Pros/Cons of taxable accounts for both spouses

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teaman
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Pros/Cons of taxable accounts for both spouses

Post by teaman » Mon May 25, 2020 7:22 pm

Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses. Please note that I'm talking strictly about taxable accounts (not tax deferred/exempt).

It seems more like a bookkeeping hassle to me. From a TLH standpoint, it could be a double edged sword as one needs to ensure that the funds in both the accounts do not track the same index (i.e, not identical), at the same time, one could create two slightly different fund tracking accounts and do TLH.

How does it work from an asset protection (from lawsuits/creditors) perspective? Would the taxable account of one spouse be protected if lawsuits/claims etc. are filed on the other one, i.e; does it provide an additional safety net to the family?

What are the other pros/cons?

Edit: Add clarification for asset protection
Last edited by teaman on Mon May 25, 2020 7:40 pm, edited 2 times in total.

mhalley
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Re: Pros/Cons of taxable accounts for both spouses

Post by mhalley » Mon May 25, 2020 7:32 pm

I can’t see any reason to do it unless you are headed for divorce or had some money before you got married that you don’t want to commingle. One advantage of separate accounts is you might have broader beneficiary elections.
This article discusses some pros and cons.
https://www.fool.com/the-ascent/buying- ... -and-cons/
Last edited by mhalley on Mon May 25, 2020 7:39 pm, edited 2 times in total.

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anon_investor
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Re: Pros/Cons of taxable accounts for both spouses

Post by anon_investor » Mon May 25, 2020 7:34 pm

teaman wrote:
Mon May 25, 2020 7:22 pm
Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses. Please note that I'm talking strictly about taxable accounts (not tax deferred/exempt).

It seems more like a bookkeeping hassle to me. From a TLH standpoint, it could be a double edged sword as one needs to ensure that the funds in both the accounts do not track the same index (i.e, not identical), at the same time, one could create two slightly different fund tracking accounts and do TLH.

How does it work from an asset protection perspective? Does it provide a safety net?

What are the other pros/cons?
Maybe if the spouses want to handle their investments differently or there is a prenup and separate accounts help keep clean accounting?

absolute zero
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Re: Pros/Cons of taxable accounts for both spouses

Post by absolute zero » Mon May 25, 2020 8:35 pm

teaman wrote:
Mon May 25, 2020 7:22 pm
Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses. Please note that I'm talking strictly about taxable accounts (not tax deferred/exempt).

It seems more like a bookkeeping hassle to me. From a TLH standpoint, it could be a double edged sword as one needs to ensure that the funds in both the accounts do not track the same index (i.e, not identical), at the same time, one could create two slightly different fund tracking accounts and do TLH.

How does it work from an asset protection (from lawsuits/creditors) perspective? Would the taxable account of one spouse be protected if lawsuits/claims etc. are filed on the other one, i.e; does it provide an additional safety net to the family?

What are the other pros/cons?

Edit: Add clarification for asset protection
Are you willing to share what state you live in? Not all community property states are the same.

Luckywon
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Re: Pros/Cons of taxable accounts for both spouses

Post by Luckywon » Mon May 25, 2020 8:44 pm

One con is that in a community property state the separate property of a surviving spouse does not get a step up in capital gains basis upon the death of one spouse. Community property and inherited property do.

To be clear, if John is married to Mary and each has separate property, upon John's death Mary will get a step up in basis on property inherited from John, but will not get a step up in basis on her own property. If they have community property, there will be a step up on on all community property, not just half of the community property.

One tax saving maneuver that could be contemplated is that if John is terminally ill, Mary could gift her separate property to John or transmute it to community property, by placing it in a JTWROS account. She would then get a step up on this property upon John's death.

Here's a reference discussing this:

https://www.cpajournal.com/2017/08/18/g ... tep-basis/

The above is my understanding of the law in California, a community property state. I'm not an attorney so don't take this as gospel or legal advice.

