably even more necessary for couples that live together without getting married. Without an estate plan, unmarried couples won’t be able to make end-of-life decisions or inherit property from each other. 

Estate planning for unmarried couples serves two vital functions: determining who can make decisions for you if you become incapacitated and who gets your assets when you die.  There are laws in place to protect spouses in couples that have failed to plan by governing the distribution of property in the event of death. If you do not have a will, property will pass to your spouse and children, or to parents if you die without a spouse or children. 

Importantly, however, there are no laws in place to protect unmarried partners. Without a solid estate plan, your partner may be completely shut out of any legal decision making or receive any inheritance upon death. The following are the essential estate planning steps that can help unmarried couples: 

• Joint Ownership. One way to make sure property passes to an unmarried partner is to own the property jointly, with right of survivorship. If one joint tenant dies, his or her interest immediately ceases to exist and the remaining joint tenants own the entire property. This is also a good way to avoid probate.

• Beneficiary Designations. Make sure to review the beneficiary designations on bank accounts, retirement funds, and life insurance to make sure your partner is named as the beneficiary (if that is what you want). Your partner will not have access to any of those accounts without a specific beneficiary designation.

• Durable Power of Attorney. This appoints one or more people to act for you on financial and legal matters in the event of your incapacity. Without it, if you become disabled or even unable to manage your affairs for a period of time, your finances could become disordered and your bills not paid, and this would place a greater burden on your partner. Your partner might have to go to court to seek the appointment of a conservator, which takes time and money, all of which can be avoided through a simple document.

• Health Care Directive. Similar to a durable power of attorney, a health care directive appoints an agent to make health care decisions for you when you can't do so for yourself, whether permanently or temporarily. Again, without this document in place, your partner might be shut out by other family members or forced to go to court to be appointed guardian. If it is important for all of your family members to be able to communicate with health care providers, a broad HIPAA release -- named for the Health Insurance Portability and Accountability Act (HIPAA) of 1996 -- will permit medical personnel to share information with anyone and everyone you name, not limiting this function to your health care agent.

• Will. Your will says who will get your property after your death. However, it's increasingly irrelevant for this purpose as most property passes outside of probate through joint ownership, beneficiary designations, and trusts. Yet your will is still important for two other reasons. First, if you have minor children, it permits you to name their guardians in the event you are not there to continue your parental role. Second, it allows you to pick your personal representative (also called an executor or executrix) to take care of everything having to do with your estate, including distributing your possessions, paying your final bills, filing your final tax return, and closing out your accounts. It's best that you choose who serves in this role.

• Revocable Trust. A revocable trust can be especially important for unmarried couples. It permits the person or people you name to manage your financial affairs for you as well as to avoid probate. You can name one or more people to serve as co-trustee with you so that you can work together on your finances. This allows them to seamlessly take over in the event of your incapacity.