Avoiding the Knot: Estate and Tax Planning for Unmarried Couples

• Publication year: 2017
• Author: By Nicole M. Pearl, Esq.*, and Elham Ardestani, Esq.*

AVOIDING THE KNOT: ESTATE AND TAX PLANNING FOR UNMARRIED COUPLES

By Nicole M. Pearl, Esq.*, and Elham Ardestani, Esq.*

Many couples today choose not to marry. Some want to avoid triggering the property rights and support obligations inherent in a marital relationship. Some have been through a painful or expensive divorce and are not eager to remarry. Others may want to preserve their social security benefits or maintain inheritance rights for children from a prior marriage. Still others may have a philosophical objection to marriage. Whatever the reason, couples should know the consequences ? some good, some bad ? of avoiding the knot.

I. FORGONE BENEFITS

By forgoing a marital relationship, couples give up all of the rights and benefits that are afforded to married couples under federal and state law. Married couples can take medical leave to care for one another without risking the loss of a job.¹ Both spouses can continue health insurance coverage under COBRA if one spouse loses a job.² Spouses can also petition for a non-citizen spouse to immigrate in a more timely and favorable manner with a higher chance of the non-citizen spouse ultimately being granted U.S. citizenship.³ These benefits are not afforded to unmarried couples.

Rights secured through marriage do not terminate when one spouse dies. Surviving spouses are entitled to inherit under state intestate succession laws⁴ and have priority to be appointed as administrator of a predeceased spouse's estate.⁵ In many states, surviving spouses are entitled to receive a portion of a predeceased spouse's assets. Surviving spouses are also entitled to social security survivorship benefits and may elect to take the larger benefits of a predeceased spouse.⁶

Even the tax laws favor married couples. The unlimited gift and estate tax marital deduction allows each spouse to transfer property to the other free of any transfer tax.⁷ Spouses can terminate a marriage and divide their assets without recognizing gain.⁸ Surviving spouses who inherit a qualified retirement plan or individual retirement account from a predeceased spouse may roll over the retirement benefits to their own individual retirement account and are not forced to begin withdrawing funds immediately upon the death of the participant.⁹

This article explores the various planning issues, including asset protection, estate planning, and tax issues that arise and must be addressed when a couple chooses not to marry. The article also explores certain opportunities that arise for unmarried couples that can offset some of the disadvantages faced by unmarried couples.

II. PRESERVING PROPERTY RIGHTS

Each state has well-settled laws that govern the property rights of spouses. These laws help married couples preserve their property rights and ensure both spouses are protected in the event of divorce. In California, property owned by either spouse prior to marriage, property received by either spouse as a gift or inheritance either before or during marriage, and all income earned on this property will remain that spouse's separate property.¹⁰ By simply making sure that separate property is not commingled with community property, each spouse can protect his or her separate property rights.¹¹

Absent an agreement to the contrary, all other income earned by either spouse during a marriage, including any income derived from either spouse's efforts during the marriage, is community property under California law.¹² The community property laws protect the less wealthy spouse ? or a spouse who has decided to stay home and raise children in lieu of remaining in the workforce ? by ensuring that he or she is entitled to one-half of all income earned by either spouse during marriage. Even in non-community property states, the less wealthy or non-working spouse is usually protected by equitable distribution statutes that allow a court to divide property in an equitable fashion on the termination of a marriage.¹³

Property rights for unmarried couples in California are less certain. Courts have found that cohabitation alone can give rise to an express or implied contract governing property rights. In Marvin v. Marvin, a woman brought an action against actor Lee Marvin with whom she lived for approximately six years. This plaintiff asserted that the couple had orally agreed that, during the time they lived together, they would combine their efforts and earnings and share equally the property accumulated through their individual or combined efforts.¹⁴ She also alleged an oral agreement that she would render services to her nonmarital partner as companion, homemaker, housekeeper, and cook and give up her career in exchange for being supported financially for the rest of her lifetime.¹⁵ Comparing nonmarital relationships to that of putative spouses, the court stated:

[Page 20]

"[A]lthough parties to a nonmarital relationship obviously cannot have based any expectations upon the belief that they were married, other expectations and equitable considerations remain. The parties may well expect that property will be divided in accord with the parties' own tacit understanding and that in the absence of such understanding the courts will fairly apportion property accumulated through mutual effort. We need not treat nonmarital partners as putatively married persons in order to apply principles of implied contract, or extend equitable remedies; we need to treat them only as we do any other unmarried persons." ¹⁶

As Marvin demonstrates, although the rights of nonmarital partners are not governed by the traditional community property laws, courts can find express or implied agreements between the parties to pool their resources and share in the property accumulated during the relationship. Conversely, nonmarital partners may agree that each partner's earnings and the property acquired from those earnings remain the separate property of the earning partner. So long as the agreement is not "explicitly founded on the consideration of meretricious sexual services," the parties may order their economic affairs as they choose and no policy precludes the courts from enforcing such agreements.¹⁷

Courts have been inconsistent as to how far they will stretch to find an implied agreement between nonmarital partners and when they will conclude that an agreement, implied or otherwise, is based on the consideration of "meretricious sexual services." In Alderson v. Alderson, the court found that the conduct of nonmarital partners over the 12-year period that they were together evidenced an implied contract between them to share equally any and all property acquired during the course of the relationship that did not rest on "a consideration of meretricious sexual services."¹⁸ The Alderson court relied on the fact that the parties held themselves out as husband and wife, went by the same surname, pooled their financial resources during their relationship, were both involved in the maintenance and recordkeeping for the properties, and took title to some of their properties jointly.¹⁹

Courts have rejected similar agreements based on the fact that the agreements rested either entirely, or in part, upon a consideration of meretricious sexual services. For example, in Jones v. Daly, the surviving partner to an oral cohabitation agreement between two males filed an action for declaratory relief against the executor of a deceased partner's estate alleging that the oral agreement between the parties had provided that the partners would live and cohabit together and would combine their efforts and earnings and share equally all property accumulated as the result of their efforts.²⁰ The Jones court held that the surviving partner's rendition of sexual services was an inseparable part of the consideration for the cohabitation agreement; thus, the agreement was unenforceable.²¹

Even without finding an implied contract between two nonmarital partners, courts have granted relief to one partner in quantum meruit based on the idea that someone should get paid for beneficial goods or services provided to another. In Maglica v. Maglica, the court found that there was no implied contract between the parties with regard to sharing the ownership of a business that two nonmarital partners worked together to create.²² However, in order to avoid unjust enrichment to the defendant, the plaintiff in Maglica was able to recover the more limited value of the compensation that should have been provided for the services that she performed. Recovery under quantum meruit limits the recovering party to the value of services provided, not necessarily the value of the impact those services may have had on the business.²³ Obtaining an equity interest in the company under an implied contract theory is often more valuable to a plaintiff than merely recovering the value of services provided.²⁴

Unmarried cohabiting couples who seek greater certainty should define their own property rights with respect to each other in a more formal, written, cohabitation agreement. This type of agreement defines property rights between the cohabitants, any potential support rights, and any inheritance rights.

III. TAX IMPLICATIONS OF EXPRESS OR IMPLIED COHABITATION AGREEMENTS

Practitioners drafting cohabitation agreements, and the parties negotiating them, must be aware of the potential tax implications of any payments made between unmarried persons. The same caution is true for any party asserting a Marvin claim based on an implied agreement between nonmarital partners. In these contexts, both the income tax and the gift tax implications must be analyzed and considered. Drafters should be aware that results under the income and gift tax rules are not always consistent.

Generally, the income tax consequences of any payments made in settlement of an actual or potential lawsuit depend on the nature of the claim for which the proceeds were received and the actual basis of recovery.²⁵ The settlement agreement must be analyzed to...