Property Rights of a Disinherited Spouse

By Vicki Kasomenakis and Denis Brody

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The federal estate tax also includes a marital deduction for property passing to a surviving spouse. When reviewing an estate, a tax advisor must determine what assets will pass to an individual’s surviving spouse upon the death to capitalize on the marital deduction. Determining the marital deduction may be important because, upon death, the value of any interest in property that passes to the surviving spouse will be deducted from the decedent’s gross estate. This will help defer the estate tax liability. When a spouse is disinherited, however, the marital deduction may be eliminated or substantially reduced. This creates a much larger taxable estate than originally anticipated, which may result in an estate tax liability.

Estate tax advisors should be informed about the property rights that a disinherited spouse may possess with respect to property owned by a decedent at the time of death, as well as other property the deceased spouse may have transferred during the spouse’s lifetime. Certain trusts and nuptial agreements can be used to protect a individual’s estate without disinheriting a spouse in ways that can preserve the marital deduction.

Background

A spouse who is legally married to the deceased spouse at the time of death cannot be totally disinherited, even if the surviving spouse was omitted either intentionally or unintentionally from the will of the decedent.

At one time, a surviving wife was entitled to a life estate interest in a portion of real property owned by her deceased husband, a right called a “dower.” A “curtesy,” on the other hand, represented a husband’s right to a life estate interest in a portion of his deceased wife’s real property. Individuals wanting to disinherit their spouse would circumvent the law by transferring real property prior to death or converting real property to personal property, thus leaving nothing to the spouse. Most states have enacted legislation that replaces dower and curtesy with a “spousal right of election,” which gives a surviving spouse a choice: Either accept the provisions of the decedent spouse’s will, or ignore the will and elect instead to receive a “statutory elective share.” Previously, the statutory elective share extended only to the decedent spouse’s probate estate. An individual could, however, easily disinherit the spouse merely by creating a nonprobate estate through one or more of the following methods:

• Placing assets in a trust;
• Owning jointly held property with a nonspouse;
• Making life insurance proceeds payable to a named beneficiary other than the spouse;
• Making outright gifts; or
• Opening a bank account that is payable upon death to someone other than the spouse.

To overcome these deficiencies, most states allow a surviving spouse to claim an elective share that is based upon a fraction of the decedent spouse’s augmented estate. Depending on the decedent’s state of domicile, generally speaking, the augmented estate is equal to the probate estate plus the nonprobate estate, which includes but is not limited to the following:

• Property that the decedent spouse placed in trust;
• The decedent’s fractional interest in property held by the decedent in joint tenancy with rights of survivorship with a nonspouse;
• The decedent’s ownership interest in a bank account payable upon death to a nonspouse;
• Transfers of property made by the decedent spouse within two or three years prior to death, in which the decedent retained certain interest in the property transferred; and
• Property the decedent spouse transferred but had the right to retain income therefrom or the use of the property until death.

All of the above transfers must have been made by the decedent with full and adequate consideration, and be made in anticipation of death.

Generally speaking, depending on the decedent’s state of domicile, the following property that is not considered part of the augmented estate would include:

• The value of property the decedent spouse received as a gift or inheritance during the marriage, providing the property was not commingled with property owned by the couple jointly;
• The value of property transferred without full and adequate consideration (a gift) when written consent was made by the surviving spouse regarding the transfer; and
• The value of property transferred to a nonspouse prior to January 1, 1991, without full and adequate consideration.

Each state has it own laws that are very specific in defining the elective share that a surviving spouse may take. In addition, each state has it own prescribed time in which the surviving spouse must file a written election with the probate court. The timing requirements are generally strict and must be adhered to; otherwise, the elective share is lost. If the written election is made on a timely basis, the surviving spouse’s elective share will take priority over other shares under the will, as well as other shares involving property not passing under the will. Debts, taxes, and expenses of the decedent spouse’s estate must be paid first, before the elective share is made, in order to arrive at the net estate, the amount on which the elective share is based. Once the elective share is made, the remaining assets in the estate will be distributed according to the will or through other contractual arrangements.

