Believing he was going to die, a father conveyed a large parcel of land he owned to himself and his son as joint tenants "to avoid probate." To his good fortune, the father recovered. To his dismay, however, his son refused to agree when he decided to sell the land. The father wanted to know if there was anything he could do. The advice was to petition the court to have the property partitioned, i.e. divided, so that he could then sell his "one-half."

The gentleman lost control of his property. As tragic as this may seem, it could have been worse. The creation of a joint tenancy is a popular form of estate planning because it appears to be uncomplicated and inexpensive. However, it has many pitfalls for the unwary, including major estate, gift and income tax consequences.

Estate Tax.  As an individual, you are allowed a credit against gift and estate taxes which shelters $2,000,000 (for 2006-2008) combined lifetime gifts and gifts made at your death (either by will, trust, or other transfer) that takes effect at death.  Many people mistakenly believe that their estates are not that large. This is because they fail to consider their life insurance and retirement plans, both of which are includible in their taxable estates.

If your estate exceeds $200,000,000, half of the value of any property you hold jointly with your spouse will be included in your estate if you die first. But if you hold property jointly with anyone other than your spouse, such as a child, the full value of the property will be included in your estate, except to the extent the surviving joint tenant can prove that he or she contributed to the property.

Furthermore, if your child predeceases you, the interest you gave away will pass back to you as the surviving joint tenant by operation of law. While this is something parents don't like to consider, it is a possibility and should not be ignored. If it happens, the property will not have been removed from your estate and may be included in your child's estate unless you can prove that your child made no contribution.

*(2011 is the Tax Act of 2001 sunset, and will revert to 2002 levels of $1,000,000 without further action by Congress).

Gift Tax. The IRS defines the word "gift" much more broadly than you or I. Basically, it includes any transfer of property for less than its fair market value. It doesn't require an intent to make a gift. There is a $12,000 ($24,000 if spouses elect gift-splitting) annual gift tax exclusion for gifts to any and all individuals to whom you wish to make a gift for 2006. But if a gift to an individual exceeds the annual exclusion amount, some (or all) of the donor's credit for lifetime gifts and gifts made at death will be used.

Both the creation and the termination of a joint tenancy can have gift tax consequences. When one joint tenant provides all the funds for the purchase of the property the creation of a joint tenancy is a gift to the non-contributing joint tenant. So by adding your child's name to a deed, you've made a gift that probably exceeds the $12,000 annual exclusion and, depending on the value of the property, may exceed the $1,000,000 applicable credit amount for gifts.

The value of the gift is not necessarily half the value of the property. If you and your child hold the property jointly with rights of survivorship, the value of the gift will depend on your respective ages. A 65-year-old donor has a shorter life expectancy than a 25-year-old donee and is less likely to enjoy the survivorship interest. The 25-year-old donee therefore receives a gift worth substantially more than half the value of the property.

The termination of a joint tenancy will result in a taxable gift if the property or proceeds from its sale are not divided in accordance with the joint tenants' interests. In our example, if the son had said, "Sure, Dad, sell the land and keep the money, after all, it's yours," the son would have made a gift of his interest in the property to his father. You can't unwind a gift by returning the property. As far as the IRS is concerned, the return of the property results in yet another taxable gift.

Income Tax. Remember that the income from property you give away is no longer yours. When you add someone's name to your property, you must be financially in a position to give away the income from that portion of the property.

Remember, too, that each joint tenant is liable for the tax on the amount of income the joint tenant is entitled to receive, not the amount that the joint tenant actually receives. Conflict is inevitable if one joint tenant receives more than his or her proportionate share of the income and another joint tenant is liable for the tax on that income.

Lifetime Effects.  Because the creation of a joint tenancy is, in effect, a gift, the joint tenant may have the right to access the account.  It is possible that taxing authorities or judgment creditors may be able to lien or seize account assets under certain circumstances.

Conclusion. You shouldn't conclude from reading this newsletter that joint ownership has no place in estate planning. Certainly joint ownership between spouses creates an important sense of security that, in many cases, offsets more advantageous tax alternatives.

The point is that you should consider the disadvantages as well as the advantages of a joint tenancy and the use of alternatives such as wills, trusts and family limited liability companies and limited partnerships. Don't presume because a joint tenancy looks simple and inexpensive, that it is. The cost in strained relationships as well as dollars may make joint ownership between generations a poor bargain.

Assets that are held jointly, with rights of survivorship, with another person will pass to the surviving joint owner.

The terms of your will or trust are irrelevant to these transfers.

This summary is intended as a source of general information.  If you have questions or desire additional information, please contact Ryan M. Wilson at (517) 377-0897 or rwilson@fraserlawfirm.com.