From Financial Planning Body Of Knowledge
A slight majority of American households consist of opposite-sex spouses. That means that almost half of American households consist of other arrangements, including but not limited to:
- Single (divorced or never married)
- Single with children (divorced or never married)
- Same sex couple (with or without children)
- Unmarried opposite-sex couple (with or without children)
- Traditional family (with dependent elderly parents or dependent adult children)
The planning needs of these households involve substantial issues not confronting historically traditional households. Examples of rights extended to legally married opposite-sex spouses (see Defense of Marriage Act below) that are not extended to other cohabitation relationships (e.g., gay or straight unmarried couples) include:
- Ability to make decisions for an incapacitated spouse,
- Ability to own assets as tenancy by the entirety,
- Ability to take advantage of the federal Family and Medical Leave Act to care for a sick partner,
- Ability to take a dependency exemption for federal tax purposes (but unmarried partner can qualify as an actual dependent if he or she passes the IRS dependency test),
- Availability of employer-offered tax-free fringe benefits to spouse including access to HSAs and FSAs for non-participant spouse. However, the following are exceptions to this rule:
- An unmarried partner can qualify if the other partner qualifies as an actual dependent (otherwise the FMV of cost of coverage is taxable to the employee with the domestic partner).
- In California or Massachusetts a same-sex domestic partner, a person in a civil union or in a same-sex marriage may obtain favorable tax treatment for employer-paid health benefits, regardless of “marital” status.
- Choice of filing status including filing a joint income tax return,
- Community and quasi-community (1) property,
- Dower and curtsey (a state law that provides that when a married person dies the surviving spouse receives the legal right to use any real estate they owned during their lives – varies by state),
- Gift splitting with non-donor spouse and use of non-donor spouse’s applicable exclusion for federal gift tax purposes,
- Intestate succession preference over others (varies by state),
- Parental rights, support obligations, and the ability of a step-parent to adopt the spouse's child,
- Precedence in being appointed as an administrator of an intestate spouse's estate and as financial and health care guardian of an incapacitated spouse,
- Protection of spousal communication (i.e., spouses cannot be forced to testify against each other in a court of law),
- Right to elect against the decedent spouse’s estate (varies by state),
- Right to roll over a deceased spouse’s IRA or qualified plan into the surviving spouse’s IRA (but beneficiary IRA (2) rollovers are allowed to non-spouse beneficiaries),
- Right to sue for loss of consortium, emotional distress for injuries to the other spouse, and wrongful death,
- Unlimited federal estate and gift tax marital deduction.
Defense of Marriage Act (DOMA) - 1996
What about those states (e.g., Massachusetts) or cities (e.g., San Francisco) that legally recognize domestic partnerships, civil unions, or same-sex marriages? The federal government does not legally sanction any marriage other than a marriage between a male and a female that is recognized by state law. Based on the 1996 Defense of Marriage Act (DOMA), the IRS and Tax Court do not recognize same-sex marriages, civil unions, or domestic partnerships recognized by some states. A state may legally recognize a marriage between two same-sex partners, but the federal government does not and probably will not for quite some time. Thorough and rigorous financial planning is needed with clients in non-traditional relationships.
Planning for Non-traditional Relationships
A domestic partnership agreement details how a couple should handle the assets each person acquired before the relationship began and subsequently brought into the relationship as well as assets brought into the relationship after it began. A special or general springing durable power of attorney allows one partner to manage the other partner’s assets and affairs to the extent granted in the power of attorney. Executing this document requires a very trusting and trustworthy relationship. A durable health care power of attorney allows a partner to make “informed consent” decisions for the incapacitated partner.
If ownership rights of a surviving partner are important, it may be convenient and practical to title assets as joint tenants with rights of survivorship (JTWROS) because there is no danger of the asset going to someone other than the surviving tenant upon the first tenant’s death. However, there are three issues that may not be obvious with a JTWROS solution:
- When the first tenant dies 100% of the asset will be attributed to the decedent’s estate unless the surviving tenant can prove consideration.
- Prior to either tenant dying, one tenant could terminate the tenancy by selling the asset without the other partner’s knowledge or consent which could cause a derivative problem: the partner that sells the asset may have created a taxable, completed gift to the partner that originally paid for the asset.
- A portion of the JTWROS asset could be subject to either tenant’s creditors.
One solution to these problems would be to own the asset as Tenants in Common wherein each tenant owns a portion of the asset as an undivided interest in the entire asset (e.g., 50/50, 30/70, etc.). Each tenant’s undivided interest in the property is protected from the other tenant’s actions or creditors and each tenant can bequeath their interest by Will to anyone else (kids from a previous relationship, etc.).
Note: Tenancy by the Entirety is not available to unmarried or same-sex married couples.
A will can be contested when an unmarried partner dies. When the probate court sides with the blood-relatives of the dead partner, the relatives inherit what the surviving partner should have inherited. Dying intestate (i.e., without a will) virtually guarantees that the family of the decedent will inherit all the separately owned assets. A better alternative is to create a living trust that becomes irrevocable at death. Make sure that the appropriate assets are then titled to the trust.
A living will is an important document for all.
Another area that needs careful attention is the proper completion of beneficiary forms. Beneficiary designations override a will. If a beneficiary designation names someone other than the account owner intended, the asset will go to the wrong person. Also, a blank beneficiary designation means the asset will be paid to the decedent’s estate and likely go to family members rather than the intended partner.
(1) Quasi-community Property
Property acquired by a married person or couple in a non-community property state that would have been community property if it had been acquired in a community property state, e.g. California. If the married couple subsequently relocates to a community property state and either the couple divorces or one spouse dies, a court in that state may treat the property like community property when determining the property interests of the divorcing or surviving spouse(s).
(2) Beneficiary IRA
A Beneficiary IRA is inherited from someone other than one's spouse. If a traditional IRA is inherited from anyone other than the beneficiary's deceased spouse, the beneficiary cannot treat the inherited IRA as his or her own. This means no contributions can be made to the IRA and no amounts can be rolled into or out of the inherited IRA. However, a trustee-to-trustee transfer is allowed as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary. The beneficiary must begin receiving distributions from the IRA under the rules for distributions that apply to beneficiaries.
- Terminal illness
- Job change and job loss
- Dependents with special needs
- Monetary windfalls