Joint Tenancy Problems in Estate Planning

Sometimes people use Joint Tenancy as a simple way to do Estate Planning. This can have drawbacks, sometimes serious and unexpected.

First, why is Joint Tenancy a simple way to do Estate Planning? At the death of a joint tenant, the property automatically transfers by operation of law to the remaining joint tenant(s). This can be attractive because it bypasses the probate process and all it entails. Probate is the process that moves property titled in the name of one person (the decedent) and moves it to the name of another person. Probate is a public process, lacking privacy. Depending upon the state, probate can be costly and time-consuming. With Joint Tenancy, probate isn’t required because it passes by operation of law by its very nature.

However, if a couple wants to avoid probate, while Joint Tenancy avoids probate at the death of the first joint tenant, it doesn’t avoid probate in the estate of the survivor. At the survivor’s death probate would be required unless further planning is done. The problem is the survivor may be unable to plan because of grieving, incapacity, or simultaneous death.

Let’s look at a quick example. John and Mary own their home in Joint Tenancy. This seems to work well for them for years. Driving home from work one day, John has a heart attack and dies. The property transfers by operation of law to Mary. However, Mary’s now distraught from John’s death and puts off planning for the property. Mary dies with the property in her name and a probate is required. Of course, if John and Mary had died in a common accident, probate would have been required, too.

However, there could be more serious problems with Joint Tenancy. Let’s say that Mary in our example above did further planning by adding John and Mary’s only child, Josh, as a joint tenant. While this would avoid probate at Mary’s death, just as it did at John’s death, it causes other issues.

Josh could decide to sell his half of the property. Of course, Mary says he would never do that. Maybe he wouldn’t, voluntarily. However, let’s say Josh is sued and they get a judgment against him. They can satisfy it against any of his assets, including his ownership interest in the property he holds in Joint Tenancy with Mary.

So, in addition to the risk that Josh might not cooperate or could make Mary’s life difficult, his actions could cause Mary to lose the half of the property in Josh’s name to Josh’s creditors. While Mary was trying to save a little money by putting the property in Joint Tenancy, she jeopardized her future.

There are also tax consequences with adding a non-owner to an asset as Joint Tenant. The original basis is assessed to the surviving Joint Tenant upon sale of the asset. In essence, there is no step up in basis for the asset. In this scenario, Joint Tenancy just bought the surviving Joint Tenant a date with the capital gains tax people.

If John and Mary had utilized a Revocable Trust instead of Joint Tenancy, the property would have avoided probate. If Mary hadn’t compounded the problem by trying to use Joint Tenancy with Josh, she could have avoided losing half the property to Josh’s creditors and avoided capital gains taxes.

Dynasty Trusts

Trusts are very useful, flexible tools to hold assets. They allow for management of assets during your life, upon your incapacity, and for the continued management of the assets after your death. Perhaps you’d continue to hold the assets in trust until your children reach a suitable age to manage the money for themselves, like age 25 or 30. But you could keep the assets in trust even longer. You could keep the assets in trust for the lives of your children, and your children’s children, and so on.

These trusts, sometimes called “Dynasty Trusts” continue for the longest possible time allowed by law. Some states have a “Rule Against Perpetuities.” The Rule in common law says that the asset must vest, if at all, no later than 21 years after the death of a “life in being” when the trust became irrevocable, typically the death of the grantor of the trust. In jurisdictions with the common law Rule Against Perpetuities, you could have the assets in the trust and then at your death, you’d look around and see who is the “measuring life.” Typically, the measuring life is the living beneficiaries of the trust, like your children and grandchildren. The trust must distribute within 21 years of the death of the last of them to die. Let’s say at your death your grandchild is 4 and lives until their 104th birthday. The trust can continue until 21 years after that. So, the trust could continue 121 years in that case.

Many states have adopted the Uniform Statutory Rule Against Perpetuities, which allows a trust to last either the traditional Rule Against Perpetuities period (a “life in being” plus 21 years) or 90 years, if longer. Some states have modified the Rule so that a trust might last 150, 365, or even 1,000 years. Some states have completely repealed the Rule so that a trust could last forever!

