Older Couples and Divorce

Payment of estate tax is the greatest economic loss faced by elderly couples who divorce. While married, each spouse may leave all or any portion of his or her estate to the surviving spouse, either in trust or outright, free of all estate and gift tax. This marital deduction, coupled with the applicable exclusion amount and prudent estate planning, saves a married couple a substantial amount of federal estate tax, and in some instances all estate tax, allowing more accumulated wealth to pass to their children and grandchildren.

An estate tax is imposed on everything an individual owns on the date of death. The federal estate tax rates for 2007, 2008 and 2009 are 46% of the decedent's taxable estate above the applicable exclusion (a sum of assets each individual can transfer upon death, estate-tax free), of $2 million (2007 and 2008) and $3.5 million (2009). The current law, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), provides for repeal of the estate tax in 2010. Commencing Jan. 1, 2011 and thereafter, estate tax rates will revert to the pre-2001 rates of 41% to 50% of the decedent's taxable estate above the applicable exclusion of $1 million. It is anticipated that Congress will pass a bill prior to Jan. 1, 2011 and at least increase the applicable exclusion to the 2009 amount of $3.5 million.

Staying Married vs. Getting Divorced

Samantha and John are a perfect example of a couple that will benefit from remaining married. Both are 70 years old and have been married for 42 years. They no longer wish to spend all of their time together, but enjoy spending time and holidays with their children and grandchildren. They have no interest in marrying anybody else.

Samantha and John have combined assets of $50 million, consisting of: a cooperative apartment in Manhattan worth $6 million, a house in Connecticut worth $6 million, $35 million in marketable securities, and $3 million in retirement funds. All assets, other than the retirement funds, are held jointly. Samantha has $2 million and John has $1 million in retirement funds, the rights to which neither has waived. Under the Federal mortality tables, John has a life expectancy of 12.81 years and Samantha has a life expectancy of 15.36 years.

If John and Samantha divorce, there will be severe estate tax consequences. If their assets are divided equally upon divorce and John dies in 2007, his estate will pay tax of 46% on $23 million ($25 million, less John's $2 million exclusion amount), or $10,580,000. Thus, John's beneficiaries will receive only $14,240,000 upon his death. Since John has lost the marital deduction upon divorce, the family will lose use and appreciation of the $10,580,000 of tax paid on John's death that would not have been paid had John remained married to Samantha.

If John and Samantha stay married, at the time of either's death, all their assets can pass estate-tax-free to the surviving spouse because of the marital deduction. If John dies in 2007 and Samantha dies in 2010, Samantha will have use of all assets, including income earned and appreciation, until she dies. Upon Samantha's death, because she died in 2010, her estate will pay zero estate tax. Samantha and John's children will receive a total financial benefit by their parents remaining married. If Samantha dies in a year other than 2010, all of the couple's assets above the exclusion amount will be taxable in her estate.

Estate Planning Options

Married couples can accomplish additional estate tax savings through proper estate planning. In our example, if Samantha dies in a year other than 2010 and both she and John have a will providing for the creation of two fractional portions, upon the death of the first spouse (John) one portion will be funded with the federal estate tax exclusion. This amount will be held in trust for the benefit of the surviving spouse (Samantha) during her lifetime and upon her death will pass, tax free, to her children and grandchildren. Samantha will receive all of the income from this trust and will also receive distributions of principal in the Trustee's discretion. The second portion, or marital portion, may either be given to Samantha outright or in trust for her lifetime benefit. In addition to benefiting from income generated from and appreciation of these assets, Samantha will be able to utilize these funds to make tax free gifts of up to $12,000 annually, further reducing the estate tax.

No estate tax will be due on John's death. When Samantha dies, her exclusion amount will be used, passing additional assets, estate tax free, to the couple's children, grandchildren or other beneficiaries. If Samantha dies in a year other than 2010, the estate tax will be 46% of $50 million, less John's exemption amount and Samantha's exemption amount. To implement the tax savings described above, John and Samantha's assets should be divided and titled in each individual spouse's name. These examples do not take into account any state death taxes that may be due or the costs of estate administration that are deducted from the gross estate.

