Whether same-sex or opposite-sex unions, unmarried couples face many estate planning issues (and opportunities). Although unmarried couples clearly face challenges that married couples do not, most are challenges that can be overcome with planning. However, because many of the issues discussed in this article are state-specific, it is important that unmarried couples preparing an estate plan seek the counsel of an attorney familiar with the laws of their states of domicile.
This article, the first in a three-part seriers, addresses some of the non-tax estate planning issues facing unmarried couples. The second article in this series discusses some basic gifting strategies unmarried couples can use to reduce or eliminate death taxes. The third and final part of this series examines several advanced estate planning strategies for high-net-worth unmarried couples.
Unmarried couples (whether same-sex or opposite sex) have the same estate planning objectives as do married couples. They want to avoid the costs, delays and publicity associated with probate; eliminate or minimize estate taxes; make certain their assets will pass to whom they want, when they want, and how they want; and protect heir assets from their heirs' inabilities, disabilities, creditors and predators.
Unlike married couples, unmarried couples do not benefit from many of the legal presumptions and default provisions under state and federal law. For example, unmarried couples are not entitled to the federal unlimited estate and gift tax marital deductions; cannot utilize the tax free "rollover" of retirement benefits in the same manner as a surviving spouse; are not covered under most state intestacy laws that determine who receives a decedent's property if there is no will; and are not permitted, by most state laws to elect against a partner's will, and thereby receive a portion of the deceased partner's property.
Same-sex couples have made some strides under the law toward qualifying for the same benefits that married couples enjoy. In Massachusetts, Connecticut, Iowa, Vermont, New Hampshire, and Washington D.C., marriages for same-sex couples are legal and currently performed. In New Jersey, civil unions are allowed, which provide state-level spousal rights to same-sex couples. In California, Oregon, Nevada and Washington (state), domestic partnerships are permitted, which provide nearly all state-level spousal rights to unmarried couples. In Hawaii, Maine, Washington D.C. and Wisconsin, domestic partnerships are permitted, which provide only some state-level spousal rights to unmarried couples. And in New York, Rhode Island and Maryland, same-sex marriages from other states or foreign countries are recognized, but they are not performed. Still, 41 states have statutes on the books prohibiting same-sex marriage, including 30 states that also have constitutional bans.
Although the U.S. Constitution requires each state to give "full faith and credit" to the laws of other states, the 1996 federal Defense of Marriage Act ("DOMA") expressly undercuts the full faith and credit requirement in the case of same-sex marriage. As noted above, 36 states have passed their own DOMA laws. Thus, because of the conflict between the U.S. Constitution and DOMA, it may ultimately be left to the Supreme Court of the United States to decide the issue of same-sex marriage.
Avoiding state default laws
Most unmarried couples will want to avoid their state's intestacy laws. These are the laws that determine who receives a decedent's probate estate if he or she dies without a will. With the exception of a few states, intestacy laws do not recognize "unrelated persons." However, assets passing to a surviving joint tenant, or payable by beneficiary designation to a person or trust, are not part of the decedent's probate estate and therefore avoid the intestacy laws. Same-sex couples will also want to avoid most states' default laws on matters such as burial desires and priority among persons to act as guardians, conservators, personal representatives, and patient advocates.
Accordingly, unmarried couples should use wills; will substitutes (i.e., joint property, beneficiary designations, and payable-upon-death accounts); revocable living trusts; general powers of attorney for financial matters; living wills and health care powers of attorney; and burial directives to avoid any adverse state law. Moreover, when unmarried couples designate partners as beneficiaries in wills or revocable living trusts, it is possible that disapproving family members may contest the will or trust. By including an "in terrorem" clause in the will or trust agreement, any person contesting the will or trust would receive nothing. Such a clause is intended to discourage persons from challenging a will or trust in court since nothing material may be gained by the action.
Qualified retirement plans
Although not technically a state default law issue, unmarried couples usually do not fare as well as their married counterparts when it comes to qualified retirement plans. Many 401(k) plans and pension plans provide that, upon a participant's death, his or her retirement account is to be distributed in a lump sum. As such, the distribution is fully taxable (as ordinary income) in the year of the participant's death. However, when the participant's spouse is the named beneficiary, the spouse can roll over the distribution into an IRA. Thus, the income tax on the distribution can be deferred until the surviving spouse attains age 70 1⁄2, at which time the spouse can "stretch" the distribution over 27.4 years.
Until recently, a non-spousal beneficiary would have been forced to take distributions of the entire qualified retirement plan within five years after the participant's death or, in some plans, immediately following the participant's death. Under the Pension Protection Act of 2006 (PPA), beginning in 2007, a non-spouse beneficiary of a qualified retirement plan can roll over, via a trustee-to -trustee transfer, the benefits into an "inherited" IRA. The inherited IRA must be titled in the participant's name for the benefit of the non-spousal beneficiary (e.g., "Mary Smith, Deceased IRA f/b/o Alice Jones"). The PPA also permits the post-mortem transfer of qualified retirement plans to inherited IRAs held by trusts for the benefit of non-spousal beneficiaries. Once the benefits are in the inherited IRA, the beneficiary may stretch the benefits over his or her life expectancy.
Domestic partnership agreements
As mentioned above, some states have enacted laws allowing domestic partners to register as such. By doing so, unmarried couples will have many of the rights and responsibilities afforded to married couples. However, in the vast majority of states, domestic partners are not recognized. Therefore, it may be beneficial for unmarried couples to define the terms of their relationship in a written domestic partnership agreement (DPA). A DPA works much like a prenuptial agreement for couples planning to marry.
Basically, a DPA is a legally enforceable contract between two unmarried persons that clarifies the rights and obligations of each person in the relationship. Following are some of the provisions typically found in a DPA: A statement of the relative rights in property acquired before the date of the DPA (for example, such property could belong to the person who earned or acquired it); how income earned by the partners will be divided; how living expenses will be shared; how inherited property will be divided, if at all; whether jointly titled assets are to be created and, if so, how they are to be divided in case of separation; how assets will be divided in the event of separation, and whether post-separation support will be provided by one partner to the other; and how assets will be distributed in the event of death.
Beyond addressing financial concerns, a DPA can help set forth other parameters in the relationship thereby helping to clarify and strengthen the relationship. A DPA can also help to avoid potential disputes and misunderstandings by specifying a dispute resolution mechanism such as arbitration. Because some states do not recognize the validity of DPAs, it is important to consult a local attorney.
Part Two of this series will deal with some basic gifting techniques that unmarried couples can use to reduce or eliminate death taxes.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.
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