California Tax Attorney Blog

I just received an email from Walt in Los Angeles, CA after reading this blog and this is what he wrote:

"Both parents are deceased. I know they had a living trust. I am not on good terms with my siblings. How can I find out about the trust and what is in it?"

Here is my reply:

"Walt, You can ask for a copy because if you are a beneficiary you are entitled to it by law. If they refuse, you can file a petition to remove them as successor trustee for breach of their fiduciary duty to give you a copy.

"California Probate Code Section 16061.5(a) provides that:

"'When a revocable trust or any portion of a revocable trust becomes irrevocable because of the death of one or more of the settlors of the trust, or because, by the express terms of the trust, the trust becomes irrevocable within one year of the death of a settlor because of a contingency related to the death of one or more of the settlors of the trust, the trustee shall provide a true and complete copy of the terms of the irrevocable trust, or irrevocable portion of the trust, to any beneficiary of the trust who requests it and to any heir of a deceased settlor who requests it.'

"If you would like me to help you file a petition to get the copy, please let me know."

If you have a similar issue, please call California probate attorney Mitchell A. Port at (310) 559-5259.

The following article is reprinted from a newsletter written by my friend, Jacob Stein, an asset protection attorney at Klueger & Stein, LLP:

Spouses' Liabilities to Third Parties: California Creates a Problem and Provides a Solution

Assume that a spouse in California becomes liable to a third party, either as a result of a tort claim, a business debt or any other source. To what extent may the other spouse (the "non-debtor spouse") be held liable for the debts of the "debtor spouse"? Unfortunately, California statutory law is mostly good news for creditors and bad news for married debtors. But the Family Code provides spouses who engage in some early planning with an escape hatch, permitting the non-debtor spouse to avoid the debts of the debtor spouse.

The problem has two sources. The first is that most of the assets of married spouses in California are community property. A spouse's earnings are community property, and assets acquired during the marriage with the earnings of one or both spouses are also community property. Even if an asset started out as a spouse's separate property, either having been received by one spouse as a gift or an inheritance or having been owned by one spouse prior to marriage, it is likely that the asset will, over time, be commingled with community property and thus became community property.

It is the second source that really creates the problem. Section 910 of the Family Code provides that, with limited exception, "the community estate is liable for a debt incurred by either spouse before or during marriage, regardless of which spouse has the management and control of the property and regardless of whether one or both spouses are parties to the debt or to a judgment for the debt." As a result of §910 -- and contrary to widespread belief – there is no such thing in California as a "community debt" or a "separate debt." The issue is not the nature of the debt but the nature of the asset. If the asset is part of the "community estate," the asset will be subject to seizure by a creditor of either spouse. The confusion probably results from the experience of family law practitioners. In the context of a divorce proceeding, the court is required to determine which of the debts that arose during the marriage were "separate or community and confirm or assign them to the parties..." Family Code §2551. But outside of the context of a divorce (and, to a lesser extent, in probate) there are no "community" or "separate" debts. Community property will stand to answer for the debts of the debtor spouse even if the debt was incurred for the debtor spouse's exclusive personal benefit. See In re Soderling, 998 F.2d 730 (9th Cir. 1993).

The rule for spouse's separate property is very different. Except for "necessaries of life," the separate property of a non-debtor spouse is not liable for the debts of the debtor spouse, whether the debt arose prior to or during the marriage. Family Code §913-914.

The harshness of the rule embodied in §910 is slightly mitigated by Family Code §911, which provides that the marital earnings of the non-debtor spouse will not be held to answer for the premarital debts of the debtor spouse. In effect, this means that a creditor cannot garnish the wages of a nondebtor spouse for the premarital debts of the debtor spouse. Once the nondebtor spouse has received the wages, the wages are liable for the premarital debts of the debtor spouse unless the nondebtor spouse deposits the wages in an account to which the debtor spouse has no access.

It is interesting to note how radical a departure Family Code §910 is from the forty "common law" states that do not have a community property regime. In these states, the general rule is that assets -- including earnings -- titled in the name of a non-debtor spouse are not liable for the other spouse's debts. See, e.g. Ill. Compiled Statutes ch. 750 §65/5 ("...neither the wages, earnings or property of either [spouse] nor the rent or income of such property, [shall] be liable for the separate debts of the other.")

Moreover, many common law states have retained "tenancy by the entirety," a form of ownership for real property. If property is titled as such, and only one spouse is a debtor, that spouse's creditors cannot seize or encumber the property as long as the marriage persists. See, e.g. Mich. Code §600.6023a ("Property...held jointly by a husband and wife as a tenancy by the entirety is exempt from execution under a judgment against only 1 spouse.") The essence of tenancy by the entirety is that it cannot be severed without the consent of both spouses, and the nondebtor spouse will never consent to a severance of the tenancy.