The Postnuptial Agreement Alternative

As an alternative to divorce and to preserve the tax advantages married couples enjoy, including filing joint income tax returns, counsel should consider advising John and Samantha to remain married, to each reside in one of the homes, to execute a postnuptial agreement dividing the assets between them and to title these assets in their individual names. The parties must have full financial disclosure and, as a result of their confidential relationship, must be represented by separate counsel.

In New York, postnuptial agreements are a viable tool. Their validity is determined by the standard applicable to individuals who have a confidential relationship. Tremont v. Tremont, 35 AD3d 1046 (3d Dept. 2006). Although postnuptial agreements are carefully scrutinized by the courts, they will not be set aside as unconscionable unless they shock the conscience. Id. In Tremont, a postnuptial agreement was upheld even though the defendant did not have his attorney review a final version of the agreement before signing and even though the agreement compelled him to pay more than his current annual taxable income in child support, maintenance and expenses. The Tremont agreement was entered into in connection with the parties' purported reconciliation and because of a request by the defendant for the plaintiff to cosign business loan documents using jointly owned property as collateral. The defendant had had his attorney in the matrimonial action (whom he had stopped using) review previous versions of the agreement, was self-employed and could control the amount of his annual salary. As a result of all these factors, the agreement was held not to be unconscionable.

A postnuptial agreement has also been held valid and enforceable where its execution was a prerequisite to a wife transferring title of real property, which had been purchased by both parties prior to the marriage, to joint tenancy. Xenitelis v. Xenitelis, 241 AD2d 490 (2nd Dept. 1997). At the time the residence was purchased, the husband was in the process of divorcing his previous wife and title was solely in the prospective wife's name. After the husband's divorce was finalized and the parties married, they signed a postnuptial agreement, giving the husband a one-half share in the house, and waiving his rights to maintenance and his wife's retirement plans. The husband, upon divorce from his second wife, attempted to set aside the agreement on the grounds of fraud and coercion. The court held that any presumptions made by the husband were speculative and could not be the result of fraud or coercion.

In Clermont v. Clermont, 198 AD2d 631 (3d Dept. 1993), appeal dismissed, 83 NY2d 953 (1994), one paragraph of a postnuptial agreement was held void and unconscionable. It provided in its subparagraph (a) that the house and land already titled to defendant husband would remain his separate property. Subparagraph (b), however, purported to give defendant all real and personal property belonging to the plaintiff wife at the time of marriage or acquired thereafter unless plaintiff demanded a writing from defendant, within 30 days of her acquisition of such property, acknowledging that the property was hers. Thus, this provision granted defendant all of plaintiff's property acquired before the marriage, but not held solely in her name, and all property acquired by her subsequently but not acknowledged by defendant to be hers. The court reiterated the precedent that an unconscionable bargain is one 'no person in his or her senses and not under delusion would make on the one hand, and as no honest and fair person would accept on the other' (internal quotations and citations omitted). Finding that a provision granting defendant all marital property even if purchased with plaintiff's separate income was a term no rational person would agree to and no fair and honest person would accept, the court excised this provision from the agreement.

A postnuptial agreement in which a wife waived her right to any business property owned by her husband, whenever acquired, and in which the husband relinquished no rights to the wife's property, was found not binding for lack of consideration in Whitmore v. Whitmore, 8 AD3d 371 (2d Dept. 2004). Stating that a postnuptial agreement, just as any contract, requires consideration, the court found that the agreement recited neither mutual promises nor any detriment to the husband, rendering it non-binding for lack of consideration. The court dismissed the husband's argument that continuation of the marriage was sufficient consideration to validate the agreement.

