Estate planning with tenancy by the entireties property.

• Author: Pratt, David

Estate planners were given one more reason to celebrate last New Year's Eve when the IRS issued its final regulations under I.R.C. [sections] 2518 regarding disclaimers of tenancy by the entireties property. What we were too jubilant to see at first glance, however, is that there is yet one more problem that must be resolved before a survivorship interest in tenancy by the entireties property can be disclaimed by a surviving spouse in Florida.

The purpose of this article is to address the various transfer tax consequences involved with tenancy by the entireties property and to identify both pre-mortem and post-mortem estate planning opportunities with such property. We will also briefly summarize the history of disclaimers, including the recently promulgated final regulations. Furthermore, we will point out a significant problem under state law and a potentially viable solution that may allow us to take advantage of the IRS' belated holiday gift.

Gift Tax and Estate Tax Consequences

Generally, there are no gift tax consequences upon the creation of a joint tenancy between spouses (either as a tenancy by the entireties (TBE) or as a joint tenancy with rights of survivorship (JTWROS)) because of the unlimited marital deduction.[1] This may not be true if the donee spouse is not a United States citizen because the gift tax marital deduction is not available for gifts made to a noncitizen spouse.[2] While the gift tax marital deduction is disallowed when a gift is made to a noncitizen spouse, the annual exclusion is increased from $10,000 to $100,000 for such gifts.[3]

Upon the first spouse's death, one-half of the value of the jointly held property is included in the deceased spouse's gross estate.[4] However, no estate taxes result due to the corresponding estate tax marital deduction.[5] The surviving spouse receives a step-up in basis for one-half of the property and a carryover basis for the remaining one-half of the property.[6] When the surviving spouse later dies, the entire value of the property owned at such time by the surviving spouse is included in his or her gross estate for estate tax purposes.

There is an exception to these estate tax and basis step-up consequences if the joint tenancy between the spouses was created before 1977 and if the deceased spouse furnished all or some of the consideration for the property. According to Gallenstein v. U.S., 975 F.2d 286 (6th Cir. 1992), all or a proportionate share of the jointly held property is included in the gross estate of the first spouse to die, and the property then passes by operation of law to the surviving spouse, who receives a full or proportionate step-up in basis. Gallenstein has been followed frequently in recent decisions, including Baszto v. US., 80 AFTR2d 97-7740 (M.D. Fla. 1997), a case which adopted the same rationale as Gallenstein in late 1997.[7]

Fiduciaries of estates that include a spousal joint tenancy created before 1977 should consider taking advantage of the increased basis step-up for as much of the value of the property for which the deceased spouse furnished consideration for the purchase. For estate tax returns already filed, fiduciaries should consider filing supplemental estate tax returns.[8] In these situations, the property would be reported on Part 2 of Schedule E of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, as opposed to Part 1, which is used to report qualified joint interests under [sections] 2040(b).

Asset Protection

TBE property can only exist between a husband and wife, and, as opposed to JTWROS property, spouses holding TBE property are treated legally as one person in Florida.[9] Neither spouse holds an individual share of TBE property, but rather, upon the death of the first spouse, the surviving spouse continues to hold the entire property.[10]

One distinct advantage to TBE property over JTWROS property is that TBE property may not be used to satisfy either spouse's individual debts.[11] A creditor typically would have to be able to sue both spouses on the same cause of action to reach the TBE property, or the tenancy would have to be set aside for fraud.[12] However, according to a decision by the Bankruptcy Court, In re Planas, 199 B.R. 211 (Bankr. S.D. Fla. 1996), a creditor of one spouse holding TBE property may be able to find relief in another way.[13] In Planas, the court held that if there is at least one joint creditor in existence who could have levied the TBE property when the bankruptcy petition was filed, then the TBE property may be liquidated in favor of all creditors, both joint and individual.[14] Furthermore, the creation of TBE property does not divest creditors of preexisting debts attached to one spouse's interest in the property prior to such property's conversion to TBE property.[15]

As this article was submitted for publication, Planas had not been followed by any other court. In fact, a 1997 decision by the Bankruptcy Court explicitly disagreed with the holding in Planas.[16] Thus, assuming that Planas is limited to its unique set of facts, TBE property should continue to be used by spouses as an asset protection technique.

Estate Planning

Prior to the enactment of the Taxpayer Relief Act of 1997, estate planners typically advised their married clients that each spouse should own, individually, at least $600,000 of assets,[17] as opposed to owning such assets jointly.[18] Upon the first spouse's death, a credit shelter trust (CST) would be funded with the $600,000 of solely owned assets, which would ensure that such spouse's unified credit would not be wasted. The remaining jointly held property...