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FIREchief
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Re: Pros/Cons of taxable accounts for both spouses

Post by FIREchief » Mon May 25, 2020 11:14 pm

Luckywon wrote:
Mon May 25, 2020 8:44 pm
One con is that in a community property state the separate property of a surviving spouse does not get a step up in capital gains basis upon the death of one spouse. Community property and inherited property do.
I don't believe that separate accounts would necessarily constitute separate property. In fact, some folks execute community property declarations that declare all of their property community property, for such things a step up basis. I believe that such a declaration would take precedence over, for example, how an account or other asset is titled. See my signature.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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celia
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Re: Pros/Cons of taxable accounts for both spouses

Post by celia » Mon May 25, 2020 11:43 pm

teaman wrote:
Mon May 25, 2020 7:22 pm
Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses.
If the assets are in a joint taxable account in a community property state, the assets get a step-up in value at the death of the first spouse. If the survivor then sells an asset in the account soon after, there would be very little capital gain or loss.

When the second spouse dies, the assets get a step-up in value again.

Luckywon
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Re: Pros/Cons of taxable accounts for both spouses

Post by Luckywon » Mon May 25, 2020 11:58 pm

FIREchief wrote:
Mon May 25, 2020 11:14 pm
Luckywon wrote:
Mon May 25, 2020 8:44 pm
One con is that in a community property state the separate property of a surviving spouse does not get a step up in capital gains basis upon the death of one spouse. Community property and inherited property do.
I don't believe that separate accounts would necessarily constitute separate property. In fact, some folks execute community property declarations that declare all of their property community property, for such things a step up basis. I believe that such a declaration would take precedence over, for example, how an account or other asset is titled. See my signature.
Good point FIREchief, and I can confirm what you say is correct-I once spoke with E*trade's and Schwab's estate teams and asked whether a step up in the basis they reported could be requested under these circumstances. The answer from both was that this could be done, but documents would have to be provided demonstrating that the account was community property. Frustratingly, neither could give specifics on what documentation would be accepted. They both stated it would be reviewed by their estate department. Of course, one can still claim the step up on one's returns, overriding the cost basis reported by the custodian. Personally, this is something I'd like to avoid doing and if my intent was that an account was community property, I would hold it titled in an either a JTWROS account or a community property account WROS (to avoid probate, which could become necessary if property is held in a community account without ROS).

I should have qualified therefore that the loss of step up I was referring to applies when one truly intends that the property in the account is separate. This is the case for myself, as most of my separate property is titled to my RLT, including investments accounts and my home. Under the terms of my Trust, there would be no possibility of my claiming this property was community property. However, I have been advised that I could at any time transmute property in a trust account to community property by simply transferring it to a community or JTWROS account. I haven't looked into how one would transmute real property to community property but I would imagine it would not be difficult.

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teaman
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Re: Pros/Cons of taxable accounts for both spouses

Post by teaman » Tue May 26, 2020 9:59 am

celia wrote:
Mon May 25, 2020 11:43 pm
teaman wrote:
Mon May 25, 2020 7:22 pm
Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses.
If the assets are in a joint taxable account in a community property state, the assets get a step-up in value at the death of the first spouse. If the survivor then sells an asset in the account soon after, there would be very little capital gain or loss.

When the second spouse dies, the assets get a step-up in value again.
Cool, does that mean that the the basis wouldn't step up upon the death of one spouse if there were two separate accounts for husband and wife?

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teaman
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Re: Pros/Cons of taxable accounts for both spouses

Post by teaman » Tue May 26, 2020 10:00 am

Great points, everyone! Please keep them coming.

