Does the Republicans' Estate Tax Repeal Plan Affect Community Property Trusts?
by Stites & Harbison, PLLC
In 2010, Tennessee became the second state to create an elective community property system through community property trusts. Community property is a system of ownership that provides for equal ownership between husband and wife. However, the property in this type of trust would be subject to the creditors of both spouses. Community property trusts therefore are different than tenancy by the entirety, whereby property held by husband and wife as tenants by the entirety are immune from the creditors of only one spouse (although they are not immune from creditors of both spouses jointly, or if the non-debtor spouse dies first).
Why would a couple give up tenancy by the entirety protection? Generally, for tax purposes, i.e., a double step in basis. Without a community property trust, when one spouse dies there is only a half step up in basis typically with property owned jointly. With a community property trust it is possible to receive a full step up on the death of one’s spouse for property owned jointly. Here’s an example: assume Mary Smith and John Smith bought a rental house for $100. At Mary Smith’s death, the property has appreciated in value to $200. If the property is sold at that point for $200 there would be a 50% step up in basis, so there would be tax on $50 of gain ($100. basis plus $50 step up). If the property had instead been in a community property trust, there would be a full step up at Mary Smith’s death and there would be no tax if the property sold for $200. There would be another full step up at the time of John Smith's death.
A Tennessee community property trust is set up if one or both spouses transfer property to a trust that:
- expressly declares that the trust is a Tennessee community property trust;
- has at least one trustee who is a qualified trustee and whose powers include, or are limited to, maintaining records for the trust and preparing or arranging for the preparation of any income tax returns that must be filed by the trust (both spouses or either spouse may be a trustee);
- is signed by both spouses; and
- contains the following language in capital letters at the very beginning of the trust document: THE CONSEQUENCES OF THIS TRUST MAY BE VERY EXTENSIVE, INCLUDING, BUT NOT LIMITED TO, YOUR RIGHTS WITH YOUR SPOUSE BOTH DURING THE COURSE OF YOUR MARRIAGE AND AT THE TIME OF A DIVORCE. ACCORDINGLY, THIS AGREEMENT SHOULD ONLY BE SIGNED AFTER CAREFUL CONSIDERATION. IF YOU HAVE ANY QUESTIONS ABOUT THIS AGREEMENT, YOU SHOULD SEEK COMPETENT ADVICE.
Tenn. Code Ann. § 35-17-103.
The issue with the current Republican tax proposal is not in regards to the technical set up of the trust in accordance with the above, and not even in regards to the ability to have elective community property treatment. Instead, the issue is that it is unclear if the proposal is passed whether or not there would still be a step up in basis at the death of the first spouse. The reason is that this double step up requires the property to be subject to the estate tax (or fall under the credit amount). Without an estate tax, it is unknown whether this double step up would be available. Therefor, more information will need to be forthcoming as the bill or bills progress, but this is definitely a situation that should be monitored by those who have or are contemplating a community property trust. Fortunately, if the double step up is no longer available, community property trusts are revocable, and as such the property could be deeded out and into a trust that has treatment similar to tenancy by the entirety.