II. Community and Marital Property Law: The Basics
A. Fundamental Principles
1. Community Property States
a.
Eight states follow a community property system (Arizona, California,
Idaho, Louisiana, New Mexico, Nevada, Texas, and Washington) and one
follows a marital property system (Wisconsin).
(1) Wisconsin's marital property system is a form of community property, and is treated as such for federal tax purposes.
(2) The community property system also applies in the territory of Puerto Rico.
b.
In addition, the State of Alaska has adopted an "elective" community
property system for Alaska residents and for assets transferred to an
Alaska trust. The Alaska Community Property Act, effective in 1998,
allows a married couple, who are both residents of Alaska, to elect to
classify property as community property. In addition, non-resident
spouses may transfer property to an Alaska community property trust,
and it will be characterized as community under Alaska law. The Alaska
community property trust has many of the same characteristics as a
community property agreement. The spouse may agree on: (1) the
spouse's relative rights and obligations in the property,
notwithstanding when and where the property is acquired and located;
(2) the management and control of the property; (3) the disposition of
the property on dissolution, death or another event; (4) the choice of
law governing the interpretation of the instrument; and (5) any other
matter that affects the property and does not violate public policy.
Alaska Statutes § 34.77.090(d), .100(d). Additional provisions exist
to protect the rights of creditors, as well as bona fide purchasers
dealing with the spouses. Alaska Statutes § 34.77.070, .080.
Furthermore, a trust may not be enforced against a spouse who proves
the instrument was unconscionable when made, was not executed
voluntarily, or was made without a fair and reasonable disclosure of
the assets and financial obligations of the other spouse. The Act also
imposes a duty of "good faith and fair dealing" on the spouses.
A number of additional requirements exist in order to create a nexus
with Alaska for nonresidents. At least one trustee must be an
individual domiciled in Alaska or an Alaska trust company or bank.
Other co-trustees may be nonresidents and may include the spouses. The
Alaska trustee's powers must include maintaining records for the trust
and the preparation of any income tax returns that must be filed by the
trust.
There is some question as to how the IRS will respond to such a
system. The Clinton Administration's Revenue Proposals issued in
February, 1999 included a proposal eliminating I.R.C. § 1014(b)(6)
basis adjustment of the one-half community property owned by the
surviving spouse. Such a proposal would eliminate one of the
significant benefits to taxpayers available in a community property
system. The Clinton Administration's main concern was the unequal
treatment of residents of community property states as compared to
non-community property states. The Bush Administration does not seem
to share these concerns because this issue has not been addressed in
President Bush's revenue proposals to date.
In general, Alaska law follows the Uniform Marital Property Act. For
more information, see Shaftel and Greer, An Introduction to Alaska's
Optional Community Property System, Estate Planning Magazine (March,
1999).
c. Wisconsin is the only state that has adopted UMPA (but as noted
above, Alaska's optional community property system was patterned after
UMPA). According to the Uniform Law Commissioners, other Midwestern
states that have unsuccessfully attempted to adopt UMPA include:
- Illinois in 1985, 1986 and 1994
- Indiana in 1985, 1986, 1987, 1988, 1989, 1990, 1991, and 1993
- Iowa in 1985
- Minnesota in 1985, 1986, 1987, and 1989
- Michigan in 1984
2. Definition of Community Property
a.
Community property is generally defined in the negative. A married
couple domiciled in a community property state is presumed to own all
of their property as community or marital property, regardless of
titling, absent:
(1) an agreement to the contrary (formalities differ from state to state); or
(2) proof that the property was:
(a) brought into marriage by either spouse;
(b) given to either spouse;
(c) inherited by either spouse; or
(d) a spouse's separate property before the couple became domiciled in
a community or marital property state.
3. Generally, each spouse owns an undivided one-half interest in each item of community or marital property.
4. Important Caveat
a.
Community or marital property refers more to a concept of property
interests than to any one state's application of that concept through
its property law. While many of the generalizations in this outline
apply to most of the community property states, the law of each
individual state can vary considerably. To understand the property
rights of migrant clients, the common law state attorney must refer
specifically to the law of the community property state from which her
clients have moved. Contacting an attorney in the community property
state may be particularly helpful in this regard.
B. Classification of Community or Marital Property
1. Classification of property is of great significance. It determines:
a. Rights of ownership
b. Rights and duties of management and control
c. Rights to make lifetime gifts
d. Rights of disposition at death
2. The Time of Acquisition Rule
a.
