Estate Planning Considerations

by

Goralka Law Firm
4470 Duckhorn Drive
Sacramento, CA 95834

Telephone: 916.440.8036
Facsimile: 916.440.8038

Rights of "surviving spouse" during dissolution process

A California dissolution of marriage cannot be final until at least six (6) months after the date of service of a copy of the summons and petition, or the date of respondent's appearance, whichever occurs first (Family Code Section 2339). A judgment of dissolution must first be entered specifying the date on which the dissolution will be final or stating that it will be final on a date to be determined on noticed motion or stipulation (Family Code Sections 2340 and 2343). Until that six month period has passed, the spouses are still legally married and each party retains their rights as a surviving spouse (Probate Code Section 78).

A surviving spouse has a number of legal rights that provide preferential treatment on the death of the other spouse. The survivor may avoid a probate of property distributed to him or her at death from the deceased spouse (Probate Code Section13500; Family Code Section 760; Probate Code Section 28). The survivor is entitled to half of the couple's community property (Probate Code Section 100). If a spouse dies without a will, the surviving spouse is entitled to all of the deceased spouse's community property and a portion of decedent's separate property under the laws of intestate succession (Probate Code section 6401). If there is a probate estate, a surviving spouse may claim a family allowance during probate and a probate homestead (Probate Code Sections 6521 and 6540). The surviving spouse has preferred position regarding selection as administrator of an intestate spouse's estate (Probate Code Sections 8461 to 8463). However, Probate Code Sections 8461 to 8463 lowers the priority of a surviving spouse to serve as administrator if he or she is a party to an action for separate maintenance, dissolution or annulment.

In Lahey v. Bianchi (1999) 76 CA4th 1056, 91 CR2d 30, the court held that a spouse who obtained a judgment of legal separation was not a surviving spouse for intestate succession purposes. Probate Code Section 78 provides that the term "surviving spouse" does not include a person whose marriage to the decedent was dissolved or annulled. The statute also excludes a "person who was a party to a valid proceeding concluded by an order purporting to terminate all marital property rights." A court in a legal separation proceeding is required to divide known assets and characterize liabilities. The judgment stated that there was no community property to divide since the parties were legally separated. That was sufficient to constitute an order purporting to terminate all marital property rights for purposes of Probate Code Section 78.
The fact that the death of one of the spouses occurs while the parties are awaiting a final decree of dissolution has little effect on most of these rights. Moreover, an existing will that provides a preferred position for the surviving spouse is unaffected by the mere filing of a petition for divorce or by a decree of legal separation or both (Probate Code Section 6122). You should evaluate the rights of a surviving spouse and possibly modify them by an updated estate plan at the beginning of the dissolution process.

Items To Review Upon Separation Or Divorce Proceedings

Wills

If you do not wish your existing will to be effective during the dissolution process, the will should be revoked immediately. In preparing a new will, your attorney should review with you all of the facts or factors that he or she would consider if that divorce were final. These factors include, but are not limited to, changes in beneficiaries, setting up trusts for children, and selection of such fiduciaries as executors, trustees and guardians for minor children if the other spouse should also die before all children reach adulthood. In addition, you should refer specifically to the dissolution proceedings in the new will that you wish to disinherit the spouse.

Revocable Grantor Trusts

You should address the issue of revocation or withdrawal of assets from revocable trust at the beginning of the dissolution process because a new will does not affect assets already transferred to an inter vivos trust. Property that a spouse has transferred to an inter vivos trust will, under usual circumstances, remain that spouse's community or separate property. The contributing spouse can, without the consent of the other spouse, usually remove such property from the trust even if both spouses serve as cograntors and cotrustees (Family Code Section 761).

Joint Tenancies

Title to real property acquired during marriage is frequently taken in joint tenancy by custom or to avoid probate at the death of the spouse who dies first. The rights of a spouse as a joint tenant are generally not affected by revisions in the other spouse's will or living trust. However, joint tenancy title to real property can be severed without consent of the other joint tenant (Civil Code Section 683.2). The same is true of personal property (Estate of Propst (1990) 50 C3d 448, 268 CR 114).

A presumption may arise that, for purposes of division of property on martial dissolution or legal separation, property acquired during marriage in joint tenancy form is community property.

Beneficiary and Pay-on-Death Instruments

Items in this category include insurance, payment-on-death provisions in contracts of employment, pension, profit-sharing and stock ownership plans, Totten trusts, pay-on-death bonds and other instruments with possible pay-on-death provisions, mortgages, promissory notes, deposit agreements or conveyances. You should analyze each instrument separately and make any new beneficiary designations if he or she decides that a change is appropriate.

