By Wendell Cayton
Posted November 03, 2008

Estate planning for the mature couple contemplating remarriage after
widowhood or divorce is complicated by a number of factors, including
large differences between net worth of parties, one or both having
children that the party wishes to provide for after his or her death,
disparity in ages, or both parties having similarly valued assets that
each wishes to keep "separate."

The institution of marriage offers definite tax advantages when it
comes to estate planning. States such as Washington and California are
community-property states, allowing each partner in the marriage an
equal share in the property, but upon the first death the entire cost
basis of the property is "stepped up" to the fair market value at date
of death. This allows the surviving spouse to sell appreciated
property without being taxed on the gain.

Community property laws also give the first spouse to die the right to
pass his or her interest in the community property to anyone he
chooses. It's this right that causes problems in a mature remarriage
where the potential partners may have children from prior marriages.

For example, H and W are contemplating marriage. Both have substantial
assets of their own (separate properties), including retirement plans.
Both have good jobs, plan to buy a house together and both have grown
children from prior marriages.

After the wedding they buy a home in a community-property state, hold
title as community property and pay living expenses from their
incomes. As a community-property asset, each has the right to say
where their respective interests go upon their death.

If H is first to die and wishes to leave W his half interest in the
home plus his separate property assets for her continued support, he
disinherits his children, but avoids estate taxes at his death by
transferring everything to his spouse. Since W has control of the
property, she is under no obligation to give up the property to H's
children at her death.

Conversely, if H decides to leave all his property interests,
including his share of the community property to his children, he
disinherits W. Further, since property left to a non-spouse does not
qualify for the unlimited marital deduction, estate taxes may have to
be paid on this distributed amount.

Among the more common solutions to these problems is for the
first-to-die spouse to leave property in trust for the surviving
spouse. This trust, known as a Qualified Terminal Interest Trust
(QTIP), allows the surviving spouse the right to receive the income or
enjoy the use of the property for his or her lifetime. Thereafter on
the death of the surviving spouse, the property passes to the
first-to-die spouse's intended heirs. The surviving spouse has no
right to give away or otherwise change the original intentions of the
decedent spouse.

This trust qualifies the property for the unlimited marital deduction
and thereby avoids death taxes at the first death. When the surviving
spouse dies, estate taxes will be due before distribution to the
heirs. Further, when the first spouse dies, the property receives a
stepped-up basis and may be sold by the trust, free of capital gains
taxes. Any subsequent income earned by the assets is considered
taxable income to the surviving spouse.

There may be an undesirable timing result from the QTIP solution if
the decedent's spouse is much younger, thereby denying his children a
timely inheritance. This could be offset with life insurance on the
life of the first to die, owned by an irrevocable life insurance
trust, with the kids as beneficiaries.

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