Generally, in all community or marital property states, the separate or
community character of an asset is determined at the time the asset is
acquired. However, as discussed more fully below, in the absence of a
private agreement between the spouses, subsequent events or actions may
alter that character.
b. Generally, under
the time of acquisition rule, if property is acquired by a spouse,
while married and while domiciled in a community property state, and is
not acquired by gift or inheritance, it is presumed to be community
property.
c. The general rule is that in classifying an asset as separate or
community property, title is not controlling. Rather, the time of
acquisition and the source of funds (or credit) used in asset's
acquisition determines whether the asset belongs to the community or is
the separate property of one of the spouses.
(1)
In Wisconsin, which adopted a marital property regime relatively
recently, classification depends heavily on whether assets were
acquired before or after "the determination date."
(a) The determination date is the last to occur of:
(i) marriage
(ii) the date of establishment of domicile by both spouses in Wisconsin
(iii) January 1, 1986 (the date the Wisconsin Marital Property Act became effective).
(b)
Generally, property acquired by a married person, other than by gift or
inheritance, after the determination date, is marital property.
(c) Generally, separate property is traceable property brought into the
marriage, or acquired through gift or inheritance.
(d) Generally, property that would have been marital property had the
Marital Property Act applied at the time of acquisition is deferred
marital property (see explanation below at 3).
3. Quasi-Community Property or Deferred Marital Property
a.
Some states create a category for a spouse's property acquired in
another state that would have been classified as community property if
acquired under similar circumstances while the couple was domiciled in
that state.
b. This classification is
designed to plug a gap in the protection of spouses against
disinheritance by providing an elective share to the surviving spouse.
The gap is caused by the interplay of two conflicts of law rules. The
first is that assets acquired by a spouse while the couple was
domiciled in a common law state are that spouse's separate property.
The second is that the disposition of property at death is controlled
by the law of the decedent's domicile at death.
(1)
Example: H and W marry in New York and accumulate an estate from H's
salary. If H and W continued to live in New York, W would be
protected against disinheritance by the New York elective share
statute. But if instead the couple moves to California, and H dies
while domiciled there, under conflict of laws rules California law
controls the disposition of his property at death. As in all community
property states, in California each spouse has an unrestricted power of
disposition over their property. Since under conflict of laws rules
H's New York salary (and the proceeds therefrom) is his separate
property, H has an unrestricted power of disposition of the entire
estate, and can now disinherit W.
c.
The gap is filled by the concept of quasi-community property or
deferred marital property. The acquiring spouse has the power of
lifetime and testamentary disposition over only one-half of the quasi
or deferred property. Through intestacy, all of the quasi or deferred
property passes to the surviving spouse. However, if the nonacquiring
spouse predeceases, he or she has no power of disposition over these
assets.
4. Characterization of Particular Assets
a. Earnings
(1) All earned income of either or both spouses is community property. This includes fees, salaries, wages, and bonuses.
b. Income from separate property
(1)
Income from separate property is separate property in five states
(Arizona, California, New Mexico, Nevada, and Washington) and community
property in four states (Idaho, Louisiana, Texas, and Wisconsin).
(a)
Example: In Wisconsin, dividends or Subchapter S distributions made
with respect to stock titled in the husband's name alone are owned
one-half by the wife, regardless of whether the stock is community or
separate property.
c. Income from community property
(1) Income from community property is community property in all community property states.
d. Property acquired with community property
(1)
Property acquired with community property, in whole or in part, is
community property in all community property states, unless the
non-community property component can be traced out (see discussion
below at 5a.).
e. Life insurance
(1)
Life insurance ownership depends on both the state and the type of
insurance. In most states, ownership of term insurance depends on the
source of payment for the premium in the year of the decedent's death.
Cash value life insurance ownership varies from state to state.
(a) In Wisconsin, life insurance is subject to special classification.
(i) The marital component of life insurance in Wisconsin begins with
the first premium paid with marital property, regardless if separate
property is used for payments thereafter.