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teaman
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Re: Pros/Cons of taxable accounts for both spouses

Post by teaman » Tue May 26, 2020 10:06 am

mhalley wrote:
Mon May 25, 2020 7:32 pm
I can’t see any reason to do it unless you are headed for divorce or had some money before you got married that you don’t want to commingle. One advantage of separate accounts is you might have broader beneficiary elections.
This article discusses some pros and cons.
https://www.fool.com/the-ascent/buying- ... -and-cons/
Thanks. I'm interested in this part of the article regarding the downsides of joint accounts:

"Joint accounts are often subject to claims from creditors of either accountholder. That can be problematic in cases involving an account in which only one accountholder really deposits money into the account, because the debts of the other can wipe out the account balance."

Does it mean that separate investment accounts would keep one spouse's account immune from lawsuits/credits filed against the other spouse? If so, doesn't it make more sense to keep them separate (instead of creating a joint account or having a single account on one person's name but funding from both spouse's income) for asset protection?

Luckywon
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Re: Pros/Cons of taxable accounts for both spouses

Post by Luckywon » Tue May 26, 2020 10:20 am

teaman wrote:
Tue May 26, 2020 9:59 am
celia wrote:
Mon May 25, 2020 11:43 pm
teaman wrote:
Mon May 25, 2020 7:22 pm
Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses.
If the assets are in a joint taxable account in a community property state, the assets get a step-up in value at the death of the first spouse. If the survivor then sells an asset in the account soon after, there would be very little capital gain or loss.

When the second spouse dies, the assets get a step-up in value again.
Cool, does that mean that the the basis wouldn't step up upon the death of one spouse if there were two separate accounts for husband and wife?
At the risk of sounding repetitive, as I was trying to answer this in my previous posts, and not with the intent of deterring anyone else from offering an opinion, I'll summarize my layman's understanding of this:

John is married to Mary. They live in California, a community property state. They have four accounts between them:

John's account which is titled in his name and contains an inheritance which John and Mary consider separate property.
John's account which is titled in his name but contains marital funds which John and Mary consider community property. (Perhaps it was funded from income earned after John and Mary were married.)
Mary's account which is titled in her name and contains an inheritance which she considers separate property.
A account titled JTWROS.

Mary dies.

John (or anyone else who inherits them) will get a step up in funds from Mary's separate account.
John will get a step up in all property in the joint account.
John will get a step up in all funds in his separate account titled in his name but containing community property. He can get this by asking the custodian to reset the cost basis. If the custodian is not cooperative, he can still claim the step up on the applicable tax filing.
John will not get a step up in the account which is titled in his name and contains an inheritance which he considers separate property. If he had transferred the funds in this account to the joint account before Mary died, he would get the step up.

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celia
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Re: Pros/Cons of taxable accounts for both spouses

Post by celia » Tue May 26, 2020 12:54 pm

Luckywon wrote:
Tue May 26, 2020 10:20 am
At the risk of sounding repetitive, as I was trying to answer this in my previous posts, and not with the intent of deterring anyone else from offering an opinion, I'll summarize my layman's understanding of this:

John is married to Mary. They live in California, a community property state. They have four accounts between them:

John's account which is titled in his name and contains an inheritance which John and Mary consider separate property.
John's account which is titled in his name but contains marital funds which John and Mary consider community property. (Perhaps it was funded from income earned after John and Mary were married.)
Mary's account which is titled in her name and contains an inheritance which she considers separate property.
A account titled JTWROS.

Mary dies.

John (or anyone else who inherits them) will get a step up in funds from Mary's separate account.
John will get a step up in all property in the joint account.
John will get a step up in all funds in his separate account titled in his name but containing community property. He can get this by asking the custodian to reset the cost basis. If the custodian is not cooperative, he can still claim the step up on the applicable tax filing.
John will not get a step up in the account which is titled in his name and contains an inheritance which he considers separate property. If he had transferred the funds in this account to the joint account before Mary died, he would get the step up.
I disagree. Since these last two accounts are titled the same, they should treated the same and get no step-up at Mary’s death.