Why might you want to keep your assets in a trust that long? First, you can have professional management of the assets to make sure the assets aren’t squandered by the beneficiaries and make sure the assets are distributed in the manner you’ve chosen even long into the future.

Next, a Dynasty Trust can save on taxes for those with a taxable estate. Let’s look at a quick example:

John (age 80)(1st generation) dies and leaves $5 million to his daughter, Sally (age 50)(2nd generation), outright. Sally lives another 30 years and the $5 million grows at 7.2%. The $5 million turns into $15 million by Sally’s death. Sally was a prudent investor and had a taxable estate in her own right even before inheriting from John. Therefore, the inheritance from John and the growth on it are all taxed at the estate tax rate, which is currently 40%. Sally’s estate pays $6 million of estate tax on the money and Sally leaves the $9 million inheritance to her child, Beth (3rd generation), who’s also very savvy with investments and has a taxable estate in her own right. Beth lives another 30 years and the $9 million she inherited from Sally triples to $27 million. Beth’s estate pays an estate tax of 40%, or $10.8 million. Beth leaves the inheritance to Josh (4th generation), who invests similarly. So, the $10.8 million he inherits grows to $32.4 million and his estate owes tax of $12.96 million, leaving $19.44 million for future generations. So, by the end of the 4th generation, the $5 million inheritance from John has grown, after transfer taxes, to $19.44 million in 90 years. That’s not bad, it’s nearly quadrupled.

But there is a better way. If at his death John (1st generation) left the $5 million to a Dynasty Trust for the benefit of Sally (2nd generation) and her descendants and allocated his GST exemption, the assets wouldn’t have been included in Sally’s estate. At Sally’s death, the $15 million wouldn’t have faced a 40% reduction due to the estate tax. Instead, the full $15 million could have continued to grow for the benefit of Beth (3rd generation) and her descendants. After 30 more years it would have tripled to $45 million and at Beth’s death, it wouldn’t have been reduced but would have passed to Josh without further estate taxes. After another 30 years of prudent investing by the 4th generation, the inheritance would have grown to $135 million.

Without a Dynasty Trust, the assets increased by 4x. However, with a Dynasty Trust, the assets went up by 27x over the same period of time and with the same investment assumptions. While a Dynasty Trust isn’t for everyone, it can have some transfer tax advantages for those with a taxable estate. 

Biden Administration Could Reduce Estate Tax Exclusion

The estate tax exclusion is the amount you can give without facing an estate tax. Under current law, you may give this amount during life or at your death and after that amount is used, you face a federal tax of 40% on assets beyond that amount. The amount has fluctuated a great deal over the years. It was $675,000 as recently as 2001. In 2021, the exclusion is a whopping $11.7 million per person. This exclusion consists of a “permanent” exclusion of $5 million, adjusted for inflation since a 2011 base year, and then temporaril doubled through 2025 as a result of a 2017 law. So, unless Congress acts to extend the doubled exclusion, it will revert to $5 million adjusted for inflation beginning in 2026. Confusing, isn’t it?

However, Congress could act sooner than 2026 to reduce the exclusion. Congress has tinkered with the estate tax many, many times over the decades. So, this would be nothing new.

Proposals from the Biden campaign indicated a desire to reduce the estate tax exclusion to $3.5 million. Such a proposal would need to pass through the House of Representatives, which Democrats control by a narrow majority of 222 seats to 211 seats held by Republicans, with 2 seats currently vacant. Assuming legislation to reduce the estate tax exclusion were to pass through the House, it would then proceed to the Senate.

At the beginning of January, the Senate consisted of 50 Republicans and 48 Democrats (and independents caucusing with the Democrats) and two seats pending runoff elections in Georgia. Beating long odds, Democrats won both those runoff elections in Georgia, so the Senate is now tied 50-50. This means the Vice President casts the tie-breaking vote in the Senate. Prior to January 20, 2021, Vice President Mike Pence enables Republicans to retain the majority. However, on January 20, 2021, Vice President-Elect Kamala Harris will be sworn in as Vice President and the majority in the Senate will shift to the Democrats.

