This article summarizes the recent Idaho law changes related to joint tenancy (owner) investment accounts held by lawfully married persons with rights of survivorship.
A joint tenancy account with right of survivorship allows married persons to own the account with equal rights to the access and management of account funds during their joint lives. Upon the death of one of the account owners, title and ownership of the account passes to the surviving owner and usually without the need for probate. Probate is the court-supervised process of re-titling a decedent’s assets to his or her beneficiaries and a right of survivorship account can avoid probate.
Although a joint account with right of survivorship is effective at avoiding probate, it can at times create an income tax issue for the surviving owner of the account. This income tax issue arises from what is called income tax basis. Basis is the value of an asset by which taxable gain or a loss is determined when an asset is sold. For example, if you bought stock for $20,000, that is your basis and if you sold it while living for $30,000, you would have $10,000 of taxable gain ($30,000 amount realized from lifetime sale less $20,000 basis).
Federal and Idaho tax law generally provides that when a person dies, his or her basis in the assets owned at death is adjusted to the fair market of the assets as of the date of death. For appreciated assets, this usually results in an increase, or “step-up”, in basis at death.
Using the stock example, if you were single and passed away owning the stock which was valued at $30,000 at your passing, the low $20,000 basis you had in the stock would be adjusted to $30,000 in the hands of your estate and/or beneficiaries and they would have no taxable gain if they sold it for $30,000 ($30,000 amount realized from sale less $30,000 basis). If the stock increased from $30,000 at your death to $31,000 on the sale date, then the taxable gain would be $1,000. If the basis in the stock had been $35,000 before your death and had a value of $30,000 at your death, then the basis would be “stepped down” to $30,000 in the hands of your estate and/or beneficiaries.
Section 1014(b)(6) of the Internal Revenue Code generally provides that for married persons in a community property state like Idaho, when one spouse dies the tax basis in his or her half share of community property assets (other than a special class of property, such as most retirement accounts), as well as the basis of the half share of his or her surviving spouse in those same community assets, is adjusted to the fair market value of the assets as of the date-of-death. This community property rule allows for basis adjustment of 100 percent of the community property assets and not just the decedent’s half of the assets.
Applying the at-death basis adjustment rules to traditional joint tenancy accounts with rights of survivorship, when one spouse dies, even if the account consists of community property, often the basis of only the decedent’s half of the account is adjusted.
This was the case in Idaho prior to July 1 because under state law, the married couple could not legally title the survivorship account as a community property account. As a result, when one spouse died, the investment firm handling the account often was not willing to treat the account as a community property account and adjust the basis to both spouses’ interests in the account. This result can leave the surviving spouse with a split basis in the account – one half of the account has a basis equal to the fair market value of the assets as of the deceased spouse’s death and one half has a different basis (which would be lower in the case of appreciated assets) representing the survivor’s interest in the account.
New legislation that officially recognizes community property accounts with rights of survivorship became effective in Idaho on July 1. Under the new law, married persons’ rights of survivorship investment accounts can now be clearly titled as community property accounts with rights of survivorship, which should result in a basis adjustment to both spouses’ half interests in the account when the first spouse dies.
Having the basis adjustment apply to the entire account should result in income tax savings to the surviving spouse if assets in the account are sold. This assumes that the assets in the account have appreciated and not depreciated. This issue has increased importance because brokerage houses now are required to report to the Internal Revenue Service the income tax basis of covered shares (those acquired on or after January 1, 2012).
With the new law now in place, we encourage married couples to review the titling of their joint tenancy with rights of survivorship investment accounts and consider the benefits of making them community property with rights of survivorship accounts when the assets in the account have appreciated.
Jason Melville is an attorney at Hawley Troxell and practices in the areas of business, corporate tax, and estate planning. John McGown, also at Hawley Troxell , practices general tax, estate planning, tax disputes, tax-exempt organizations, and probate law. He is one of a handful of individuals nationwide to be certified as a qualified mediator for multistate tax disputes under the Multistate Tax Commission’s Alternate Dispute Resolution Program and has served as outside counsel to the Idaho Community Foundation, Inc. for over 20 years.