The New York State Right of Election Law appears in article 5 of the Estates, Powers, and Trusts Laws (EPTL), “Rights of Surviving Spouse.” The minimum spousal right of election is one-third of the net estate. The spouse’s share of the estate is reduced by the value of any interest that passes directly from the decedent to the spouse. This election must be made within six months from the date of the issuance of Letters Testamentary or of Letters of Administration and no later than two years after the date of the decedent’s death. The election must be in writing and must be served in accordance with the statute. Only the Surrogate’s Court may extend the time period for making the election. In New York, a spouse’s right of election can be circumvented only by a written agreement between the spouses, such as a prenuptial agreement or a separation agreement. Each of these agreements must specifically provide that each party is waiving their right of election under this specific New York statute.

It was common practice in New York for wills drafted prior to August 31, 1994, to contain qualified terminable interest property (Q-TIP) trusts, which provided the spouse with income only while qualifying for the unlimited martial deduction. Under the current EPTL section 5-1.1A, however, in combination with the Q-TIP election [as provided in IRC section 2056 (b)(7)], a surviving spouse is permitted to satisfy the right of election by taking income for life and the marital deduction is allowed as long as no other person has any rights in the Q-TIP trust during the surviving spouse’s life.

The same benefit applies to a credit shelter trust, where a will may provide that the spouse receives income for the rest of the spouse’s life. The spouse may, of course, choose to use the right of election instead.

It is important for a CPA to see the distinction between a person dying with a will and dying without (intestate). If a person dies without leaving a will and is married with children, then only 50% of the estate goes to the surviving spouse, and 50% goes to the children, thus creating a marital deduction of only half of the estate. If an estate is subject to taxation, the loss of one-half of the marital deduction could be costly and avoidable. In this case, disinheriting the spouse was accidental, which may potentially result in greater estate taxes.

Examples

Augmented estate scenario 1. Bradley Jones has been legally married to his wife, Beatrice, since 1958. They live in a state where the surviving spouse may elect to take one-half of the net estate if there are no surviving children of the decedent, and one-third of the net estate if there are surviving children. Bradley has one son, George, from a previous marriage, and another son, Harry, from his marriage to Beatrice. Bradley died in 2007, leaving all of his property to his son George. The estate was subject to $75,000 in debts and administrative expenses. The property values on the day of Bradley’s death were as shown in Exhibit 1.

In some cases a surviving spouse chooses to take the statutory elective share, disrupting specific bequests that are made under the will to a nonspouse.

Augmented estate scenario 2. Assume Thomas Jenkins has been legally married to his wife, Karen, since 1970. They live in a state where the surviving spouse may elect to take one-half of the net estate if there are no surviving children of the decedent, and one-third of the net estate if there are surviving children. Jenkins dies in 2007, leaving $2,125,000 in his will to his son Jacob and the rest of his estate to his childhood friend Bernie. Jenkins intentionally omitted his wife, Karen, from his will. The estate is subject to $95,000 in debts and administrative expenses. The property values on the day of Jenkins’ death were as shown in Exhibit 2.

It is important to note that if a taxpayer abandons a spouse and the abandonment continues until the death of the spouse, the deserting spouse is not entitled to claim the statutory elective share.

Alternatives to Disinheritance

A spouse can be legally disinherited by a waiver of a spousal right of election or by a nuptial agreement, which can be executed before the marriage (prenuptial) or after the marriage (postnuptial). When advising someone who seeks to disinherit a spouse and is unaware of the estate tax consequences, the first step is to determine the individual’s intentions.

For example, perhaps the individual’s only intention is to limit the spouse’s access to the estate in the case of a subsequent marriage, while wishing the spouse to have sufficient income to live on. Upon the spouse’s death, this individual wishes to have the balance of the estate distributed to the children, with the estate tax consequences as favorable as possible. In such a situation, an advisor should point out that using certain types of trusts, such as credit shelter trusts and Q-TIP trusts, could accomplish this goal. The marital deduction may be preserved while providing the spouse with sufficient income and passing the balance of the estate to the children at reduced estate taxes. A prudent financial planner should point out that it is possible to protect the estate and accomplish the individual’s goals without disinheriting the spouse.

While estate taxes are always an important factor, other components generally covered by a pre/post-nuptial agreement, such as support, possession of the family home, distribution of personal property, and other personal matters, are also important and can be dealt with in a pre/post-nuptial agreement in such a way as to avoid impacting the marital deduction while reducing estate taxes.

The rules governing property rights of disinherited spouses are very complex and vary in each state. The authors highly recommend that an experienced attorney specializing in estate planning be consulted.

©2009 The New York State Society of CPAs. Legal Notices