HOW BENEFICIAL IS FLORIDA'S COMMUNITY PROPERTY TRUST ACT TO THE MARITAL ESTATE? A LEGISLATIVE ANALYSIS OF FLORIDA'S COMMUNITY PROPERTY TRUST ACT.

Date22 March 2022
AuthorAlonso, Massiel
  1. INTRODUCTION

    Florida is a migratory state, famous for its tropical climate and its generous tax laws. (1) Now, Florida is joining Alaska, Tennessee, South Dakota, and Kentucky in offering a Community Property Trust for marital property. (2) One of the benefits of a Community Property Trust Act ("CPTA") is that when a spouse owning community property dies, the basis of both the deceased spouse's and the surviving spouse's (50%) shares of the property are adjusted to the property's fair market value at the date of the decedent spouse's death. (3) This sort of tax adjustment is referred to as a "double step-up in basis," and as long as the community property has appreciated, it results in a tax benefit for the beneficiary of the property. (4)

    An analysis of Florida's CPTA reveals that it is misleading in several ways. First, it gives estate planners the option to make the trust irrevocable; however, if a married couple were to place their homestead property in an irrevocable trust, they would lose their homestead exemption which affects the way the property is taxed. (5) Second, if one spouse dies and the surviving spouse is a non-citizen of the United States, and the decedent left their property to the surviving non-citizen spouse, that spouse is now subject to gift taxation rates as applicable to non-citizens under the Internal Revenue Services ("IRS") code. (6) Lastly, this new legislation does not clearly state whether the assets used to fund the trust would be classified for tax-exempt purposes. (7)

    This Comment will analyze the Florida Community Property Trust Act by closely evaluating the statute itself. (8) Part II will offer background information on the CPTA, including definitions of essential terms. (9) Part III, section A, will analyze the risk of providing an irrevocable trust as an option for homestead property and offer a novel solution that proposes an amendment to the CPTA to eliminate irrevocable trusts. (10) Part III, section B, will analyze the issue of devising property to a non-citizen spouse for tax purposes and propose a tax exemption for non-citizen spouses with a community property trust. (11) Part III, section C, will analyze the uncertainty regarding how the IRS will treat community property trusts settled in a non-community state and will recommend clarity in the law as it refers to this issue. (12) Part IV will state the novel solutions proposed for each critique. (13) Lastly, part V will summarize the analysis done throughout the comment and conclude. (14)

  2. BACKGROUND

    On July 1, 2021, Florida adopted Florida's Community Property Trust Act ("CPTA"). (15) The CPTA allows married couples to form a community property trust and fund it with the marital property treated as community property. (16) This new legislation "gives the settlor spouses broad discretion to structure the trust as they wish, including determining whether the trust shall be revocable or irrevocable and how the trust property shall be disposed upon death or divorce." (17) Another advantage of the CPTA is that the settlor spouses do not have to live in Florida; only the Trustee must. (18) However, the ultimate benefit of the CPTA is having all the property in the trust receive a step-up based on the fair market value at the time of death of the first spouse and second spouse. (19)

    Community property is governed by statutory and judicial laws that have developed in community property states. (20) The IRS is one of the central governing bodies with respect to community property, and it describes community property as "(1) property that one or both spouses acquire during their marriage (or domestic partnership) while residing in a community property state, (2) property the spouses agreed to convert from separate property to community property, or (3) property that simply cannot be deemed separate." (21) It is important to note that upon the death of the first spouse, the deceased spouse's interest in the community property does not pass automatically to the surviving spouse; instead, the testator must explicitly devise it to the surviving spouse if that is their wish. (22) Notably, one of the most significant advantages of owning community property is its double step-up in basis taxation, which essentially re-evaluates each spouse's share of the property at the time of their death. (23)

    1. BACKGROUND ON DOUBLE STEP-UP IN BASIS

      When an asset receives a step-up in basis, the asset's value has been readjusted to the fair market value when it passes from its owner to its heir. (24) Typically, the asset's value will be higher at the time of inheritance than at the time of purchase, so the step-up in basis allows the beneficiary to minimize capital gains tax. (25) Now, a double step-up in basis simply means that the asset will receive a step-up in basis twice: once when the first spouse passes, and again when the surviving spouse dies. (26)

