A Simple Tip for Avoiding Estate Tax

It is not uncommon for a married couple to own most of their significant assets jointly.  Jointly held property will pass to the surviving spouse upon the first spouse's death without going through probate.  Couples who own their home jointly as tenants by the entirety also enjoy protection from creditors.  Joint ownership, however, can be extremely detrimental from an estate tax perspective, because it can subject the property to estate tax more than once.  Fortunately, some alternative arrangements exist that provide the benefits of joint ownership without the negative estate tax consequences.    

Joint owners will be liable for estate tax on their jointly-held assets upon the death of the first joint owner, and again upon the death of the second joint owner.  Pursuant to the federal internal revenue code and Massachusetts state law, if a married couple owns property as joint tenants or as tenants by the entirety, one-half of its value will be included in the estate of the first spouse to die.  If the surviving spouse does not transfer the property prior to his or her death, its entire value will be included in his or her estate as well.  Consequently, the couple will end up paying estate tax on 150% of the asset's value, whereas they would only be taxed on 100% of its value if just one of them owned the property.

The estate tax consequences can get even uglier if the joint owners are not married.  The asset's entire value will be included in the estate of the first joint owner to die unless the other joint owners can establish they made a contribution to purchase the asset.  Consequently, two unmarried individuals owning an asset jointly can incur estate tax on its entire value twice:  Once when the first joint owner passes away, and again when the second joint owner passes away.  In other words, two unmarried joint owners can end up paying estate tax on 200% of the value of their jointly owned asset.

Fortunately, individuals can enjoy all of the benefits of joint ownership without all of the negative estate tax consequences by transferring their assets to a carefully drafted trust.  Assets in a trust can be passed to descendants without going through probate.  The trust can also be drafted to provide certain creditor protection features which are similar to a tenancy by the entirety .  In addition, the trust's creators can name themselves as trustees, and thereby retain control over the assets transferred to the trust during their lifetimes.

In writing this post, I do not wish to suggest that people should change the ownership structure of their assets without consulting with a qualified lawyer.  Each taxpayer's situation is unique, therefore a technique that is appropriate for a certain individual may produce disastrous results for someone else.  If you have any questions about the estate planning techniques discussed in this post, please don't hesitate to leave a comment or contact me directly.