(b)
For a discussion of the general apportionment of proceeds between
separate and community based upon the percentage of premiums paid with
each, see Polk v. Polk, 39 Cal. Rptr. 824 (1st Dist. Ct. App. 1964); Field v. Bank of America National Trust, 100 Cal. App. 2nd 311, 223 P. 2nd 514 (2nd Dist. 1950).
f. Deferred Employee Benefits
(1) In all community property states, retirement benefits are part
separate property and part community property, in proportion to the
contributions to the plan before marriage and the contributions to the
plan during marriage. In some community property states, the
allocation is based upon actual contributions to the plan before and
after the marriage. In most states (e.g., Wisconsin), the allocation
is based upon number of months of participation before and after
marriage.
(a)
Example: H began working for Miller Brewing Co. in Wisconsin in 1985.
In 1990, he married W. In 1994, H and W moved to Vermont. In 1995, H
died, and a lump sum payment of $500,000 was made to W. $250,000 is
H's separate property; $250,000 is H's and W's community property.
(b) In Wisconsin, employee benefits are part separate property and part
community property, in proportion to contributions to the plan before
and after the determination date.
(2)
The Supreme Court recently held that ERISA preempts state community
property law to the extent that state law grants testamentary
disposition rights with respect to an ERISA-covered employee benefit
plan which are inconsistent with ERISA. Boggs v. Boggs, 117 S.Ct. 1754 (1997).
(3) In most community property states, if the non-employee spouse
predeceases the employed spouse, the community property interest of the
non-employee spouse in the deferred employee benefits of the employed
spouse terminates at the death of the non-employee spouse.
5. Special Rules for Classification
a. Tracing
(1)
Assets acquired during marriage with separate funds, or with the
proceeds of sale of a separate asset, are separate property. However,
to maintain their separate character, the assets must be clearly
traceable as separate property. As a practical matter, this is very
difficult, although not always impossible.
(a)
Example: W, married and domiciled in Wisconsin, is given $20,000 in
bonds by her grandparents. She later sells the bonds and uses the
proceeds to buy a lot for a cottage. Although the lot was acquired
during marriage and was not itself acquired by gift or inheritance, the
lot is W's separate property because it was purchased with separate
funds.
b. Commingling
(1)
In all community property states there is a presumption that all
property is community property. The presumption is particularly strong
when separate and community property funds have been commingled. If
adequate records are not kept, separate property may lose its identity
because of commingling. If commingling makes tracing the separate
property impossible, it will become community property.
(a)
Example: Same facts as above, except that prior to purchasing the lot,
W sells the bonds and places the proceeds in her pre-existing mutual
fund, which she has purchased with $5,000 of her income earned during
marriage. No record is kept to segregate the $20,000 of separate
property. The separate property has been mixed with community
property, and is now community property. When W sells $20,000 of the
mutual fund and uses the proceeds to purchase the lot, the lot is
community property.
(b) Example: W,
domiciled in a community property states, receives a check for $100
from her parents for her birthday, and deposits it in her and her
husband's joint bank account, which thereafter holds $2,000. During
the next six months, H and W deposit $5,000 from their earnings in the
account, and withdraw $6,500 to make purchases and pay bills. The
account earns $25 in interest. If W cannot show that the remaining
$525 includes her $100 of separate property, the funds have been
commingled and are community property.
(c) Example: Harold Bunker (H), domiciled in Wisconsin, owns 100 shares
of stock (i.e., 100% of the outstanding stock) in Bunker Corp. He
formed the corporation before his marriage to Wilma Bunker (W). From
time to time after his marriage, he added additional capital to the
corporation. This additional capital could be in the form of cash
returned to the business in lean years (after taken out in good years
in the form of salary, bonuses, and fees), etc. If the additional
capital was community property, separate and community property have
been commingled, causing all of the stock to become community property.
c. Pre- or Post-Nuptial Agreements
(1)
Separate property practitioners should be aware that in many cases
clients moving to their states from community property states will have
classified their assets by agreement.
(a)
Example: In 1998, H and W, each previously married, and formerly
domiciled in Louisiana, move to New York. After their marriage in
Louisiana in 1988 and prior to their move to New York, H purchased 500
shares of stock A with his earnings. Under Louisiana community
property law, all 500 shares of stock A would be community property.
However, prior to marriage, H and W entered a valid pre-nuptial
agreement which classifies the earnings of each spouse as separate
property. Stock A is H's separate property.
(2)
The rules applicable to pre- and post-nuptial agreements vary from
state to state. However, most states have rules similar to those in
the Uniform Premarital Agreement Act.
