Community property is a regime of marital property. It traces its roots to civil law systems. This is compared to the common law marital property regime tracing its roots back to common law.
With community property, all earnings are owned by the “community” and each member of the community has an undivided one-half interest in that property. This sounds simple enough but attorneys from non-community property states typically do not understand this concept completely.
There are two common traps that snare the unsuspecting non-community property state estate planning attorney. First, property may be community property even though it is titled in only one person’s name.
Example: John and Susan are married and live in a community property state. John earns $100,000 per year (after taxes) and deposits it into his checking account. The account is in his name alone.
The $100,000 in John’s checking account is community property because the source of the funds was John’s earnings—notwithstanding the fact that the account is in John’s name alone. This concept is alien to most non-community property state attorneys. Ask yourself: What is the source of the funds?
A common error related to this trap is the funding of an Irrevocable Life Insurance Trust (“ILIT”). If John uses the funds in his checking account to fund the ILIT, they will be considered to be one-half from Susan because the funds are community property. Thus, if Susan is a beneficiary of the trust, one-half of the ILIT could be included in her estate under I.R.C. § 2036.
The second trap that snares unsuspecting non-community property state estate planning attorneys is automatically severing community property interests. Often, when clients move to a non-community property state from a community property state, the attorney will sever the community property into a more familiar form of property. Community property can be advantageous in that both halves of the community property qualify for the step-up in basis at death (step-up regime) or additional basis allocation (carryover basis regime). Thus, the transmutation from community property can have negative income tax consequences after death.
If your clients are married and they 1) have lived in a community property state while married, or 2) own real property in a community property state, they may have community property—even if they now live in a non-community property state. Be sure you don’t fall into these community property traps.
Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys
Direct Line: (858) 300-4739
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