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George F. Bearup, J.D. Senior Legal Trust Advisor

2-Jan-20

Quasi-Community Property

Take-Away: As we have covered in the past, Michigan is a common-law jurisdiction. Married individuals are permitted to own and control their own separate property. We also know that married couples who move from one of the handful of community property states to Michigan can agree to have the property that they bring with them to Michigan retain its character as community property. If Michigan residents move from Michigan to a community property state, however, there is no ‘one rule fits all.’

Background: The concept of community property takes on significance in estate planning in two separate ways.

  • ‘Free-basing:’ On the death of one community spouse, the entire community property asset enjoys a 100% income tax basis adjustment to the date of death value. [IRC 1014(b) (6).] Accordingly, the surviving spouse can sell the community property asset and avoid paying capital gains taxes. In a common-law jurisdiction like Michigan, if the spouses own the asset as tenants-by-the entireties, while the surviving spouse will have full ownership of that entireties asset, there will be only a 50% income tax basis adjustment to the entireties owned asset on the death of one spouse, and thus some exposure to capital gains taxes if the survivor decides to sell the asset. [IRC 2033.]For this reason, spouses who move from a community property state to a common-law state will probably want to preserve the community property character of the assets that they bring with them, identifying those assets in a Community Property Agreement, and not commingle those community property assets with assets that they accumulate in the common law jurisdiction, in order to be able to claim that the asset receives a 100% income tax basis adjustment on the death of one spouse. The Michigan Disposition of Community Property Interests on Death Act achieves this objective.  [MCL 557.261.]
  • Elective Rights: Most common law jurisdictions provide certain elective rights to a surviving spouse to ensure that the survivor is not completely disinherited by the deceased spouse. Each state has its own elective rights statutes, which vary in their terms, amounts or how the elective share amount is calculated. For example, some states calculate the elective right based on the number of years of marriage, or the share is calculated taking into consideration a deceased spouse’s funded revocable trust. In contrast, Michigan’s elective share statute does not define the estate against which the survivor’s elective share is calculated with regard to a funded revocable grantor trust- the elective share right that is given to the surviving spouse may be exercised only against the deceased spouse’s probate estate (not the decedent’s revocable trust.) [MCL 700.2202.] In community property jurisdictions there generally is no elective right available for a surviving spouse, since the survivor is legally owned one-half of all of the marriage’s assets, so there is arguably no need to protect the surviving spouse from any disinheritance.

Community Property States: While community property states do not have elective share statutes, a few of them provide for what is called quasi-community property. As a generalization, as each state is somewhat different, quasi-community property is any property that would have been community property had the couple acquired it while living in the community property state. If a married couple moved from Michigan (common law) to California (community property), the assets that the couple brings with them from Michigan will be treated as quasi-community property if one spouse dies domiciled in California. Accordingly, the surviving spouse will have a one-half interest in the quasi-community property along with a one-half interest in the community property that was actually acquired while the married couple lived in the community property state.

  • Example: Archie and Edith lived most of their lives in Michigan. Archie was the breadwinner. Archie retained almost all of their assets in his name alone; Archie affectionately called Edith a dingbat who could not be trusted with finances. Archie plans to leave all of the assets in his name alone to a testamentary trust established for Edith’s benefit on Archie’s death. In their retirement years Archie and Edith to move to Nevada for Archie’s health, and where their daughter Gloria lives. Archie plans to name Gloria as the testamentary trustee to assist Edith’s finances after Archie is gone. Moving from Michigan to Nevada will cause all of the assets held in Archie’s name alone to be treated as quasi-community property on Archie’s death. While Archie had intended to transfer all of the assets held in his name to a trust for Edith’s lifetime benefit, with the remainder passing to their Gloria on Edith’s death, under Nevada’s quasi-community property law all of Archie’s assets, despite being held in Archie’s name alone, will now be treated as being owned 50% by Edith, and thus one-half those assets held in Archie’s name will not be available to fund the testamentary trust as Archie had intended. Edith will own and control 50% of the Archie-Edith assets.

Quasi-Community Property Jurisdictions: Of all the community property states, only Texas, Arizona, and New Mexico do not apply the quasi-community property concept in the context of a decedent’s estate, although community property principles may apply in other contexts, such as a divorce. Louisiana, California, Idaho, Nevada, Washington and Wisconsin all apply the quasi-community property concept to a decedent’s estate and to the assets that are moved to that community property state from a common law state like Michigan. As such, there will be a trade-off of some sort: the surviving spouse will receive the inherited assets with a 100% income tax basis adjustment, balanced against which is the reality that the surviving spouse will own 50% of all of the community property assets, which might frustrate the deceased spouse’s testamentary wishes.

Conclusion: Elective share and community property principles can pose challenges when planning the disposition of a married individual’s estate. While almost all spouses do not intend to disinherit their survivor, an intentional disinheritance is sometimes intended the case in second and third marriages where the decedent wants to provide for his/her children from a prior marriage. A strong understanding of spousal inheritance protections and community property can lessen the impact of these restrictions, improve both tax and nontax outcomes, and maximize a married individual’s freedom to dispose of assets as he/she chooses.