The Family Code, having created the problem in §910, provides a solution in §850, which permits spouses to "transmute" their assets from community to separate. By means of simple "transmutation agreement," spouses may effectively remove themselves from the entire California community property regime, as fully as of they had never set foot in California. The result is, of course, that only the separate assets of a debtor spouse can be seized by that spouse's creditors to satisfy that spouse's debts. Presumably, even after a transmutation agreement, the separate assets of one spouse could be reached by a creditor who provided "necessaries of life" to the other spouse.

There are only two requirements for a valid transmutation agreement, one that is easy to comply with and the other which is fraught with difficulties. In order for the transmutation of real property to be effective against third parties, the transmutation must be recorded. Family Code §852(b). Presumably, a deed transferring title from both spouses to one spouse, as that spouse's "sole and separate property," should be sufficient to satisfy this requirement, but the better practice is to record a "Memorandum of Transmutation Agreement," making explicit just what has occurred.

The second requirement poses the challenge for practitioners. Family Code §851 provides that "A transmutation is subject to the laws governing fraudulent conveyances." Fraudulent conveyances in California are governed by the Uniform Fraudulent Transfer Act, Civil Code §3439 et. seq. What is and what is not a fraudulent conveyance is way beyond the scope of this article. However, it is safe to assume that a transmutation agreement that transmuted all of a married couple's assets into the separate property of the low-risk spouse, leaving the high-risk spouse with nothing, would be a fraudulent transfer, since no one gives away assets and receives nothing in return unless the avoidance of creditors is the motivation. However, it is equally safe to assume that if each spouse were to cede a community property interest in half of the assets to the other, with the result that each spouse were to emerge from the transmutation agreement with a separate property interest in half of the marital assets, such a division could not be considered a fraudulent conveyance. This places a premium on fairly valuing and carefully dividing the assets. It is recommended that each spouse emerge from the transmutation agreement with a sufficient amount of liquid assets. If one spouse receives nothing but cash, and the other spouse receives a separate property in interest in unproductive raw land, the spouse with the raw land cannot pay his or her debts as they come due, resulting in that spouse's insolvency, a hallmark of a fraudulent conveyance.

One might assume that, at best, a transmutation agreement solves only half of the problem, leaving a high-risk spouse's separate assets vulnerable to creditors. But not all assets are equally desirable to creditors. Assume that a married couple owns only two assets, a parcel of commercial real estate fairly valued at $1,000,000, and a business fairly valued at $1,000,000. As we have seen, if both assets are community property, both may be seized by the creditors of each spouse. A creditor may effectively seize the real estate simply by recording a judgment. The creditor may – but need not – foreclose upon the property. Eventually the debtor will have to deal with the creditor, because the real estate cannot be sold or refinanced without the creditor's judgment being removed. But the business is another matter entirely. It might be sold to a willing buyer at arm's length for $1,000,000, but it might be worth far less in the hands of a creditor, especially if the debtor is willing and able to compete with the business following the seizure. In order to satisfy a judgment, a creditor will have to install a receiver in the business, an expensive and not always effective remedy. Creditors generally are not interested in operating businesses. They want assets that are either cash or are readily reduced to cash. These are the assets that should be transmuted into the separate property of the low-risk spouse.

Finally, transmutation agreements share one thing in common with almost every other asset protection device: The "earlier" you do it, the more likely it will hold up.

Preservation and growth through multiple generations is one of the biggest challenges that California's wealthy families must confront regarding their wealth. One solution for many wealthy families is a tradeoff involving ownership versus control. That is, structuring wealth in a way in which family members can have the desired degree of control over that wealth without having ownership for transfer tax purposes. Sometimes the private trust company might be the best way to thread that needle.

Wealthy families place a high premium on giving each generation the opportunity to participate in decisions regarding the preservation and growth of their wealth. However, preservation and growth are threatened by the federal transfer tax system, divorce and litigation.

One response to these threats by wealthy families is to use irrevocable trusts which often involve transferring family wealth to them. When an individual or a financial institution is serving as trustee of irrevocable trusts, the ability of family members to have a voice in the management of their wealth inside of those trusts is difficult if not impossible.

To retain some voice in the management of their wealth, wealthy families look for structures that permit and encourage the participation of each generation in the investment management of family wealth held in irrevocable trusts. One such structure that is the private trust company.

A private trust company is also referred to as an exempt trust company or a family trust company. Except in a few states, it is a entity chartered by a state that is formed for the express purpose of providing trust and fiduciary services to a single family; it is not allowed to transact business with the general public. More importantly for wealthy families desiring involvement in the management of family wealth in irrevocable trusts, it creates a forum for current and future generations to discuss and influence the preservation and growth of that wealth.

