CINCINNATI BUSINESS COURIER
February 20 – 26, 1989
Investments
By Charles D. Vaughan
Joint ownership can end up a mess, as ‘they say’
WHAT A MESS! I remember when my kids were little they liked playing with modeling clay. One time they managed to mold something of both red clay and blue clay. It was great until the artwork got mashed. Then the colors ran together without exactly blending. Just an ugly, nondescript blob.
For most people that’s what joint ownership of property may be in reality – a mess. The vast majority of people use joint ownership, especially between spouses, as a substitute for good estate planning. Some, in fact, use it as a substitute for a will. Lawyers sometimes refer to joint ownership as the “poor man’s will.”
Chances are very great that you have some or most of your property in joint name and even greater that you don’t know what a dangerous deal it is. There are two reasons people use this form of ownership. The first is that “they say” it can save you the time and cost of probate administration. The second is that “they” almost always suggest it to you when you buy property. “They” may be your Realtor, banker, or garbage collector. Most of our property winds up being registered that way because somebody suggested it, not because we made a reasoned decision.
It is basically true that joint tenants with right of survivorship registration do avoid probate for the first to die. There are some exceptions to this. Most of the people who advise you to use joint ownership know nothing more than that. If they did they would be afraid to speak. Publications for financial advisers counsel great caution in recommending joint ownership. The reasons are many. Let’s consider a few of them.
Most joint ownership is between husband and wife. This does not have any substantial income, estate or gift tax consequence. But, it can cause the loss of a step- up in the cost basis on appreciated assets transferred to joint ownership. The main problems stem from the inflexibility of the decision for joint registration. Like the two lumps of colored clay, they are easily combined, but virtually inseparable.
Joint tenants do not each own half of the lump; they share ownership in the whole lump regardless of who paid for it. This means that each partner has equal access to the assets and has the right to sell anytime. It also carries the risk of unintentionally disinheriting children should the survivor transfer assets into joint tenancy with a new spouse. In case of disability of one spouse, the other will probably be unable to get to joint assets without court intervention because liens or transfers generally require both signatures.
Upon the death of one joint owner, the entire value of joint assets is included in the gross estate for tax purposes. The marital deduction removes half the value, but for non-spousal joint tenants matters get progressively worse. Full values are subject to federal estate tax (less the lifetime exclusion) unless the survivor can prove contribution by himself or a third party.
For most people joint tenancy with someone other than a spouse is not tax motivated. But, it can create big tax problems. The exact tax treatment depends on the type of property and on ruling state law. Older investors frequently have a favorite child or niece listed as joint tenant on bank accounts and CDs for convenience. This may trigger unnecessary income or gift tax. More importantly, it may wind up unintentionally giving the entire inheritance to one person who may not want to share.
Those who hope to avoid probate by registering stock in joint name with future heirs (non-spousal) really create problems. A gift is made for tax purposes when the transfer occurs. Any income from such investments may be taxable one-half to each owner, regardless of who paid for the stock or who actually gets the income. If the IRS discovers any lack of reporting, it may demand payment of back income and gift taxes. The tax status of joint ownership stock in street name is unclear but may create similar problems. Legal action against one of the joint tenants can tie up the whole asset; so the innocent holder suffers as well.
The average person thinks of “estate planning” as nothing more than techniques for the ultra-rich to avoid taxes. The true purpose of such planning is to be sure that your assets will be used to provide for your own needs and the needs of your loved ones during your lifetime. It should also see that your assets go where you want them to when you depart.
Joint ownership should be treated as the major decision it is and should be reviewed by an attorney. If you use joint ownership indiscriminately, you are adopting the estate plan as dictated by “they say.” Don’t be surprised if you wind up with a mess.