Financial Planning . . . ALERT

The information contained in this ALERT is not intended to constitute legal, or financial advice.  Decisions with regard to these matters should only be made after consultation with a competent professional.

From my experience in nearly 30 years of helping clients solve legal and financial problems, one of the most misunderstood aspects of planning is the joint ownership of assets.  People certainly know what it is; they just misunderstand when and why it should be used.  I am talking about joint accounts with rights of survivorship, which vests in the survivor full legal title to the asset upon the first death.  I am not talking about tenancy in common, another from of joint tenancy in which the interest of the first to die does not pass automatically to the survivor, but rather is an asset of the decedent’s estate and can be left to a third person or another entity.

People get tempted to use joint tenancy with rights of survivorship because it is familiar, cheap and easy, and it seems to solve problems.

Familiar?  Yes, as married couples have owned residential real estate in this

ownership mode forever.  Also, banks often encourage depositors to “put another name” on a bank account in case “something happens.”

Cheap and Easy?  Yes again, as all the work is done for the customer without charge.  There is no third party input, nor does a lawyer need to be hired.

Solve Problems?  Absolutely, say the proponents, as property owned with rights of survivorship is not a probate asset, so it passes to the survivor directly and avoids the probate process.  This point, perhaps more than any other, causes many husbands and wives to own all their assets jointly.

However, the problems with joint tenancy can be significant . . .

The first is that although joint tenancies are frequently established as a matter of convenience, the arrangement can backfire.  For example, a widow or widower will put the name of a child on an account, often at the suggestion of a bank officer, so the child can access the funds if mom or dad becomes incapacitated.  But, the account is now also an asset of the child and if the child gets divorced, has an uninsured (or underinsured) accident, or suffers a business reversal, that account can be attached by a creditor to pay a judgment or award.  It is not a defense to say, “it’s really my mother’s money.”  And in a situation where the jointly held asset is real estate, an attachment by a creditor could lead to the parent losing the real estate.  Such would be an exceptionally unfavorable result if the property was the parent’s residence.

The next concern is that simply putting someone’s name on an asset creates the possibility a gift has been made and that gift taxes, or at least a reduction in the donor’s lifetime exemption equivalent, will result.  If mother-daughter joint ownership is on a bank account, any withdrawals by the daughter will be deemed gifts UNLESS it can be shown the money was withdrawn for the mother’s benefit.  The annual individual gift tax exemption remains at $12,000, so any withdrawals above that amount may trigger gift taxes and the requirement to file a gift tax return.  If this situation exists in your family, make sure detailed records are kept on each withdrawal and for what purpose the money was expended.

A very big mistake husbands and wives make with joint ownership is that they forget that the current structure of the federal estate tax allows a sum to be left to someone other than the spouse without incurring federal estate taxes (this amount is $2,000,000 in 2008).  Because of the existence of the unlimited marital deduction – any amount can be left to a spouse without incurring federal estate taxes – many families get confused and waste the ability to get up to $2,000,000 out of the estate.  Property held jointly by a husband and wife automatically passes to the survivor, so there is no ability to pass out $2,000,000 (or any amount) to someone other than the surviving spouse, or to a trust.  A huge tax benefit is lost needlessly.

Lastly, another tax benefit is wasted by the use of property held as joint tenants with rights of survivorship.  Under current federal tax law, at death, the property of the decedent is “stepped up” to its fair market value as of the date of death, or the alternate valuation date.  Assume a wife has a $500,000 stock portfolio in which her cost basis was $100,000.  If she leaves it to her husband, his basis, or tax cost, in the portfolio becomes $500,000, as of his wife’s death.  This allows him to liquidate the account and not owe any income taxes.  However, if the wife puts her husband’s name on the account to create a joint tenancy with rights of survivorship, the tax result at her death is much different.  There would only be a step up in half the assets, so his basis would then be just $300,000 (half of the account steps up to $250,000, and the half of the original basis of $50,000 is carried forward).  Therefore, if he then liquidated the account for $500,000, he would owe income taxes on a gain of $200,000.  However, if this hypothetical occurred in a community property state, the husband would get a full step-up in basis.

What is the bottom line to all of this?  There is a reason why professionals such as tax lawyers and certified financial planners exist.  Virtually nothing today in the legal and financial world is as simple as it may appear.  Get competent, objective, help when making important legal and financial decisions.

The hiring of a lawyer is an important decision that should not be based solely upon advertising. Please visit the Doherty Professional Association at www.dohertypa.com today to learn about Mr. Doherty’s credentials and how he might assist you in estate and financial matters.