Note that eliminating the other spouse as a beneficiary does not prevent the other spouse from claiming his or her half community interest in the assets of a spouse who died during the dissolution proceedings.

If you are the noninsured-nonemployee spouse and the insured spouse dies during the dissolution process, you may protect your community property interest in potential assets by notifying the employer, administrator, fiduciary, or insurance company of the insured spouse of your community property interest in the assets. Without such notification, the payor will generally be discharged from adverse claims regarding payment to other named beneficiaries, and the surviving spouse may instead find it necessary to proceed against recipients of the property in order to recover his or her own half of the community property.

Safe Deposit Boxes and Personal Effects

Although a joint contract between individuals and a corporation for rental of a safe deposit box does not create a joint tenancy or otherwise establish ownership in the content of such boxes (Civil Code Section 683.1), consider the potential for access to a safe deposit box with a client who is a party to a dissolution proceeding.

If you are concerned about a spouse's possible wrongful claim of ownership to valuable family heirlooms or other separate personal property, you should prepare a complete inventory of the your separate property.

Earnings After Separation

Your earnings are often the building blocks of your estate plan. Earnings and accumulations of a spouse during the period in which the spouse is living separately or legally separated from the other spouse are the separate property of the acquiring spouse (Family Code Sections 770 and 772; also Marriage of Wright (1983) 140 CA3d 342, 189 CR 336). Your family law attorney should advise a client with possible separation earnings to do all that he or she can to fix the date of separation. Case law has held that separation must involve an actually breakdown of the family relationship rather than a temporary separation for economic or social reasons (Marriage of Baragry. (1977) 73 CA 3d 444). Such joint acts by the spouses as filing joint tax returns or accompanying each other on social occasions can create ambiguity regarding the date of separation despite prolonged or turbulent physical separations, or even after a petition for dissolution has been filed (Marriage of Mardsen. (1982) 130 CA3d 426).

Tax Issues During Dissolution Process

Before entry of the judgment of dissolution, both spouses may elect to continue to file joint federal and state income tax returns. The filing of joint returns may be more convenient and result in lower overall taxes. However, the filing of joint returns results in joint and several liability for any taxes, tax deficiencies, interest and penalties (Internal Revenue Code Section 6013 (d)(3)). Internal Revenue Code Section 6015 may provide some relief to innocent spouses. When you choose to file joint returns during the dissolution process, a spousal agreement should be considered, stating the manner in which they intend to allocate tax liability between themselves. This agreement should unequivocally bind each of their estates and should be acknowledge in any later property settlement agreement.

Estate Planning Issues in Property Settlement Agreement

Income Tax Issues

Income tax issues pertaining to the division of property incident to divorce are moderated by IRC Section 1041 which generally provides that no gain or loss is recognized on a transfer of property incident to divorce. Nevertheless, gain or loss may be recognized on a later sale. Further, there are many assets that will generate taxable income in other ways afer the division of property. These include rights to receive deferred compensation and rights to receive continuing payments under a contract for the sale of appreciated property following an IRC Section 453 installment payment election. These potential tax consequences must be taken into account.

Estate and Gift Tax Changes

At the time of dissolution you should also consider the estate and gift tax aspects of the property settlement agreement. For example, a transferor may inadvertently retain sufficient incidents of ownership over property transferred under property settlement agreement that the property is included in his or her estate for federal estate tax purposes (IRC Sections 2036 and 2038 (various controls over property); IRC Section 2037 (transfers taking effect at death); IRC Section 2041 (powers of appointment); IRC Section 2042 (retention of incidents of ownership of life insurance policies). A property settlement agreement should also be drafted so that the obligation of a spouse's estate to make transfers for the benefit of a surviving former spouse (other than alimony) gives rise to a valid federal estate tax deduction.

Property Tax Issues

Although Article XIIIA of the California Constitution (Proposition 13) provides that the assessed value of property, for property tax purposes, is to be generally held at 1975 levels, a change of ownership will cause reappraisal of the property to current fair value. A transfer of ownership between spouses is generally an exempt event and should not cause reappraisal (Revenue and Taxation Code Section 63).

California Documentary and Transfer Taxes

Revenue and Taxation Code Section 11927 provides an exemption from transfer taxes with respect to a division of property on dissolution, but the exemption applies only if the division is under a specific written agreement and the transfer document specifically states that the transfer is entitled to the exemption. Revenue and Taxation Code Section 11930 exempts gifts and testamentary transfers from transfer taxes.