In addition to the ability to be involved in the management of family wealth in irrevocable trusts, the following are some of the key reasons wealthy families form private trust companies:

Limited personal liability. As a general rule, the members of the board of directors of a private trust company have limited liability, and they are operating within a business standard as opposed to the higher fiduciary standard for trustees. Family members and trusted advisors who serve as individual trustees have unlimited personal liability.

Greater willingness to consider retention of heavily concentrated family assets. Private trust companies are less risk adverse and better attuned to family assets and the special place they hold within the context of the family compared to corporate trustees.

Elimination of trustee succession issues. Trustee succession issues which often occur when individuals or financial institutions are named as trustee are resolved.

Ability to select a favorable forum. Nevada, Texas, Wyoming, South Dakota and Texas are some of the more popular states where wealthy families are chartering private trust companies because they promote such trusts by enacting favorable tax laws.

Potential Disadvantages of a Private Trust Company

Required information disclosure. As part of the charter application process, certain information will have to be disclosed to regulatory authorities about family members and non-family members who will be board members, principal shareholders or executive officers of the proposed trust company.

Capital requirements. A private trust company must meet minimum capital requirements to exercise the fiduciary powers granted to it by the chartering state. These capital requirements vary from state to state.

Threat of additional regulation. Since a private trust company must apply for and obtain a charter from the state where it is to be located, the private trust company is subject to the laws and regulations of that state which can change from time to time by that state’s legislature. The lone exception is an unregulated trust company which can be formed in Massachusetts, Nevada, Pennsylvania, Virginia, and Wyoming.

The IRS issued Notice 2008-63 which contained a proposed revenue ruling addressing the transfer tax and income tax consequences of a private trust company serving as trustee of family trusts. The stated goal of the IRS was to show that the tax consequences of using a private trust company as trustee were no more restrictive than if the taxpayer acted directly in that role.

For more information about this, call your tax attorney. Mitchell A. Port is a tax lawyer in Los Angeles.

When preparing your California Will, nominating guardians to raise your minor children can be difficult. Guardians are the individual or couple who will physically and emotionally take care of your children by clothing them, feeding them, educating them and raising them to be decent human beings.

1. If you’ve named a couple to take care of your children, what should happen if one of persons in the couple dies or if they divorce? Do you nominate one of them to serve alone as guardian or do you nominate someone else entirely new; how disruptive to your child would that be?

2. Is the person you’ve chosen young enough to take on the responsibility? While choosing your parents may make sense, they may be too old for the job or may die before your children are still minors. If you do choose individuals who are older than you, always name back up guardians.

3. Does the individual have values similar to your own and the traits necessary to raise your children? Some of those values include religious beliefs, education (private vs. public schools, religious vs. secular schools, out-of-state or California schools), patience and a sense of humor?

4. Is the proposed guardian financially secure, emotionally stable and physically well? Does he or she have a healthy lifestyle? Will he or she stay in California?

The California Probate Code addresses the topic of guardians in Code Sections 1400 et seq., 1500 et seq., and 2100 et seq.

The topic is much more nuanced than presented here. Call your estate planning attorney for help.

California, all the other 49 states and the District of Columbia have enacted laws governing probate and estate planning – the probate process, the validity of wills, creation of trusts, and more. These laws can fall under various names, often as collections of laws called "codes." The different estate and probate codes that can be found from state to state include "Estate Administration," "Decedents' Estates," "Trust and Fiduciaries, and the "Uniform Probate Code."

In the table provided here, you will find links and citations to estate and probate laws for all 50 states and the District of Columbia.

Speak to a probate attorney in California about your questions. Call Mitchell A. Port at (310)559-5259.

In general, the IRS issues summonses only when the taxpayer (or other witness) will not voluntarily produce the information or other records. When a taxpayer or third person is willing to testify and produce documents voluntarily, a summons may not be required. With limited exceptions, the IRS has the power to issue an IRS summons without court approval. The Service should only issue a summons when it is prepared to seek judicial enforcement if the summoned party fails to fully comply.

The IRS typically asks that taxpayers provide information to the IRS. These IRS requests usually involve an "information document request." The IRS summons is the primary means for enforcing these information requests.

Internal Revenue Code Section 7602 provides the Service with summons authority.

Once served, the taxpayer must act to comply with the IRS summons or act to quash the summons. If the taxpayer fails to act, the IRS will seek to have a court enforce the IRS summons. If the taxpayer fails to act after a court has ordered enforcement, the court can and does impose sanctions on the taxpayer.

The summons does not require the witness to do anything other than appear on a given date to give testimony or produce existing books, papers and records or both. A summons cannot require a witness to prepare or create documents, including tax returns, that do not currently exist.

If the IRS issues an IRS summons, it is imperative that the taxpayer immediately contact an experienced tax attorney.

