Are you planning to share property with your partner?Perhaps the property is your residence, a car, a bank account, equity in your business, or some other combination of properties. As mentioned in the prior article, married couples are entitled to certain default rights to the other spouse's property if legal documents such as a will or prenuptial agreement were not signed. Furthermore, federal tax law grants married couples exemptions from tax for property transfers between spouses. Unmarried couples have neither these default rights nor these tax exemptions.
A couple important points need to be mentioned about taxes:
• You can generally gift an annual exclusion amount to your partner each year. The exemption does not accumulate: either gift by December 31st to utilize the exemption or lose the exemption for that year. This exclusion, adjusted for inflation, is $13,000 for 2009 and 2010. While that exclusion may sound too high to apply to you, adding your partner's name to your home easily may exceed this exclusion amount. Should you gift less than the exclusion, you are not required to file a return.
• Even though filing a gift tax return is required for gifts exceeding the annual exemption, generally only accumulated taxable lifetime gifts exceeding $1 million will be taxed with tax rates capped at 45%. The estate tax is scheduled to be repealed in 2010. In 2011, the estate tax applies to estates with net worth at the time of death plus prior lifetime taxable gifts exceeding $1 million. Although your net worth may not be $1 million now, it may grow significantly by the time you die.
• Paying your partner's obligations such as the mortgage or living expenses may be included as "accession to wealth" and hence be taxable events.
• If taxes are triggered on the transactions, the taxes generally will be based upon the fair market value of the property.
• Similar to failing to file an individual tax return, failing to file a gift tax return generates penalties and interest and even perhaps criminal penalties if criminal intent is shown. Furthermore, failing to file allows the IRS unlimited time to audit those unfiled years which is the reason some taxpayers file gift tax returns when below the annual gift exclusion amount.
• Historically, the government increases IRS audits in times of high deficits. Increasing revenue from non-filers is more politically palatable than raising taxes. Once the IRS auditor locates a problem in the year of audit, they tend to expand the audits to all auditable years because they know the same error tends to repeat.
Many options are available. These strategies could be done on an asset by asset basis or group of assets, and each has some pros and cons. This is a general discussion and you should always consult with a professional before implementing any plan of action:
• Doing nothing right now because perhaps your partner has debt trouble, you are uncertain of the relationship, or you both are independently well off.
• Gifting outright each year up to the annual gift exclusion amount.
• Setting up a will with your partner as a heir to whatever specified assets upon your death. If you separate, you can always unilaterally undo without creating any tax consequences.
• Designating your partner as beneficiary of your retirement plan if you die. Like a will, you generally can unilaterally undo upon separation without any tax implications.
• Establishing a cohabitation or domestic partnership agreement that documents the ownership of existing property and the ownership of property after a separation occurs. In many ways, a cohabitation agreement is like a prenuptial agreement.
• Designating a trusted person ( including your partner ) with power of attorney that triggers that power upon incapacity.
If you are at the next level with a more committed relationship and highly valued assets, the following options should be considered:
• Setting up a trust with your partner as the beneficiary or establishing a LLC and giving membership interests to your partner. Depending upon the trust or operating agreement terms, this could be difficult to undo upon separation. However, discounts may significantly lower the gift taxes. In addition, income taxes may be lowered by moving the income from your higher tax bracket to your partner's lower tax bracket.
• Changing the title of property from your name to joint tenants with rights of survivorship. Careful with this option as it could create an immediate taxable consequence depending upon the type of asset, the fair market value of the asset, the debt on the asset, and the state where the asset is located.
• Establishing and paying premiums on a life insurance policy on yourself with the beneficiary being your partner. Careful structuring must be done to ensure the premiums qualify for the annual exclusion.
To assist in deciding which options are best, the following questions need to be addressed and a determination made as to whether the answer is acceptable to you:
• What are the costs of such a strategy given the value of the assets involved?
• What do I need to do once the strategy is implemented ( e.g. creation of the legal documents ) ? Do I need to change the title into a new legal entity's name?
• What happens with this strategy upon the following events:
o Separation?
o Death?
o Bankruptcy or claims from creditors?
• What are the consequences of such a strategy for income, gift and estate tax purposes? Are there any benefits such as utilizing the annual gift exclusion or discounting the value of the property for lack of marketability and minority interest?
Care needs to be taken in sharing property with your loved one. Through proper planning and the use of the right professionals, you and your loved one should be able to live happy and healthy into old age despite the lack of marital rights and the tax hurdles until we achieve marriage equality.
Thomas H. Franklin holds a CPA and a Masters of Science in Taxation degree from Northern Illinois University. His practice specializes in advising same sex and other unmarried couples on tax and other financial matters. He has spoken before the Illinois Society of Certified Public Accountants on same sex couple issues. You can look on his web site at www.thomashfranklin.com . His email is thomashfranklin@gmail.com and he welcomes all comments.
