Published 7/19/2010

And They Lived Happily Ever After ... for now: Marriage and the Estate

Relationships can be complicated, but the tax issues surrounding them are an even bigger challenge. Here are three common scenarios and the simple solutions for transferring your wealth.

Irvine Blackman, Brian I. Whitlock

From a tax-planning viewpoint, once a first marriage ends, a business owner falls into one of three distinct categories, each requiring different economic and tax strategies.

You’re already married the second (third, fourth ...) time around.

This is by far the biggest group with the most complicated set of estate tax and economic issues. Complications typically arise from one or more of the following sources: age difference, health issues, kids (his, hers or theirs, plus the kids’ spouses and the complicating factors of which kids are in the business and which are not), lack of a premarital agreement, and the dilemma of how to provide for the surviving spouse when the business owner dies while still leaving as much as possible to the kids.

Let’s solve the last, and toughest problem first. A qualified terminable interest property (Q-TIP) is the perfect two-step strategy. The first step involves the business owner transferring the business to the business kids using an intentionally defective trust (IDT). This transfer gets the business out of the estate while the owner is alive, yet allows him or her to retain control until death.

The second step involves rolling all of the owner’s assets—residences, IRAs, 401k, etc.— into an IRA during the owner’s life, and all of the investment assets—real estate, stocks, bonds, etc.—into the Q-TIP at death. No estate tax is due upon the death of the business owner, and the surviving spouse then has a life estate, which includes living in the residence until death and enjoying income from the other assets.

What happens when the spouse dies? The Q-TIP show is over. All of the assets go to the kids (and/or grandkids), and estate tax is now due based on the value of the assets that were passed on. Second-to-die life insurance can be purchased on the couple to cover the estate tax due when the second spouse dies.

With the exception of curing health issues and settling family quarrels, the provisions in an estate planning document, usually a trust, can solve the rest of the issues previously listed. If you have a health issue, start your estate planning now. Time becomes critical, and a good estate planner will service health-issue clients first and fast.

You’re ready to tie the knot … again.

Do it. However, before saying “I do,” the soon-to-be bride and groom must sign a prenuptial agreement. Failure to do so makes a lot of unhappy campers, particularly the spouse with the most wealth.

If the marriage is a winner, it’s easy to blow off the prenuptial and play the estate planning game as described in the first category.

You have a significant other but are not married.

When I ask, “Will you marry down the road?” answers vary from “no,” to “maybe,” to “someday” or some variation. Whatever the answer, when the relationship is solid and for the long-term, the business owner is committed to taking care of the partner after death.

What’s the estate tax problem? When the couple isn’t married, there is no marital deduction—no Q-TIP. If the business owner dies before his or her partner, the estate tax is due immediately. With a Q-TIP, the monster estate tax is not due until both partners have gone to heaven.

So what’s the plan? Create a Q-TIP-type trust. The trust is funded with the assets needed to maintain the partner’s lifestyle. Typically, these include the residence and income-producing assets. The partner has a life estate only, living in the residence and receiving the income from the assets. At the partner’s death, the assets go to the business owner’s kids and grandkids.

The only fly in the ointment is that the estate tax is due at the owner’s death. When he or she is insurable, insurance on his or her life is the simple answer. Of course, the policy death benefit must be set up, usually an irrevocable life insurance trust, so none of the death benefit is subject to estate tax.