Married Joint Tenants Can Still Get Tax Break

QUESTION: My husband and I were horrified to read last week about the tax consequences of holding our house in joint tenancy. Please tell us what steps we can take to avoid the dire income tax consequences of this.--M. A.

ANSWER: Fortunately for residents of California and other community property states, there is a fairly simple way to handle this situation without changing the vesting of the property. According to Marvin Goodson, a tax attorney with the Los Angeles law firm of Goodson & Wachtel, the Internal Revenue Service recognizes the right of a husband and wife in a community property state to enter into a written agreement that eliminates the tax disadvantages of joint tenancy ownership of property acquired with community funds.

First, let’s quickly review the differences between joint tenancy and community property ownership of marital assets. Traditionally, husbands and wives have held their property as joint tenants to avoid lengthy and costly probating of the estate when one spouse dies. However, in California and some other states spouses are allowed to hold their assets as community property. This vesting may not avoid probate on the death of one spouse, but it does lower the income tax consequences when the survivor disposes of the couple’s assets.

Here’s the difference. In the case of assets held as community property, the base value of the halves held by both the deceased spouse and the surviving spouse is generally set as of the date of death. This means that a house purchased for $25,000 but worth $400,000 when one spouse dies, receives a value of $200,000 for the share of the deceased and $200,000 for the survivor’s share.

However, for assets held as joint tenants, the base value of the deceased’s half is assigned the fair market value as of the date of death, but the surviving spouse’s share is assigned the original value. Taking the above example of a house worth $400,000, the deceased’s share would be worth $200,000, but the survivor’s would be worth just $12,500. Obviously, the income tax consequences of selling that asset would vary greatly. If the community property survivor sold the house for $400,000, no taxes would be owed; the joint tenant survivor would owe taxes on a gain of $187,500.

Although accountants and attorneys have urged clients in community property states to change the vesting of their assets to community property to exploit the income tax advantages, Goodson says there is another, less costly way of achieving this goal while preserving the joint tenancy vesting and its probate advantages.

According to Goodson, a couple may sign a statement noting that they are “holding their property in joint tenancy for convenience only” and that it is their “intention that the property remain as community property.” Goodson says such a statement will allow both halves of any assets to be revalued as of the date of death of the deceased spouse.

Goodson says this statement, which can be included in a couple’s mutual wills, does not have to be notarized nor recorded. “It is simple to do,” he says, “and it can save a substantial headache as well as a lot of money.”

Debenture Holders Protected in Takeover

Q: I own a debenture issued by a department store chain. The debenture is due and payable in the year 2016. However, I have heard rumors that the chain may be acquired by a competitor. My question is: What happens in the event of a takeover to the interest payments I am currently receiving? Will the new owners start paying them?--H. L. L.

A: What happens to the interest payments due on the debentures--or any debt notes issued by a company being acquired--depends on the terms of the takeover. But barring a complete collapse of the department store chain, you should be well protected.

In all likelihood, the takeover agreement will spell out how the new owners will handle the long- and short-term debts of the chain. The new owners can either continue making payments on the debentures at the specified interest rate, or they can redeem the issue, most likely at a premium to the sellers. The terms of the acquisition agreement should be available from the investor relations office of both the buyer and the company being acquired.

It’s Tough to Defer Tax on Early Distribution

Q: The company for which I work is going to distribute all of our deferred compensation. Is there any way I can avoid paying tax on this money right now by putting it into some other tax-deferred account? Can I put this money into an individual retirement account?--P. W.

A: Unfortunately, you don’t have many options. In fact, your only choice may be to take the money, pay your tax obligation and invest it quickly in something that will suit your individual needs.

According to our experts, deferred compensation distributions cannot be rolled over into IRAs because they are entirely different types of accounts, and funds from these accounts cannot be mingled.

The U.S. tax code classifies IRAs as qualified trust accounts; deferred compensation plans are merely arrangements between employer and employee specifying the terms under which salary, bonuses and other reimbursements for services are to be paid out over the years. IRAs are regulated by a complex set of laws that prescribes the terms of all contributions and withdrawals. The terms of deferred compensation accounts vary from agreement to agreement and do not face the same stringent government guidelines.

So, if you do receive the proceeds of your deferred compensation account directly, there is a very strong likelihood that you will be liable for taxes on the distribution. However, our experts say there is still a remote possibility that you can avoid the distribution.

Ellen Marshall, an attorney in the Costa Mesa office of Morrison & Foerster, advises that you carefully review your deferred compensation agreement to see if your company is complying with its terms by making an early distribution of the deferred compensation. If the company is violating the agreement with the disbursement, you can challenge it. An alternative plan, Marshall says, would be to attempt to persuade your employer to roll the deferred compensation funds into a special trust account for the involved employees. However, your employer may not like that idea because the company will not be able to claim payment of those funds as a business expense until the employees actually receive the money.

Marshall notes that you might just want to take your deferred compensation, pay the taxes owed on it and be done with the whole matter. “Many experts believe the current tax rates are as low as they are going to be for a long, long time,” she explains. “So, it may make sense to pay the taxes now and invest the money for future returns.”

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.