Should You Create a Joint Trust?

If you're married and thinking of setting up living trusts. You might be asking yourselves: "Can't we have just one living trust for the two of us?"

A joint living trust seems logical because most married couples often view their money, home, securities and other property as "our" assets. They start out by opening a joint bank account. Later, when they buy their first home, they may place the title in joint tenancy, etc.

Couples who live in one of the nine community property states generally are treated by law as co-owners of most property "earned" by either of them in that state during their marriage (though these laws vary from state to state). Property that is received as a gift or inherited does not qualify as community property. Also, if you move to a community property state, property that was characterized as separate property in the original state in which you lived will retain that character in the community property state. Property acquired in a non-community property state but would have been characterized as community property had you lived in a community property state will be considered "quasi-community property" should you relocate to one of the nine community property states. The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

The remaining 41 states follow the non-community property law and don't treat property acquired by husbands and wives during marriage as community property. However, if the couple wishes, they can choose to hold some or even all of their assets jointly.

That brings us back to the question: Is a joint trust a good idea?

How a Joint Trust Works

First, don't confuse a joint living trust with jointly owned property. A joint trust is created by a single document that manifests the wishes of both spouses with respect to the disposition of the property placed in the trust. With joint ownership (there are various forms) the most familiar is joint tenancy. When property is held in joint tenancy, the share of the deceased joint owner passes automatically and outright to the surviving joint owner.

With a joint trust, community property and separate property of both spouses may be transferred into the trust and retain their character as community or separate property. Both spouses benefit from the trust during their joint lifetime. When one spouse dies, the entire trust continues for the benefit of the surviving spouse.

Tax Advantages

Estate Tax Advantages In some cases, there can be significant estate tax advantages to a joint trust.

Typically, the terms of such a joint trust are somewhat like this: When the first of the couple dies, the trust splits into Trusts A and B. The assets allocated to Trust A qualify for the federal estate tax marital deduction and include the survivor's share of the community property and the survivor's separate property, if any.

Example: John and Jane Doe have $3 million of community property in a joint trust. When Fred dies, normally one-half, or $1.5 million, would be allocated to Trust B, intended eventually to bypass Jane's taxable estate. However, this would generate estate tax in John's estate on the excess over a tax-free allowance -- $3 million through 2012. So, assuming John made no prior gifts, the excess of $500,000 will be allocated to Trust A. Result: Trust A will wind up with $2 million and Trust B with $1 million, both fully exempt from federal estate tax.

However, the potential estate tax advantages must be weighed against many other factors and issues created by joint trusts.

Income Tax Advantages Particularly in non-community property states, the use of a joint trust can result in a substantial capital gains tax savings for the surviving spouse following the death of the deceased spouse. Through the use of a joint trust, couples living in non-community property states are able to take advantage of the capital gains tax break available to those living in community property law states.

In a community property state, all property held as community property is considered to be part of the deceased spouse's estate for estate tax purposes. Such being the case, unlike jointly held property, all property passing to the surviving spouse passes with a step-up in tax basis as to 100% of the property. The new tax basis of the property for capital gains computation will be the fair market value as of the date of the first spouse died. With jointly held property, only 50% of the property receives the stepped up basis.

Property held in a joint trust is afforded the same stepped up basis treatment as community property.

Example: John and Jane Doe have a home which they purchased several years ago for $50,000.00. At the time of John's death, the home has appreciated in value to $550,000.00. If John and Jane held title to the home other than as community property or in a joint trust, then Jane would only receive a stepped up basis as to one-half of the increase in value of the property. ($50,000 being the original basis plus half of the appreciation of $250,000 results in a new adjusted basis of $3000,000.) If Jane were to sell the home following John's death, she will pay capital gains tax on everything over $300,000. This same principle applies to all properties subject to capital gains.

If the same property were held in a joint trust, Jane would receive a stepped up basis as to 100% of the property or $550,000.00 and if she sold the property for that amount following John's death, there would be no capital gains tax. This is because, in a joint trust all property not specifically set aside as separate property, is considered to be in the estate of the deceased spouse for estate tax purposes and, consequently, receives a stepped up basis as to 100% of the property.

Since all property passing to a surviving spouse passes free of estate taxes, this step-up in basis can result in a substantial tax savings benefit for the surviving spouse.

Although for most couples a joint living trust makes the most sense, there are some instances where a separate trust for each spouse is more desirable either from a tax and a distribution to heirs point of view.

Those couples with substantial estates should consult with their CPA or a tax specialist familiar estate taxes and capital gains prior to creating a living trust.

Married couples with prior marriages should read the section on Separate Living Trusts to determine which type of trust best suits their needs.