A fairly common occurrence among married couples is the holding of most, if not all, of their property as tenants by the entirety. Quite often, couples are unaware of the alternative methods of titling, as well as some of the trade-offs involved in selecting a particular form of holding property.
There are four primary ways to hold property:
- In Your Own Name. Anyone may choose to own property in his or her own name. Owning property outright gives the owner complete control over the property, but such property is generally included in the owner's gross estate for estate tax purposes and will usually have to pass through the probate process.
- As Tenants in Common. This method allows two or more parties to own property together, with each owner maintaining the right to sell his or her interest without the consent of the other co-owners. Generally, such ownership interests must be bequeathed through a will and do not pass automatically to the co-owners at death. Consequently, such property typically will be subject to probate.
- As Joint Tenants. Also called joint tenancy with right of survivorship, this form of ownership provides each "tenant" with an undivided interest in the entire property. An owner may not sell without the consent of the other co-owners. If one owner should die, the surviving owners automatically inherit the decedent’s interest (i.e., the property passes "by law" and does not go through probate). Caveat: A creditor may force the sale of such held property to satisfy the debts of only one owner. Negligence, for example, may create potential liability exposure beyond the limits of currently held insurance policies.
- As Tenants by the Entirety. This is a special form of joint tenancy solely for married couples with one significant difference: The property cannot be sold to satisfy the debts of one of the owners.
Each form of property ownership has specific implications, and when using one particular method, the benefits gained must be balanced against the benefits lost.
Consider Simon and Ellen Howard (a hypothetical scenario) who have two college-aged children, Andrea and Jason. Life has been good to the Howards, and they have built an estate worth $4 million, with all of their assets jointly held as tenants by the entirety. (For the sake of simplicity, we will not consider retirement plan assets, which cannot be held jointly.)
While on vacation, the Howards are involved in a tragic fire. Simon dies instantly; Ellen lives for four days and then dies. In this unfortunate set of circumstances, what are the estate tax implications for their jointly held $4 million estate?
At Simon's death, his interest in all jointly held property automatically passes to Ellen free of federal estate taxes by virtue of the unlimited marital deduction. For the four intervening days that Ellen is alive, she is the sole owner of the previously joint $4 million estate. At her death, $2,000,000 of the estate would be offset by her $2,000,000 applicable exclusion amount in 2007.* Because all property was jointly held, Simon's $2,000,000 exclusion amount was lost. Failure to plan for using Simon's exemption ultimately decreased the amount passing to Andrea and Jason.
Had the Howards "equalized" their estate (i.e., each owned $2,000,000 outright), each could have set up a bypass trust with $2,000,000. In this example of nearly "simultaneous" death, the assets in Simon's bypass trust would pass to the children free of estate taxes (the $2,000,000 exemption offsets the assets in the trust). Since Simon died first, Ellen's bypass trust effectively terminates. When Ellen dies four days later, the assets that were in her bypass trust would also pass to the children free of estate taxes by using her $2,000,000 exemption. With equalized estates, $4 million in 2007 passes to the children free of federal estate taxes.
Now the "trade-off" may be more apparent. By owning their property as tenants by the entirety, the Howards achieved creditor protection (remember, for a husband and wife who title assets this way, a sale cannot be forced to satisfy one spouse's debts), but they also exposed their joint estate to the possibility of higher estate taxes. On the other hand, had they chosen to minimize estate taxes (Ellen and Simon each making use of their $2,000,000 exemption), the property that each held outright (or as tenants in common) might have been exposed to claims by creditors.
Consult and Assess
We have used the Howards to demonstrate one of the dilemmas of property ownership: If you want maximum estate tax reduction, you must usually sacrifice maximum creditor protection, and vice versa. How important is creditor protection? It depends. Unfortunately, there are no easy answers in this area of estate planning. However, examining the trade-offs involved in using various forms of property ownership may be a good first step toward developing a strategy that most benefits your family. In addition, be sure to check with your attorney for applicable state laws concerning methods of property titling. 20/20
*This amount is scheduled to rise gradually to $3,500,000 by 2009. In 2010, the federal estate tax will be repealed for one year and then reinstated in 2011 at levels in effect prior to passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).