Joint tenancy is a type of ownership in California where two or more people share an interest in real or personal property often with a right of survivorship. Homebuyers in Los Angeles, Orange, Santa Barbara and Ventura Counties are often advised to hold the property in joint tenancy with a right of survivorship so that when one of them dies, the other receives the property. Married couples often take title to their home as joint tenants and when one of them dies, the surviving spouse gets full title to the property.

There are occasions where joint tenancy may be the correct way to hold title; when doing that, just make an informed decision.

One benefit to joint tenancy is the avoidance of probate. Since title “automatically” transfers to the surviving joint tenant, probate is unnecessary.

However, joint tenancy in California has problems associated with it. For instance:

Problems with Creditors - Creditors of a joint owner can come after the property to satisfy the debts of one of the joint owners which means the other joint owner can lose his interest in the property even when he is not responsible for the credit problem. If a joint owner has a judgment rendered against him, the creditor can seek to satisfy the judgment by forcing a sale of the property.

Capital Gains Tax Issues - By using joint tenancy instead of a living trust, a husband and wife may be forfeiting certain tax benefits that would be available such as what is called a “double step-up in basis”.

Gift Tax Issues – Also, by putting someone on title with you as a joint tenant, you may be making a taxable gift and a gift tax return may have to be filed.

Loss of Flexibility – The surviving joint owner who receives an asset will get the asset outright. The joint owner cannot spread out distribution of the asset over time. Let’s say a 20 year old receives an inheritance from a joint checking account upon the death of the co-owner, he will receive the entire account all at once rather than over a period of years as he matures.

Loss of Control - When you own property with other joint tenants, you give up unilateral control over the property. You no longer have the right to act alone with regard to selling, making improvements or refinancing the property.

To discuss how to take title to property, speak with a qualified tax attorney. Call Mitchell A. Port at (310) 559-5259.

Some tax liabilities are dischargeable in bankruptcy.

Usually older federal income tax debts are dischargeable in bankruptcy. The tax must be more than three years old. The tax return which reported the tax debt must have been filed with the Internal Revenue Service and if it was filed, then it must have been filed more than 240 days before filing the bankruptcy petition.

Some tax penalties may also be discharged in bankruptcy and you may be able to halt the accrual of interest during the bankruptcy proceeding. If the tax debt and penalties are not dischargeable in bankruptcy then it is still possible that the tax debt and penalties can be restructured in bankruptcy.

Many tax experts believe that unpaid payroll tax which has been converted into a personal liability of the responsible person who willfully failed to pay the tax is not dischargeable in bankruptcy.

In addition to being able to discharge federal income taxes in bankruptcy, filing a bankruptcy petition may stop the IRS’s collections activities. Therefore, bankruptcy may be an option to prevent the IRS from levying on bank accounts, wages or other assets.

If your tax debt is dischargeable in bankruptcy, it may be possible that the threat of filing bankruptcy can persuade the IRS to settle your debt on more favorable terms for you.

But there are disadvantages to filing bankruptcy. For instance, IRS liens may survive the bankruptcy process and to the extent that the tax debt is not discharged in bankruptcy, the IRS may view you (who now has fewer debts) as being in a better position to pay the IRS.

Call an experienced tax attorney to help you determine if bankruptcy is an option for resolving your tax debt.

As high as the divorce rate in California is, the tax rules regarding alimony payments become increasingly important. Not following the tax law may result in the IRS assessing significant taxes, penalties and interest. Preventing or solving this tax problem can easily be done with the proper advice from your tax lawyer.

Alimony payments may be included in gross income to the payee spouse and tax deductible by the payor spouse. If under federal tax law the payments do not qualify as alimony, the payments may be excluded from gross income of the payee spouse and may not be tax deductible by the payor spouse.

Recharacterizing alimony payments is very common for the IRS on audit. For the payor spouse, this may result in the IRS disallowing tax deductions for the alimony payments. For payee spouse, this may result in the IRS finding that the spouse failed to report alimony income.

These problems are avoidedable with proper tax planning. Separating and divorcing spouses can recognize significant federal income tax savings when aware of what payments do not qualify as alimony. Generally, payments do not qualify as alimony for purposes of federal tax law if:

• the spouses are members of the same household at the time the payments are made,

• the divorce decree or separation agreement designates the payments as non-alimony,

• the payments are not made pursuant to a divorce decree or separation agreement,

• the spouses are married and file a joint tax return (married couples who file a joint tax return may qualify for innocent spouse relief),

• the payments are child support,

• the payments consist of property rather than money,

• the payments are for the payee spouse’s bills (such as mortgage payments and real estate taxes),

• the payments call for significantly larger payments in the first three years following separation or divorce, and

• there is an obligation to continue the payments after the death of the payee spouse (either in the decree or agreement or in state law).

Divorce decrees or separation agreements should be written in a way that addresses these rules. As with other major financial transactions, taxpayers should consult with their tax attorney if they have any doubt about the taxation of their alimony or other payments.