Death,Divorce, and Taxes
By Louis Sroka
In Brief
Planning Can Avoid Unforeseen Distributions
A separation or divorce can have a large impact on an individual’s estate or inheritance rights. Without insight and planning, unanticipated consequences will almost certainly result if one of the spouses dies unexpectedly during this transition period. It is crucial to take necessary precautions in order to prevent the problems that may occur.
When a spouse dies while the couple is separated or in the midst of a divorce,
what are the consequences? Does an old will still prevail? Does the person
the decedent recently accused of adultery or cruel and inhuman treatment still
inherit the entire estate? And for the surviving spouse, does the divorce
process of equitable distribution continue, or does a recently changed will
take precedence? Planning issues that arise during an extended separation
or divorce proceeding can cause interesting problems.
A marriage endures until a judge executes a final judgment of divorce, regardless of the length of separation, lack of communication, or bitterness of allegations. Two specific consequences arise from this principle. First, when one spouse dies in the midst of a divorce, the parties are still considered legally married. The ongoing divorce action automatically abates because the court has lost jurisdiction to decide the marital status of the parties. It has also lost jurisdiction to decide any property issues arising out of that status. Second, the decedent’s estate plan prevails. The law states that the surviving spouse is entitled to whatever bequests are described in the will, and whatever accounts or assets for which she is the named beneficiary.
The New York State Estate, Powers, and Trusts Law (EPTL), section 5-14, provides that as soon as a divorce decree is signed, the provisions of a will leaving property to the now-divorced spouse become null and void, and the will is construed as if the divorced spouse predeceased the survivor. But until a judge’s signature is affixed to the final decree, the marriage lasts, and so does the effectiveness of the will and all other testamentary dispositions.
A couple who have been separated or engaged in a divorce are therefore, in the eyes of the law, restored to “normal” marital status when one of them dies. The will, trust, and beneficiary designations are all effective. Because the question of marriage is one of state law, the unlimited marital deduction still applies. Similarly, the stopgap rights of a disinherited spouse, or the elective share protections, apply as well.
Example. Mary and George are married, and it is a second marriage for each of them. They separated in 1998 and, after a brief attempt at reconciliation, George filed for divorce in 2001, alleging that Mary was repeatedly unfaithful to him and treated him with perverse cruelty. George dies in 2002, three weeks before the divorce trial was set to commence. The divorce action abates immediately and Mary, as named executrix of George’s estate, files his will for probate. George’s adult children are incensed, but know that George never got around to changing his will. They consider contesting the bequests to Mary, but are advised that they have no grounds. Mary inherits a large portion of George’s estate, in all likelihood a much larger amount than she would have received in an equitable distribution award from the court had the divorce trial proceeded.
Defeating the Elective Share
When a spouse dies during a period of separation or in the midst of a divorce, the decedent’s estate plan prevails. If that plan is generous to the surviving spouse, a windfall could result. If the plan is not generous, or if the decedent changed the will after filing for divorce to disinherit the spouse, the surviving spouse is not without recourse. A spouse, including a nearly divorced one, is protected by law from being disinherited. A surviving spouse may “elect” against the estate and receive the “elective share,” which is the greater of one-third of the net estate or $50,000. Additionally, pursuant to changes made to the EPTL in 1992, the estate subject to the election was substantially enlarged to include many nonprobate assets, such as pension or profit-sharing accounts. These assets are thus subject to a divorcing or separated spouse’s right of election, even if the spouse was never named as a beneficiary.
It would seem that the surviving spouse simply goes from having a right to equitable distribution in divorce to the rights of an ordinary spouse in an estate, either as a beneficiary or as an “elector.” The elective share law contained in EPTL 5-1.2, however, has a fascinating twist. A surviving spouse can be denied the elective share if the spouse had abandoned the deceased spouse or failed to provide for the deceased spouse, despite a duty and ability to do so.
If these facts are present, although the divorce action may abate, the litigation will not. The inquiry switches from the supreme court to surrogates court, where a different judge determines whether the surviving spouse is entitled to the elective share. Proof of abandonment requires demonstrating that the surviving spouse had abandoned the decedent and that the abandonment continued until death. Abandonment is defined by law as one spouse leaving the marital home without any intention of returning, and without the consent of the other spouse. Proof of nonsupport may consist of demonstrating that the offending spouse had the means to contribute to the support of the other, but failed to do so, despite the other’s need. In Bennett [142 A.D.2d 578, 530 N.Y.S.2d 38 (2d Dept., 1988)], the husband was found to have lost his right to an elective share when he moved out of the marital residence several years before the wife’s death and never paid any rent despite the fact that she was evicted. Both abandonment and nonsupport were present.
New York State law says the abandonment must last for a period of at least one year to be grounds for a divorce. There is no minimum time requirement in order to deny the elective share, however. Other grounds for a New York divorce, such as cruel and inhuman treatment or adultery, are not available to defeat a surviving spouse’s right to elective share. Nonsupport, the second ground for defeating the elective share, is a ground for judicial separation in New York, but not for divorce.
Thus, under the New York framework, a surviving spouse may lose the right to equitable distribution and rights in the estate. Returning to the previous example, if George had changed his will and beneficiary designations after the commencement of a divorce action in order to completely disinherit Mary, Mary would still be entitled to notice of the probate of George’s new will, and would have the opportunity to inform the estate of her intention to take an elective share. George’s children, however, could contest and defeat her right to an elective share if they can show that Mary abandoned George or failed to support him despite a duty to do so. If the children prevail, Mary would receive nothing from George’s estate.
