Nonspousal joint tenancy can create tax liability

Healthcare Financial Management, Sept, 1996 by William G. Kistner

Joint ownership of assets with family members other than a spouse can create tax liabilities and other problems that should be understood before entering into such arrangements.

Parents often hold assets in joint tenancy with one or more children for three reasons: to avoid probate, to manage the assets more conveniently, or to initiate a "gifting program." Before adopting joint tenancy with children as a method for holding title to property, however, parents should consider the potential Federal income tax and gift tax liabilities, both short term and long term.

The rules governing joint ownership with family members other than a spouse are complicated and somewhat dependent on individual state laws, but potential Federal tax liabilities generally fall into three categories: gift, income, and estate taxes.

Gift Taxes

Establishing joint ownership of assets generally results in a taxable gift unless each of the joint owners contributes equally to the acquisition of the property. In the case of one owner adding a second owner's name to the title of the asset after it is acquired, the gift is equal to half the value of the asset, and that amount is taxed.

For a jointly held brokerage account in which the securities are registered in a street name, special rules apply. The IRS has ruled that no gift tax is incurred until the securities or cash are withdrawn from the account. In such instances, adding the name of a child to a brokerage account, or acquiring additional securities to add to the account, will not result in immediate Federal gift tax consequences.

Special rules also apply to jointly held bank accounts. IRS regulations provide that if the contributor to the joint account can gain access to the entire balance without the consent of the other joint tenant, the account is revocable. In this instance, a gift can occur only when the noncontributing joint tenant withdraws funds.

However, in some states, the law provides the noncontributing joint tenant with an inalienable, or vested one-half interest in the bank account. In these states, a gift can occur when only one party contributes to the account.

The IRS allows an exclusion that currently permits an individual to give, tax free, up to $10,000 each year to any number of individuals. The exclusion is $20,000 when giving jointly with a spouse. Gifts in excess of the annual exclusion use up part of a $600,000 unified credit equivalent, an allowance that permits a couple to leave to an heir, estate-tax free up to $600,000 in assets. If an individual's remaining unified credit covers the gift, no gift tax is due.

Income Taxes

Generally, once an interest in property is transferred in the form of a gift, the recipient of the gift, for income tax purposes, is considered the owner of the portion donated. Therefore, any income or capital gain from the jointly held asset must be divided among the owners in proportion to the interest they are considered to own under state law.

As with any gift of property, the shifting of post-gift income and appreciation to the recipient can have advantages or disadvantages, depending on the tax bracket involved. If, for example, a recipient child is in a lower tax bracket than the parent, less income tax would be due on the child's portion of the income. However, for a child under age 14 who receives unearned income in excess of $1,300 annually, that income would be taxed at the parents' marginal tax rate.

Estate Taxes

When a joint tenant dies, Federal estate tax liability depends on whether the owners were married. In the case of spousal joint owners, only 50 percent of the jointly owned property is included in the estate of the first spouse to die. Since that half automatically passes to the surviving spouse, the allowance of the marital deduction postpones any estate tax payment until the death of the surviving spouse.

This one-half inclusion has an important impact on the property's cost basis when inherited by the survivor. One-half of the property's income tax basis is stepped up to fair market value at the date of death. Therefore, if the surviving spouse sells the property, one-half of the pre-death (and all of the post-death) appreciation will be subject to capital gains tax.

A different rule applies to a non-spousal joint tenancy, however. In this case, the estate of the first joint tenant to die would include only the proportionate share of the value of the property that is based on the portion of the original purchase price furnished by that joint tenant. Thus, if a parent owns property or an account outright and adds a child as a joint tenant later, 100 percent of the property's value will be included in the parent's taxable estate if the parent dies first. As a result, the basis of the entire property would be stepped up to fair market value at the date of death, and the tax consequences would be considerably greater for the surviving joint tenant.

Those considering placing assets in nonspousal joint tenancy must remember that the foregoing rules are Federal tax rules. In states that do not levy a gift tax, joint tenant ownership with a nonspousal family member often can reduce the amount of inheritance taxes imposed on the property upon the death of one of the joint tenants.