If you want the account with marital assets to be considered joint, it should be titled joint, just as the ‘joint’ account is. Who knows in your scenario if Mary may have gifted the assets in the ‘marital assets’ account to John? Or Mary had similar wages and spent it all as it came in? Now John is trying to get it both ways (have your cake and eat it too, as they say).

Note that the person settling the estate should Mary die first and John has cognitive decline or is in a nursing home most likely will just go with the account title as the custodian would do. If John really wants to get a step-up on the marital assets account with only his name, it is much easier to fix this now than later. Right now, it is trivial. But if heirs or a blended family or a lawyer objected, It won’t be as simple as to ‘fix it’ on his taxes.

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celia
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Re: Pros/Cons of taxable accounts for both spouses

Post by celia » Tue May 26, 2020 1:19 pm

teaman wrote:
Tue May 26, 2020 9:59 am
Cool, does that mean that the the basis wouldn't step up upon the death of one spouse if there were two separate accounts for husband and wife?
Correct. Only the separate account of the deceased would get a step-up.

To make it clearer, look at our trust (in California). Retirement accounts are not in it. But our house is and our joint accounts are. We each also have separate Vanguard accounts for inheritances we each have received. We’ve kept these separate so we could each have beneficiaries favorable to our side of the family pre-marriage.

These separate accounts are titled:
‘<trust>, Separate property of <person’s name>’

When one of us dies, everything will get a step-up in basis except for the survivor’s separate account. Our lawyer emphasized this and we are fine with it.

Luckywon
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Re: Pros/Cons of taxable accounts for both spouses

Post by Luckywon » Tue May 26, 2020 1:28 pm

celia wrote:
Tue May 26, 2020 12:54 pm
Luckywon wrote:
Tue May 26, 2020 10:20 am
At the risk of sounding repetitive, as I was trying to answer this in my previous posts, and not with the intent of deterring anyone else from offering an opinion, I'll summarize my layman's understanding of this:

John is married to Mary. They live in California, a community property state. They have four accounts between them:

John's account which is titled in his name and contains an inheritance which John and Mary consider separate property.
John's account which is titled in his name but contains marital funds which John and Mary consider community property. (Perhaps it was funded from income earned after John and Mary were married.)
Mary's account which is titled in her name and contains an inheritance which she considers separate property.
A account titled JTWROS.

Mary dies.

John (or anyone else who inherits them) will get a step up in funds from Mary's separate account.
John will get a step up in all property in the joint account.
John will get a step up in all funds in his separate account titled in his name but containing community property. He can get this by asking the custodian to reset the cost basis. If the custodian is not cooperative, he can still claim the step up on the applicable tax filing.
John will not get a step up in the account which is titled in his name and contains an inheritance which he considers separate property. If he had transferred the funds in this account to the joint account before Mary died, he would get the step up.
I disagree. Since these last two accounts are titled the same, they should treated the same and get no step-up at Mary’s death.

If you want the account with marital assets to be considered joint, it should be titled joint, just as the ‘joint’ account is. Who knows in your scenario if Mary may have gifted the assets in the ‘marital assets’ account to John? Or Mary had similar wages and spent it all as it came in? Now John is trying to get it both ways (have your cake and eat it too, as they say).
Feel free to disagree with the law, but it remains the law. Here is an article from California CPA Education Foundation which directly contradicts what you state and affirms that holding community property in an individually titled account does not preclude getting the step up, although it imposes a burden of proving it is community property.

https://www.calcpa.org/public-resources ... f-a-spouse

This is the content of that link:

I live in California, a community property state. I have a brokerage account that holds various securities that were acquired during the years of our marriage, but my wife was never listed on the accounts. She died recently, so do I still get a step-up on the basis of the accounts?

