Community Property and Estate Taxes

Many married couples have probably lost track of what property belongs to either spouse individually instead and what belongs to both spouses as community property. After being married for decades, the separation between separate and community property may be irrelevant for any day-to-day needs.

But the distinction between separate and community property can become suddenly critical when the first spouse dies. At that point, it becomes necessary to determine what property the deceased spouse owned at death so that their estate tax liability, if any, can be calculated. (Even if the deceased spouse’s estate does not owe any estate tax, it can still be important to file an estate tax return so that the surviving spouse can inherit any of the lifetime gift and estate tax exemption that the deceased spouse did not exhaust.)

Generally, a deceased spouse’s estate will include the entire value of their separate property and half of the value of the couple’s community property, but several other factors can also be important to consider.

Interspousal agreements can change property from community to separate and vice versa.

Through a pre-nuptial agreement, post-nuptial agreement, or a community property agreement, spouses can agree that certain property that would otherwise be characterized as separate property or community property may be “transmuted”—or changed—by written agreement. In almost all cases, a transmutation requires a written agreement between the spouses and cannot be accomplished by adding language to a will.

An interspousal agreement can be particularly useful where one spouse may or has received a substantial inheritance. By default, inheritances are considered separate property. An interspousal agreement may convert inherited property to community property or ensure that it remains separate property.

Record title is important but not determinative of the character of property.

Some couples, in anticipation of the death of one spouse, change record title for their community real estate property to the surviving spouse, in hopes that the property will pass to the surviving spouse without the need for probate. But this is a risky and inefficient strategy. Although the manner in which title to property is held can be important, courts will often look past the names stated on deeds to determine whether certain property was actually community property at the time of death.

Instead of changing title to the name of just one spouse, it is usually more efficient to hold title through a trust or to hold title as community property with right of survivorship. (For more information see: Characterization of Community Property and Separate Property)

The marital deduction will shield inherited assets from estate tax but is limited for non-US citizen surviving spouses.

In general, property inherited by a surviving spouse from a deceased spouse is entitled to an estate tax deduction. In other words, a deceased spouse’s estate is allowed to deduct the value of any assets that pass to the surviving spouse on the deceased spouse’s estate tax return. But those same assets will be taxed as part of the surviving spouse’s estate unless they are spent, given away, or otherwise disposed of before the surviving spouse’s death. This deduction can be important to shield surviving spouses from a sudden tax bill.

But the martial deduction is disallowed for surviving spouses who are non-US citizens. In that case, Congress is concerned that non-citizen spouses will take their inherited assets back to their home country and escape any transfer taxes.

The martial deduction can be recouped for non-citizen surviving spouses if they receive their inheritance through a Qualified Domestic Trust, known as a QDOT. A QDOT trust includes certain restrictions that ensure that the surviving spouse will pay any estate taxes owed from the value of the trust.

Establishing a Qualified Domestic Trust can be technical and complex. Contact an estate planning attorney or certified financial planner if you need help establishing a QDOT for you or your spouse.

The surviving spouse should always consider whether to elect portability.

Although the vast majority of estates are not subject to estate taxes, all surviving spouses should consider instructing their deceased spouse’s executor to file an estate tax return so that the executor and surviving spouse can elect “portability” of the deceased spouse’s lifetime gift and estate tax exemption.

Under current law, every individual is entitled to a lifetime gift and estate tax exclusion of about $11 million (adjusted for inflation and set to adjust downwards significantly starting in 2025). A surviving spouse may inherit any exclusion not used up by their deceased spouse, and add that amount to their own exclusion, potentially allowing the surviving spouse to pass up to $22 million in property to future generations through inheritance or gift without incurring any taxes.

But, in order to inherit a deceased spouse’s unused lifetime exclusion, the deceased spouse’s estate must file an estate tax return and elect “portability.” Thus, even if the deceased spouse’s estate will not trigger any estate taxes, it can be extremely valuable to file the return.

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Contact the Law Office of Ravi Patel if you and your spouse need help creating an estate plan or understanding your community and separate property.