Thus, beginning January 20, 2021, Democrats will have the narrowest of majorities in the House and Senate. Even with a narrow majority, there are hurdles to passage in the Senate. Senate rules require 60 votes to end debate on most matters. Also, it’s not at all certain every Democrat would agree, as they’re often a fractious caucus.

But, with deficits mounting, Congress may seek to raise revenue from many sources, including reducing the estate tax exclusion. Why wait to see what Congress does? Your best chance of taking advantage of the current unprecedently high exclusion is to use it now.

If you’re married, you could give assets in the amount of your remaining exclusion to a trust for the benefit of your spouse and/or descendants. Your spouse could be the trustee of the trust and would have the ability to use the assets for their support. If you’re unmarried, you could give your assets to a trust for the benefit of your descendants.

January’s political events have altered the political landscape substantially. Consider whether taking advantage of the current estate tax exclusion is right for you.

Starting the New Year Right

Welcome to the dawning of 2021! Most of us will leave 2020 without any hesitation. 2020 was not the best year for most of us. But you have an opportunity to start 2021 prepared for anything. You can do the responsible thing and get your estate plan in order.

The tumultuous events of 2020 show just how important it is to have your planning in order. Millions became seriously ill from the coronavirus. All too many of them died. When they became ill, those who had their estate plan in order could focus on more important things, such as spending precious time with loved ones.

Even as we hope 2021 will be much better than 2020, it’s important to start out right, by putting an estate plan in place.

What’s an estate plan? At its most basic, it’s a set of instructions about how you want your affairs handled if something happens to you. It’s a message that shows your loved ones you care. A basic estate plan includes a Healthcare Power of Attorney, a General Durable Power of Attorney, a HIPAA Authorization, a Will, and typically also a Trust.

First, what’s a Power of Attorney? It’s a document by which you appoint someone as your “Agent” to act on your behalf. If that Agent is unwilling or unable to act, the document can appoint one or more successor Agents. In other words, you give someone else (the Agent) powers you inherently already have yourself. With a Financial Power of Attorney, otherwise known as a General Durable Power of Attorney, you appoint your Agent to make financial decisions for you. The Power could be drafted to be “immediate.” In other words, the Agent would have the power to make decisions regarding your financial assets right away and without regard to your ability to make those decisions for yourself. In most states, you could make the Power “springing,” in other words it would only become effective upon you not being able to act for yourself because of incapacity. A Power of Attorney is “durable” if it continues notwithstanding you having incapacity. A Power of Attorney which is not durable would not allow your Agent to act during your incapacity.

A Healthcare Power of Attorney appoints an agent to make medical decisions for you when you are unable to do so for yourself. A HIPAA Authorization appoints an agent to access protected health information.

It’s important to keep your Powers of Attorney up-to-date so that you have the people you want as your agents. The agents you select under your Powers of Attorney are vital to your incapacity plan. Make sure you keep the right people in those roles.

Without a Will, the assets titled in your name go as set forth in state intestacy law. This typically is not exactly how you would like. A Will allows you to select to whom and how you want your assets to go. It also allows you to name who you would like to handle your estate after your death. If you have minor children, your Will allows you to nominate guardians to care for them.

Both intestacy and a Will are subject to a public probate proceeding. Depending upon the state, this can be a lengthy and costly process. If you want to avoid probate and maintain your privacy, you can use a Trust. With a Trust, you transfer the assets to the Trust during your lifetime and can manage them as the Trustee. This allows you to avoid the probate process since the Trust doesn’t die. The Trust has the added benefit of making incapacity even easier. Due to cases of fraud, often institutions more readily recognize a successor Trustee acting on your behalf than an agent under your power of attorney.

Hopefully, 2021 will be better than 2020. Even a basic estate plan will allow you to face whatever 2021 has in store for you. Resolve now to get your estate planning done this year, sooner rather than later.