Federal tax code section 1014(b)(6) provides that community property assets step up 100 percent in basis at the death of one spouse (even though the other spouse survives). Example: Stock worth $100 at date of death with a basis of $20 steps up to $100 basis upon date of death. This is distinguished from "common law" states (non-community property states) where step up occurs to the extent of the decedent's ownership (e.g., basis of one-half of property held in joint tenancy or tenancy-by-the-entirety step ups on death of one spouse with other spouse surviving). Example: Stock worth $100 at date of death with basis of $20 has a new basis of $60 at date of death, which is $50 decedent's share (one-half of $100) plus $10 survivor's share (one-half of $20).

The answer to your question is likely yes, you will get a 100 percent step up in basis, as your facts indicate that the securities are community property. The general rule is that property acquired during marriage that is not inheritance or gift is considered community property. Assuming you did not inherit the securities or receive them as a gift, they are community property.

Yours is a challenge of proof. To prove 100 percent basis step-up to IRS, you will have to demonstrate that you did not bring the securities into the marriage (which would be separate property) and that they are not inheritance or gift. In the alternative, you would need to trace the securities' purchase back to funds that were community funds (e.g., wages or income from self-employment). Also, if the two spouses adopted a "spousal property agreement" (this often occurs when husband and wife adopt a joint estate plan, wills, living trust, etc.), the spousal property agreement will often declare that all assets are community property. Note: wages and self-employment income of a spouse in a community property state are community property.

Luckywon
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Re: Pros/Cons of taxable accounts for both spouses

Post by Luckywon » Tue May 26, 2020 2:24 pm

celia wrote:
Tue May 26, 2020 1:19 pm
teaman wrote:
Tue May 26, 2020 9:59 am
Cool, does that mean that the the basis wouldn't step up upon the death of one spouse if there were two separate accounts for husband and wife?
Correct. Only the separate account of the deceased would get a step-up.
Disagree with this. Teaman, If the separate accounts were funded with marital property, for example with earnings from post marital income, both separate accounts would be eligible for a step up. Unfortunately you are getting conflicting opinions from me and Celia. See the link from the California CPA Education Foundation I cited above and speak with qualified counsel or CPA and make up your own mind, but my opinion is that if for some reason you decide to hold some marital funds (which are agreed to be and can be proven community property) in an individually titled account in your name, you are eligible for a step up in that account upon the death of your spouse.

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HueyLD
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Re: Pros/Cons of taxable accounts for both spouses

Post by HueyLD » Tue May 26, 2020 7:35 pm

teaman wrote:
Mon May 25, 2020 7:22 pm
Assuming an individual lives in a community property state, I'm trying to understand what are the benefits of setting up a taxable account for both spouses. Please note that I'm talking strictly about taxable accounts (not tax deferred/exempt).

It seems more like a bookkeeping hassle to me. From a TLH standpoint, it could be a double edged sword as one needs to ensure that the funds in both the accounts do not track the same index (i.e, not identical), at the same time, one could create two slightly different fund tracking accounts and do TLH.

How does it work from an asset protection (from lawsuits/creditors) perspective? Would the taxable account of one spouse be protected if lawsuits/claims etc. are filed on the other one, i.e; does it provide an additional safety net to the family?

What are the other pros/cons?
Which state? Different community property states have different rules.

What are your primary concerns? Bookkeeping, asset division in a divorce, or basis step up and asset distribution upon the death of one spouse?

Topic Author
teaman
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Re: Pros/Cons of taxable accounts for both spouses

Post by teaman » Wed May 27, 2020 11:56 am

Thanks LuckyWon, for taking the time to reply.

HueyLD,

(Sorry, am unable to disclose the state of residence at this time). If need be, we can skip the discussion on the assets that are distributed differently from one community property state to the other.

I can think of the following options for funding taxable accounts in a brokerage:
1. Two separate individual accounts
2. One joint account where both working spouses contribute
3. Single account on one spouse's name to which both spouses contribute

I'd assume that the each option above will likely have a different answer for each of the categories below.

My order of priority is:
1. Asset protection of one spouse's accounts from creditors/lawsuits filed against the other spouse
2. Step-up in the basis upon the death of one spouse
3. Bookkeeping

Thanks

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