Very often estate planners will come across parents placing their child’s name on all of their accounts and on the deed to their home in an effort to save their child the hassles involved in the probate process and to provide the child with access to their accounts in the event of an emergency. Parents may consider their child to be completely trustworthy and responsible, and that may be the case, however, rarely do parents consider the unexpected events that happen in daily life. For example, what if the child got divorced? filed for bankruptcy? was named a defendant in a personal injury lawsuit? These types of circumstances arise often, and very rarely are they anticipated or intended. Placing a child’s name on an account can carry unintended and dire consequences, including serious tax implications. As discussed further herein, the serious and unnecessary implications to this type of do-it-yourself estate planning could be easily avoided through responsible legal means, while still accomplishing the individual’s personal estate planning goals.
Typically, inserting an additional individual’s name on a deed or checking account means that the inserted individual has been granted a proportional ownership interest in the property. Therefore, those assets could be included in any analysis of the individual’s creditors who seek to attach or repossess their assets. Very often I am rhetorically asked “o.k., but what is the likelihood the creditor would be successful in attaching the asset?” That is a very good question, and in the case of a checking account, the defense could be that the child was given legal title to the account merely for convenience and had no actual equitable ownership interest in the property. This defense could be substantiated by evidence that the child had never engaged in transactions involving the account. The Bankruptcy Code does seek to exclude equitable interest in this type of property from the bankruptcy estate under 11 U.S.C. § 541(d) and is sometimes referred to as a “naked title interest.” However, notwithstanding the possibility that the parent could be successful in defending this type of action, the parent must consider the likely substantial financial and emotional cost of defending the claim, which is all but guaranteed to be litigated by the creditor.
Another topic not typically considered (or understood) by a parent intending to place a child’s name on their property is the tax obligations the child may incur as a result of their good intentions. Each person who acquires property has a “basis” in that property, which would be the value in which the individual paid to acquire the property. This basis is what determines an individual’s capital gain on the property when they transfer the asset. For example, if an individual acquires a parcel of real estate for $100,000.00 in 1985 (their basis) and thereafter sells that property for $550,000.00 in 2014, the capital gain for the property would be $450,000.00, and the IRS would use that number in determining how much tax to impose. The Internal Revenue Code has an exception to their rules regarding an individual’s basis to allow for a beneficiary of a decedent’s estate to acquire the decedent’s property at a basis of the value of the property at the time of the decedent’s death. This is referred to as a “step up in basis.” The relevant portion of the Internal Revenue Code relating to a step up in basis upon a decedent’s death states that “the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be— (1) the fair market value of the property at the date of the decedent’s death…” [1] Now, as clearly stated in the statute, for this exception to be effective the decedent must not have “sold, exchanged, or otherwise disposed of” the property prior to their death. Therefore, an individual acquiring an interest in property via rights of survivorship, as a result of having joint ownership in a property with a decedent, would not qualify the individual to claim their basis in the property as the fair market value at the time of the decedent’s death. Rather, the individual’s basis would be the amount in which the decedent acquired the property for, which could (and likely is) an amount far lower than the fair market value at the time of their death. Therefore, a simple attempt to avoid probate by a parent could result in a substantial capital gains tax liability on the child once they go to transfer the property. However, “[p]roperty acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent” does qualify for a step up in basis.[2]
The question that now stands is, how are all of the nightmares and headaches relating to joint ownership of property avoided, while still avoiding the potential nightmares and headaches involved in a probate proceeding. The typical answer would be to create a fully funded revocable living trust wherein the parent transfers all of their property into a revocable trust in which they have complete access and control during their lifetime, and upon death, title to their property passed to their children in any manner and proportion they elect. Under this type of trust, creditors would be unable to attach assets of the trust because the child’s ownership interest in the property has not vested and the child would also avoid capital gains taxes by receiving a step up in basis on the property they inherited. Additionally, a parent can appoint their child(ren) as Successor Trustee(s) of the trust so that their child(ren) have the ability to manage their affairs in the event of their incapacity.
[1] 26 U.s.C § 1014
[2] 26 U.s.C § 1014(b)(1)
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