Planning for a Divorcing or Separated Couple
Clearly, the issue of estate planning must be discussed at the time of separation from a spouse or of commencing a divorce, and not be deferred until the situation concludes. The essential question is what should be done with her estate if she dies while still separated or before a divorce is final. The knee-jerk response may be to give the spouse nothing, but that may not be the most appropriate course of action.
Most estate plans are constructed not only for the benefit of the surviving spouse, but also for the children. Tampering with it to the detriment of the spouse may also create negative consequences for the children. These considerations are important in all divorce situations, but especially so in first marriages where the couple has children together. For example, many family-run LLCs and LLPs are established with both parents as general partners or one parent named as the successor general partner if the other dies. Often this is done to provide for a continuity of control and consistent management. Removal of a spouse from this position may result in a management vacuum, internecine fighting among the children, or loss of family control to an outsider.
In another situation, many irrevocable insurance trusts name the spouse and children as beneficiaries. In such a case, the individual may want to disinherit the spouse by refusing to fund the trust’s payment of the premiums, resulting in a cancellation of the policy. The spouse is harmed, as well as the children. The impact of loss of insurance on the overall estate must be considered, as must the ability of the insured to obtain new insurance due to current age, health, and cost factors. For this reason the current “spouse” is often named beneficiary instead of using a person’s name.
Additionally, loss of the unlimited marital deduction is a critical factor to consider. Pursuant to IRC section 2056, any amount, regardless of size, that one spouse transfers to the other at the time of death is free of transfer tax. The deferral and doubling of the unified credit features inherent in this statute make it a foundation of many estate plans. In general, by planning for the spouse to receive less upon death, the amount subject to immediate taxation increases dollar for dollar. If a spouse loses an elective share contest and receives nothing, then the entire estate could be subject to taxation at the time of death. The estate tax that would ordinarily be deferred until the death of the surviving spouse would be accelerated. Under the 2001 Tax Act, any action that accelerates the estate tax at this time can be considered foolhardy in the extreme because the unified credit is set to increase substantially over the next eight years, followed by complete repeal of the estate tax in 2010. In the current tax-planning climate, deferral of taxes through use of the unlimited marital deduction is more valuable than ever, as that deferral may result in no tax at all, should the surviving spouse live until 2010.
In these circumstances, the more appropriate issue may be whether the individual believes that, despite whatever differences may exist between the couple, the spouse would act to protect the children and preserve the assets for their benefit. If so, then the appropriate decision may be to leave the estate plan intact until the divorce is finalized.
Couples that are separated or in the midst of a divorce may want to consider the enhanced protection available through a qualified terminable interest property trust (QTIP). Such a trust provides that a portion of the estate will be placed in trust for the spouse as a sole lifetime beneficiary, with income payable annually for life. The grantor of the trust determines who shall receive the funds after the death of the spouse. Through this device, the surviving spouse cannot dissipate the assets and cannot change the ultimate beneficiaries of the corpus, but the deferral of tax desired through the unlimited marital deduction will still be achieved.
A spouse might still opt out of such a trust by claiming the elective share. To prevent this, the terms of the QTIP must be more attractive than the elective share, because a spouse can no longer establish an elective share trust. The QTIP must produce enough income to be either equal to or greater than the amount of income derived from the elective share. For example, if a individual’s estate is worth $1 million, the share would be equal to roughly $333,333. If a QTIP were funded with $500,000, however, that would produce substantially more income and present the survivor with a difficult choice. If the QTIP appoints a trustee who will not act to harm the surviving spouse, and the trustee is empowered to invade the principal in an emergency situation, then foregoing the elective share in favor of the QTIP may be very attractive.
When an individual wants to disinherit a spouse, a new will should be prepared and all beneficiary accounts should be changed to eliminate the spouse. To maximize the chances of prevailing in an elective share contest, the individual should develop a case for abandonment or lack of support against the other spouse, and include such claims in any action for divorce or separation. Often, such specific planning is not done. It is assumed that the parties will not contest the divorce and grounds will not have to be proved, or that the case will be settled before trial. An individual concerned about surviving until the conclusion of a divorce case should prepare for an elective share contest immediately.
Although injunctions are routinely granted in divorce actions against one or both spouses to prevent the disposition of property during the course of proceedings, that type of relief does not generally prevent a party from altering an estate plan. The law empowers the court to enjoin the disposition of property upon the premise that dissipating the property denies the court’s ability to deal with it at the time of equitable distribution. Because, by definition, equitable distribution is unavailable after one party dies, such an injunction would not likely be granted.
With the injunction device unavailable, such an individual should vigorously contest any allegation of abandonment in a divorce action and seek to obtain admissions from the other spouse that the abandonment was consensual or justified. Similarly, admissions should be sought that any nonsupport was consensual or based upon an inability to pay. These admissions can be obtained through the discovery devices normally allowed in a divorce action, such as depositions or interrogatories. Trying to prove these facts after death is substantially more difficult due to the Deadman’s Statute that generally prevents testimony against a decedent from being introduced.
©2006 The CPA Journal. Legal Notices
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