10.2 Nature of Nonprobate Assets

• Library: Estate Planning in Virginia (Virginia CLE) (2018 Ed.)

10.2 NATURE OF NONPROBATE ASSETS

10.201 Distinction Between Probate and Nonprobate Assets.

A. Definition. For purposes of this chapter, probate assets include assets that pass pursuant to a decedent's will as well as assets that pass pursuant to Virginia's intestacy statutes of descent and distribution, since the latter pass through virtually the same statutory probate system. Generally, probate assets include assets that are: (i) titled in the decedent's name alone; (ii) titled jointly without survivorship; (iii) titled jointly with right of survivorship if the joint owner does not survive the decedent; (iv) payable to a beneficiary who does not survive the decedent; or (v) payable to the decedent's estate at his or her death. Essentially, a will and the intestacy law provide a formal way of transferring title from a decedent to his or her beneficiaries or heirs at death.

Nonprobate assets are assets that pass title outside of a will or the intestacy law, such as by deed, contract, or other instrument. These arrangements are often referred to as "will substitutes," but just as wills must be

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scrutinized for compliance with testamentary formalities, nonprobate transfers must also be scrutinized to be sure they are not regarded as testamentary instruments requiring compliance with the statutory formalities applicable to wills. Generally, if an instrument passes a present interest, it is considered nontestamentary and does not need to be executed with all the formalities applicable to wills, even though enjoyment of the present interest may be postponed until the death of the maker. ¹ The most common forms of nonprobate transfers are nontestamentary in character and need not comply with the statute of wills, but in the absence of statute or other authority, the estate planner should be alert to the distinctions. If what is perceived to be a nontestamentary instrument is subsequently determined to be an attempted testamentary transfer that is void for noncompliance with the statute of wills, the affected asset will pass pursuant to the decedent's will or intestacy law rather than pursuant to the instrument in question.

Section 64.2-620 of the Virginia Code lists a broad range of commercial, financial, and other written instruments that may contain provisions for a nonprobate transfer on death that will be regarded as nontestamentary. Nontestamentary transfers also include "writings stating that money or other benefits due to, controlled by, or owned by a decedent before death shall be paid after the decedent's death to a person whom the decedent designates either in the instrument or in a separate writing, including a will, executed either before or at the same time as the instrument, or later." ² Nonprobate transfers under this statute do not limit rights of creditors.

B. Tax Treatment. A common misconception of clients is that nonprobate assets avoid federal estate taxation in whole or in part.

1.Probate Estate Versus Gross Estate. A decedent's gross estate for federal and Virginia estate tax purposes includes the value of all property to the extent of any interest held therein by the decedent at the time of death. ³ As discussed later in this chapter, there are various estate tax statutes that specifically include nonprobate assets in a decedent's gross estate. Generally, unless a decedent irrevocably divests himself or herself of

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all interest in or power over a specific asset during lifetime, it will be includible in the decedent's gross estate for estate tax purposes.

2. Taxable Gifts. Titling an asset in nonprobate form may have gift tax consequences, depending upon the nature of the interest or power retained by the owner or transferor. Generally, if the owner or transferor retains the right to revest title solely in himself or herself or retains the right to change the identity or interest of the transferee or named beneficiary, the transfer will not be a completed gift for federal gift tax purposes. ⁴

3. Income Tax. Income taxation of nonprobate assets generally follows ownership or control of the assets. This is generally determined by state law and by the terms of the instrument creating the asset.

10.202 Common Examples of Nonprobate Assets.

A. Jointly Held Assets with Right of Survivorship. These are discussed in paragraph 10.4 below.

B. Payable on Death Accounts. These are discussed in paragraph 10.5 below.

C. Life Insurance Contracts Payable to a Named Beneficiary. These are discussed in paragraph 10.6 and, to some extent, paragraph 10.7.

D. Retirement Benefits Payable to a Named Beneficiary. These are discussed in paragraph 10.7 below.

E. Assets Passing by Exercise of Powers of Appointment. These are discussed in paragraph 10.8 below.

F. Lifetime Gifts. A donor may make lifetime gifts in which the donor reserves an interest or a power while title vests in another or remains in the donor in a fiduciary rather than an individual capacity. Such assets will pass outside of the donor's probate estate unless the transfer requires a reversion to the donor's estate.

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1. Life Estate. An example of a lifetime gift would be a deed of real estate in which the transferor or donor reserved a life estate. Although the value of the entire property would be included in the...