Spousal Support Issues

Except as otherwise agreed by the parties in writing, the obligation of any party under any order or judgment for the support and maintenance of the other party terminates on the death of either party or the remarriage of the other party (Family Code Section 4337). Consequently, a supported spouse should consider including provisions in the property settlement agreement to provide for continued support if the supporting spouse dies. Continuation of support by the estate of the deceased spouse is a possible provision. Effective use of these provision s require that sufficient assets be available in the supporting spouse's estate to cover support costs. If there is a substantial risk that the assets of the estate will be insufficient to meet all of the claims against it, this provision becomes less attractive.

In many circumstances, the supporting spouse should purchase and maintain an annuity or insurance on his or her life payable to or for the benefit of the supported spouse (Family Code Section 4360). In other situations, both spouses may find it more advantageous from a tax perspective if the supporting spouse simply pays in increased spousal support an the supported spouse purchases insurance on the supporting spouse's life.

You may also consider drafting an irrevocable marital support trust/ payments (other than child support payments) from an irrevocable marital support trust are either treated as alimony under IRC Section 71 or are taxed, often more favorably to the payee spouse, under IRC Section 682. You should carefully review these two sections and their differing requirements and tax effects before drafting an irrevocable marital support trust. One purpose of such a trust may be to own or be the designated beneficiary of insurance on the life of the supporting spouse's life.

In drafting support provisions, note that spousal support payments will not quality as alimony for federal income tax purposes if the obligation to make the payment continues beyond the death of the payee spouse (IRC Section 71(b)(1)(D)).

Child Support Issues

The parties will usually make provision in the property settlement agreement for continuing support of minor children by the primary provider of support. However, the parties should also address in the agreement the issue of continuing support for minor children if the supporting spouse dies. The use of mandatory life insurance, an irrevocable trust, or a combination of the tow is often desirable.

Using a trust can have several advantages. Someone other than the former spouse can be selected to administer funds on a child's behalf if the provider spouse dies. The drafter can specially tailor the provisions for payment of medical and educational expenses and any extraordinary expenses.

The property settlement agreement may provide for transfer of assets for the benefit of a child to a custodian under the California Uniform Transfers to Minors Act (CUTMA) (Probate Code Sections 3900-3925). Custodial transfers differ from transfers to trust in several ways. For example., more than one child can be the beneficiary of a trust. In contrast, separate custodial arrangements must be made, and a separate custodian must be appointed for each child (Probate Code Section 3910). The incidence of income tax on trusts for minors are discussed in chapter 4.

The duties and responsible of a custodian are generally defined by the Civil Code rather than in an instrument executed by the transferor Under Probate Code Section 3920.5, a custodian can hold transfers made during the lifetime of the transferor for the child until the child reaches age twenty-one (21); testamentary transfers can be held until the child reaches age twenty-five (25). Unless an older age is specified, the property will be transferred when the minor turns eighteen (18) (Probate Code Section 3920.5(f)). Property transferred to a trustee, on the other hand, can be held in trust for the life of the child or until any specified age. The custodial arrangement also can avoid the costs of drafting and administration associated with creation of a formal trust and may, therefore, be preferable when transfer of smaller sums is contemplated. Transfers by a supporting spouse to a custodian may take place either at the time of dissolution, or at certain dates afterward that are specified in the agreement, or they may be made from the estate of the supporting spouse if the supporting spouse dies before the child reaches the prescribed age.

Instead of making current irrevocable transfers, the supporting spouse may agree in the property settlement agreement either to maintain life insurance or to include certain provisions in his or her will for the benefit of minor children. In that situation, compliance should always be monitored. The non-supporting spouse should be aware that, if the supporting parent does not honor his or her commitment, the child may have nothing more than a claim against the deceased parent's estate. Such a claim might be expensive and difficult to pursue, particularly if a subsequent spouse and later children, or both, have an interest in the supporting parent's estate.

Effect of Dissolution on Prior Property and Estate Planning Instrument

Provisions in a will that provide for a former spouse are automatically revoked unless the will expressly provides otherwise (Probate Code Section 6122). Note that such provisions are revived on remarriage to the same spouse (Probate Code Section 6122(b)). The revocation provision of the Probate Code applies only to wills. It is imperative that the rights of the parties under living trusts, joint tenancy arrangements, and payment-on-death instruments, be stated in these instruments, and that the instruments themselves be later amended or changed to reflect the terms of a subsequently drafted property settlement agreement. For example of the importance of amending instruments after a change in circumstance see Snyder v. Snyder (1987) 197 CA 3d 6. If property is to be held in continued joint ownership after dissolution, the respective rights of the parties to use, encumber, and transfer interests in the property should always be stated in the agreement.