Family Law and Estate Planning: Transmutations, Tax and Malpractice Prevention
| Publication year | 2007 |
| Author | By Charlotte K. Ito and Garrett C. Dailey |
By Charlotte K. Ito* and Garrett C. Dailey**
Family law attorneys would never dream of representing a married couple (clearly husband and wife are adverse parties), and perceive their estate planning counterparts as cowboys for routinely representing both husband and wife. Estate planners have no idea that they are the Evel Knievels of the law and are often surprised to learn that their innocent representation of husband and wife is fraught with danger. This article examines the similarities and differences in the property characterization between the two practice areas and the traps for the unwary estate planner.
A. Scene One, Estate Planning
Wanda and Hank, a married couple, approach an estate planning attorney for a joint estate plan. At the first client meeting, the attorney defines community property as "all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in California,"1 and separate property as everything else, i.e., property acquired by the person before marriage, property acquired by the person after marriage by gift or inheritance, and the income generated by such separate property.2 Wanda and Hank describe their estate as "very simple," list their assets, and offer an opinion as to character of their property. They do not tell the attorney that they have separate property that they wish to protect, and to the attorney there appears to be no conflict of interest. The attorney advises the couple that they can obtain a double step-up in basis3 upon the death of the first spouse to die if property is held as community property. The couple agrees that achieving such a tax benefit would be beneficial. Cheerfully, Wanda and Hank depart. The estate planner prepares as marital property agreement, characterizing all of the couple's property as community property. The couple returns, signs the agreement and again departs full of cheer.
B. Scene Two, Divorce
The next scene also plays out in an attorney's office. Adversely affected by the property agreement, Hank tells a family law attorney that Hank did not understand that he was changing the character of his property for all purposes. Hank says that he did not understand that his assets were separate property, or part separate property, and that he felt trapped when the estate planning attorney asked in front of Wanda whether he was going to share with her his separate property.
C. Scene Three, Deposition
The next scene also plays out in an attorney's office. Present are the estate planning attorney, her insurance defense counsel, Hank and Wanda, their respective family law attorneys and a court reporter. The family law attorneys depose the estate planning attorney for six grueling hours. As this scene fades, the family law attorney is begging her insurance defense counsel for reassurance that this will be the last scene.
In this era of later marriages and frequent remarriages, family law attorneys view the estate planning practice of joint representation as dangerously simplistic. Family law attorneys frequently find that couples own property of a mixed character. Both estate planners and family law attorneys know of the presumption that title determines the character of the property. This presumption is, however, rebuttable.4 Similarly, property acquired by the spouses during marriage in joint form is presumed to be community property, but this presumption is also rebuttable.5
Importantly, the characterization presumptions do not affect the statutory right of reimbursement, either for separate property contributions to the acquisition of community property or for one spouse's contribution to the other spouse's acquisition of separate property.6 The term "contributions" include down payments, payments for improvements, and payments that reduce the principal of a loan used to finance the purchase or improvement of the property. "Contributions" do not include payments of interest on the loan or payments made for maintenance, insurance, or taxation of the property.7 This statutory right of reimbursement cannot be waived without an express declaration.8
Further complicating matters, the community may acquire an interest in a spouse's separate property. This may happen in many ways, including, for example, commingling of separate with community property,9 community services that enhanced the value of a separate property business,10 or the use of community funds to pay down the mortgage on a separate property residence.11
Regardless of purpose, transmutations of property are governed by Family Code sections 850 to 853. Married persons may by agreement or transfer, with or without consideration, transmute community property to the separate property of either spouse, transmute separate property to community property, or transmute separate property of one spouse to the separate property of the other spouse. Such transmutations must, however, be in writing and made, joined in, consented to, or accepted by the spouse whose interest in the property is adversely affected.12 Although no magic words are required, the writing must contain "language which expressly states that the characterization or ownership of the property is being changed."13 The writing must be unequivocal and cannot be left up to the court to divine the parties'' intent.14
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Transmutations do not affect the statutory right of reimbursement unless the writing expressly waives it.15 Thus, even if the donor intends to give a full community property interest, the gift will be ineffective absent an express written waiver of the right to statutory reimbursement. Absent such a waiver, the party whose name is added to a separate property asset will be limited to one half of the increase in equity thereafter. If there is no increase in equity, then the property is returned to the donor as separate property.16
The adequacy of the Section 264017 reimbursement depends on whether the asset acquired is an appreciating or depreciating asset. If the owner of real property adds her spouse's name to title when the property is worth $50,000 that is all the reimbursement the original owner will get, even if the property is worth a million dollars upon divorce. If, on the other hand, a party contributes $10,000 of separate property to acquire a community vehicle for $30,000 and if the car is worth $9,000 upon divorce, the vehicle will be assigned as separate property to the spouse who made the $10,000 contribution, because the community's equity will be depreciated first.18
Finally, a statement in a will of the character of property is not admissible as evidence of a transmutation of property in a proceeding commenced before the death of the person who made the will.19
Determining the character of mixed or commingled assets is difficult. The analysis is very fact-specific and is not always controlled by what the parties think or believe. It is unlikely that a couple will communicate accurately to their estate planning attorney the relevant facts. Nor is the couple likely to understand the consequences of the relevant facts. For an estate planning attorney to try divine the character of the property or the parties' intention should they divorce is fraught with risk.
When drafting estate planning documents, the attorney contemplates the consequences of the clients' death, not divorce. Divorce is an unplanned, unforeseen event for the estate planning attorney and the estate planning client, thus the estate plan is likely to fail in the event of a divorce. If decisions made during the estate planning process spill over and taint the characterization of property upon divorce, one or both of the spouses may regret those decisions and blame the estate planner for the consequences.
When this happens, one of the key issues will be whether the attorney adequately explained, disclosed and documented the risks of dual representation. The adequacy of the disclosure will not be examined in the context of an intact marriage, where conflicts of interest may appear merely potential, but in the context of divorce, where conflicts of interest are always actual. Indeed, from the perspective of the family law attorney, a married couple's conflicts of interest are always actual and the estate planning attorney calls them "potential" at his peril. Family law attorneys are keenly sensitive to conflicts of interest and therefore avoid representing both parties.
In contrast, estate planners regularly represent husband and wife, despite the inherent conflict of interest. Estate planning attorneys do not view the process as adversarial and are therefore accustomed to dealing with both parties. The estate planner wants to produce an estate plan that satisfies the clients' goals and minimizes taxes upon death. Moreover, clients do not want to hire two attorneys to do something as "simple" as an estate plan. Clients also do not view the process as an adversarial one. Hence, many estate planning attorneys draft estate plans for both husbands and wives without adequately addressing the consequence of using...
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