(3) Uniform Premarital Agreement Act (UPAA) States
(a)
The UPAA has been adopted in the following states: Arizona, Arkansas,
California, Connecticut, Delaware, District of Columbia, Hawaii, Idaho,
Illinois, Indiana, Iowa, Kansas, Maine, Montana, Nebraska, Nevada, New
Jersey, New Mexico, North Carolina, North Dakota, Oregon, Rhode Island,
South Dakota, Texas, Utah, Virginia and Wisconsin.
(4) Substantive provisions of the UPAA
(a) Formalities
(i) A premarital agreement must be in writing and be signed by both parties.
(b) Parties to a premarital agreement may contract with respect to:
(i)
the rights and obligations of each of the parties in any of the
property of either or both of them whenever and wherever acquired or
located;
(ii) the right to transfer in any way, or otherwise manage and control property;
(iii) the disposition of property upon separation, marital dissolution,
death, or the occurrence or nonoccurrence of any event;
(iv) the modification or elimination of spousal support;
(v) the making of a will, trust, or other instrument to carry out the provisions of the agreement;
(vi) the ownership rights in and disposition of the death benefit from a life insurance policy;
(vii) the choice of law governing the construction of the agreement;
(viii) any other matter, including their personal rights or
obligations, not in violation of public policy or criminal law.
(c) the right of a child to support may not be adversely affected by a premarital agreement.
(d) A premarital agreement becomes effective upon marriage.
(e) A premarital agreement is not enforceable if the opposing party proves that:
(i) the agreement was executed involuntarily; or
(ii) the agreement was unconscionable when executed, and before execution, that party:
a) was not provided a fair and reasonable disclosure of the property and obligations of the other party; and
b) did not voluntarily and expressly waive, in writing, such disclosure; and
c) did not have, or reasonably could not have had, an adequate
knowledge of the property or financial obligations of the other party.
(5)
All community property states recognize the validity of pre-nuptial
agreements, although only four have adopted the UPAA. The remaining
states have similar rules.
(6) All
community property states except Washington require that the agreement
be in writing, signed by both parties, and acknowledged in the manner
in which deeds are acknowledged in the individual state.
d. Community Property Agreements
(1) Similarly, spouses may have entered a community property agreement during marriage.
(a)
Example: H and W, formerly domiciled in Wisconsin, become domiciled in
Florida. Prior to their marriage, W inherited marketable securities
having a cost basis of $50,000. Just before leaving for Florida, W's
securities portfolio had a fair market value of $3 million. While
living in Wisconsin, H and W entered into a valid community property
agreement that provided all of W's marketable securities would be
marital property. After living in Florida for several years, W's
marketable securities portfolio had a fair market value of $3.6
million. H died. W received a new cost basis in the entire portfolio
of $3.6 million. W liquidates the entire portfolio in order to better
diversify her holdings. W receives $3.6 million with no capital gain
taxes.
(2) Commonly, these agreements provide that:
(a) all or some portion of existing property is community property
(i) perhaps with specific exceptions
(b) all or some portion of property acquired in the future is community property
(c) all survivorship community property vests with the surviving spouse at the death of the first spouse
(d) the agreement does not apply with respect to divorce
C. Powers Dependent Upon Classification
1. Power to Manage and Control Property
a.
Managerial rights vary from state. In most community or marital
property states, either spouse alone may manage the community or
marital property to some extent (title is sometimes important in this
respect), and may fully dispose of their separate property.
(1)
Managerial rights are not usually relevant to a lawyer in a common law
jurisdiction dealing with imported community property. Once the nature
of the spouses' ownership interests are recognized under community
property principles, common law jurisdictions apply their own rules and
policies in determining creditor's rights and the spouses' powers to
manage their assets during lifetime.
2. Power to Make Lifetime Gifts
a.
In some community property states, a gratuitous transfer of community
property without the other spouse's joinder or consent can be set aside
by the spouse during the donor spouse's lifetime or (to the extent of
one-half of the property) on the donor's death. In other states, the
same rule applies, but with a de minimis exception for small transfers.
3. Testamentary Disposition Rights
a. In all community and marital property states, each spouse has an unrestricted right to dispose of their separate property.
b. Each spouse has the unrestricted power of testamentary disposition
of his or her one-half interest in community or marital property,
regardless of the order of death of the spouses.
(1)
Example: H dies leaving "all my property" to C. All of H's separate
property and his one-half interest in community property go to C.
c.
In states that recognized quasi-community or deferred marital property,
the surviving spouse may have an elective share of one half of that
property.property.
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