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Every Married Couple Needs To Learn About The Community Property Tax Benefit

For married couples we start the living trust process discussing one of the most important and generous tax benefits available to those residing in community property states such as California. We call it the community property tax benefit and it often proves to be the single most valuable part of a comprehensive living trust process – so valuable that it has allowed countless surviving spouses to legally shelter hundreds of thousands, even millions of dollars from income taxation. This underscores why every married couple should take the time to learn about this issue and why it should be a vital part of every married living trust process. You can do that right here and it only takes a few minutes.

The Conflict Agreement Heavily Ties With This Community Property Issue

We discuss the Conflict Agreement and the Community Property Worksheet together because they are closely tied to each other. The conflict agreement begins with a few formalities explaining that we cannot take sides or favor either spouse’s position; that we cannot keep secrets from the other spouse; and that both spouses must be in full agreement for us to proceed. The conflict agreement then moves on to discuss community and separate property. While this is normally a family law issue, the enormous tax-sheltering potential of community property makes it an important estate planning issue. That is why we give every married couple in a community property state the opportunity to complete a community property agreement – which is something each married couple may elect or decline using the community property worksheet.

A Community Property Agreement Overrides Joint Tenancy Which Can Nullify The Community Property Tax Benefit

Most couples are unaware that the common practice of holding title as Joint Tenants in a community property state can nullify this major tax benefit. Part of the reason for a Community Property Agreement is to override Joint Tenancy and help the surviving spouse qualify for the community property tax benefit. Again, it is no exaggeration to state that almost every surviving spouse that has a signed community property agreement has benefitted from it and it has enabled countless surviving spouses to legally shelter hundreds of thousands, even millions of dollars from income taxation. That is why most couples are eager to qualify for this benefit.

Spouses Concerned About Preserving Separate Property Should Still Decline A Community Property Agreement

Despite the potential tax benefit however there are still some spouses that should decline a community property agreement. More particularly, any spouse that is concerned about preserving potential separate property rights should decline to sign such an agreement. Why? — because it will legally override any separate property rights and we don’t want anyone regretting that — most especially in the event of a divorce.

An Overview of Community and Separate Property Issues

Compounding this problem is the fact that many have community or separate property rights without even knowing it. That is why it is important for this to be an informed decision. So please, if you are in a community property state such as California, take the time to understand the overview of community and separate property contained in the conflict agreement before making your decision.

 Among other things it clarifies:

• That marriage does not automatically make everything community property.
• That any assets owned prior to marriage are generally separate property.
• That gifts and inheritances received during marriage are generally separate property.
• That earnings from either spouse’s labors during marriage, including retirement plans, are generally community property.
• And that by law, an agreement between spouses regarding the characterization of any property is legally binding – and this is so of any Community Property Agreement you may sign during the living trust process.

If By Law Everything Is Community Property Anyway There Is No Downside To A Community Property Agreement But If You Have Separate Property Then……

As a matter of perspective, if you began your marriage with little or nothing, have since received no gifts or inheritances, have no nuptial agreement, and what you have accumulated is a result of your work, then it is highly likely everything is community property anyway, and in such cases there is no downside to signing a community property agreement. On the other hand, if you entered the marriage with significantly more assets or have since received gifts or inheritances, it is likely that you do have separate property and, if you are at all concerned with preserving it, you should decline a community property agreement.

In Practice Most Married Couples Have Little Problem Signing A Community Property Agreement

In practice, we find that most couples have little problem signing a community property agreement, especially since legally speaking, many have no separate property anyway and still many others are wholly unconcerned about the issue. Yet that doesn’t mean it is appropriate for everybody, and it is rightfully an individual decision. Just remember that you cannot qualify for the community property tax benefit and preserve your separate property rights at the same time. Only you can decide which is more important to you.

Our Final Guideline Is To Make Sure You Are Comfortable With Your Decision

As a final guideline, if you are the slightest bit hesitant or uncomfortable with this issue or feel you need more information you should decline the option of a community property agreement and consult a family lawyer. Otherwise, we are happy to include a community property agreement as part of your trust package.

Some Other Provisions In The Conflict Agreement

According to the Rules of Professional Conduct of the State Bar of California (the “rules”), a law office may not represent “multiple” clients who have conflicting or potentially conflicting interests without their informed written consent. This even applies to a husband and wife, who in the context of a joint estate plan are deemed to be multiple clients who might have potentially conflicting interests. Thus in order to represent the two of you together in the completion of your joint living trust we must obtain your informed written consent. These rules require us to advise you of any reasonably foreseeable adverse effects that may arise as a result of representing both of you. Accordingly it is possible (although unlikely) that the following adverse effects could arise from representation of both of you in the preparation of your new estate plan:

1. Since we will be representing both of you, each of you is considered to be my client. As a result, matters which either of you discuss with us will not be protected by the attorney/client privilege from disclosure to the other. The rules prohibit us from agreeing with either of you to withhold information from each other. Anything either of you may discuss with us is, however, privileged from disclosure to third parties.

2. It is possible that the two of you have differences of opinion concerning your estate plan. We can discuss the pros and cons of such differing opinions, but the rules prohibit us, however (as the lawyer for both of you), from advocating one of your positions over the other.

3. Although we doubt it will happen, if conflicts do arise between you of such a nature that it is impossible, in our judgment, to perform our obligations to each of you in accordance with this letter, we will have to withdraw as your joint attorney and to advise you both to obtain separate, independent counsel. We would not, and could not, continue to represent either one of you under those circumstances.

4. You may each have a difference of opinion about who should get what property at each of your respective deaths and/or who should be in charge (trustee or executor). We cannot take sides. Nor can we continue with your living trust unless you do in fact agree. You hereby agree to inform us if you do not agree on your joint estate plan. If you do not agree, we can however, do separate estate plans for each of you. In the event you decide to complete individual estate plans, by signing this, you each agree to allow us to prepare estate plans for either or both of you, although you are under no obligation to utilize the services of this office. You each are entitled to or may wish to have independent counsel.

5. Finally, at the forefront of potential conflicts between a husband and a wife is the issue of community versus separate property. What belongs to the husband? What belongs to the wife? What is the right of each at death to dispose of their respective property as they see fit? How is property split in the event of a divorce? (The Conflict Agreement then goes through an overview of community and separate property.)