      For instance, a married couple--Allan and Jo Ann--purchased a home in 1977 for $350,000. (27) Allan passed away first in 2006, and at the time, the house received a step-up in basis for its market value of $500,000. (28) Jo Ann passed away in 2015, leaving the property valued at $700,000 to their daughter Stephanie. (29) As a result of the double step-up in basis, "Stephanie inherits a home that steps up in basis twice and avoids paying a large amount of taxes because of the double step-up rule." (30) Significantly, this only affects Stephanie once she decides to sell the home. (31)

    2. BACKGROUND ON IRREVOCABLE TRUSTS

      An irrevocable trust is a type of trust that, once funded, the grantor is no longer allowed to modify. (32) More importantly, once the grantor transfers their funds into the trust, they have effectively relinquished all of their ownership rights over those assets. (33) Once the trust is funded, "[t]he trust now legally owns the assets, which have been retitled or registered in the trust's name, and since the trust property is no longer yours, it will have no bearing on the value of your estate or your tax liability." (34) An irrevocable trust is often created for the protection and division of an estate--for instance: "[t]o take advantage of the estate tax exemption and remove taxable assets from the estate [;]" "[t]o prevent beneficiaries from misusing assets;" and "[t]o gift assets to the estate while still retaining the income from the assets." (35)

    3. BACKGROUND ON REVOCABLE TRUSTS

      Contrary to an irrevocable trust, a revocable trust is one that "can be amended or revoked as the grantor desires and is included in estate taxes." (36) It is common practice for the grantor of a trust to also act as the trustee of the revocable trust because the trust agreement will provide for a successor trustee. Upon the grantor's death, the trust becomes irrevocable. (37) For tax and legal purposes, an important consideration is, "[w]hen you transfer assets into a revocable trust, you still legally retain ownership over the property... so you [will not] get the same sheltering tax benefits of an irrevocable trust." (38)

    4. BACKGROUND ON UNLIMITED MARITAL DEDUCTION

      The unlimited marital deduction is an estate tax provision that allows spouses to transfer an unlimited amount of money amongst each other, including by devise at any point during the marriage, without incurring any penalties or additional taxation. (39) In essence, this provision treats the married couple as "one economic unit." (40) Additionally, "the unlimited marital deduction allows married couples to delay the payment of estate taxes upon the death of the first spouse because after the surviving spouse dies, all assets in the estate over the applicable exclusion amount are included in the survivor's taxable estate." (41) Additionally, "the unlimited marital deduction allows married couples to delay the payment of estate taxes upon the first spouse's death[]" because "[a]fter the surviving spouse dies, all assets in the estate over the applicable exclusion amount will be included in the survivor's taxable estate." (42) Importantly, the unlimited marital deduction is not allowed for the transfer of property to a non-citizen spouse. (43)

    5. BACKGROUND ON HOMESTEAD EXEMPTION

      The Florida homestead exemption is a provision governed by the state's constitution that shields the home from a forced sale and most creditors. (44) This exemption provides ongoing protection to surviving spouses. (45) Significantly, only a natural person may claim the exemption. (46) In essence, the homestead exemption guarantees a maximum exemption from property taxes, and it "also protects the value of residents' homes from property taxes, creditors, and circumstances that arise from the death of the homeowner's spouse." (47)

  3. DISCUSSION

    1. THE DOWNFALLS OF UTILIZING AN IRREVOCABLE TRUST FOR HOMESTEAD PROPERTY

      The CPTA offers grantors the option of forming either a revocable or irrevocable trust. (48) The downfall of this is that if the grantors place their homestead property in an irrevocable trust, the grantors are relinquishing their homestead exemption. (49) Crucially, "[b]ecause the homestead exemption remains with the owner, you may lose the homestead exemption once the trust takes title to the property." (50) Along with the homestead exemption, the grantors relinquish all legal and equitable title to the assets. (51)

      Both an irrevocable trust and the homestead exemption offer protection from creditors, assurances that the property devises within the bloodline or to a designated beneficiary, and ongoing tax protection. (52) Accordingly, to the grantors, it may appear like they have nothing to lose; however, by placing their homestead property in an irrevocable trust, they vest legal ownership of the assets in the trustee. (53)

      Pursuant to Fla. Stat. [section] 736.151(1), "[p]roperty that is transferred to or acquired subject to a community property trust may continue to qualify or may initially qualify as the settlor spouses'...

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