In addition to avoiding a declaration of invalidity and reciting valid consideration, in New York a postnuptial agreement must also contain waivers of the spousal right of election in order to preserve use of marital and exemption equivalent trusts. New York's Estates Powers and Trusts Law (EPTL) 5-1.1-A(3) provides for a waiver of a spouse's right of election. To be effective, the waiver must be in writing, subscribed by the maker and acknowledged or proved in the manner required for the recording of a deed. The elective share, which in most cases is one-third of the net estate including testamentary substitutes as defined in EPTL 5-1.1-A, must be given outright to the surviving spouse.

Conclusion

Economically, John and Samantha should remain married and execute a postnuptial agreement. The agreement will divide the marital assets, which will be retitled in the respective spouse's name. As a result, their children and grandchildren will receive the benefits of deferring estate tax until the death of the surviving spouse; or as is possible in the very limited circumstances discussed, paying zero estate tax.

Judith E. Siegel-Baum, a member of this newsletter's Board of Editors, is a partner at Wolf, Block, Schorr and Solis-Cohen LLP, and heads the firm's New York office's Private Client Services Group. Gail Goldfarb is an associate at the firm, practicing with their Private Client Services Group in New York.

Payment of estate tax is the greatest economic loss faced by elderly couples who divorce. While married, each spouse may leave all or any portion of his or her estate to the surviving spouse, either in trust or outright, free of all estate and gift tax. This marital deduction, coupled with the applicable exclusion amount and prudent estate planning, saves a married couple a substantial amount of federal estate tax, and in some instances all estate tax, allowing more accumulated wealth to pass to their children and grandchildren.

An estate tax is imposed on everything an individual owns on the date of death. The federal estate tax rates for 2007, 2008 and 2009 are 46% of the decedent's taxable estate above the applicable exclusion (a sum of assets each individual can transfer upon death, estate-tax free), of $2 million (2007 and 2008) and $3.5 million (2009). The current law, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), provides for repeal of the estate tax in 2010. Commencing Jan. 1, 2011 and thereafter, estate tax rates will revert to the pre-2001 rates of 41% to 50% of the decedent's taxable estate above the applicable exclusion of $1 million. It is anticipated that Congress will pass a bill prior to Jan. 1, 2011 and at least increase the applicable exclusion to the 2009 amount of $3.5 million.

Staying Married vs. Getting Divorced

Samantha and John are a perfect example of a couple that will benefit from remaining married. Both are 70 years old and have been married for 42 years. They no longer wish to spend all of their time together, but enjoy spending time and holidays with their children and grandchildren. They have no interest in marrying anybody else.

Samantha and John have combined assets of $50 million, consisting of: a cooperative apartment in Manhattan worth $6 million, a house in Connecticut worth $6 million, $35 million in marketable securities, and $3 million in retirement funds. All assets, other than the retirement funds, are held jointly. Samantha has $2 million and John has $1 million in retirement funds, the rights to which neither has waived. Under the Federal mortality tables, John has a life expectancy of 12.81 years and Samantha has a life expectancy of 15.36 years.

If John and Samantha divorce, there will be severe estate tax consequences. If their assets are divided equally upon divorce and John dies in 2007, his estate will pay tax of 46% on $23 million ($25 million, less John's $2 million exclusion amount), or $10,580,000. Thus, John's beneficiaries will receive only $14,240,000 upon his death. Since John has lost the marital deduction upon divorce, the family will lose use and appreciation of the $10,580,000 of tax paid on John's death that would not have been paid had John remained married to Samantha.

If John and Samantha stay married, at the time of either's death, all their assets can pass estate-tax-free to the surviving spouse because of the marital deduction. If John dies in 2007 and Samantha dies in 2010, Samantha will have use of all assets, including income earned and appreciation, until she dies. Upon Samantha's death, because she died in 2010, her estate will pay zero estate tax. Samantha and John's children will receive a total financial benefit by their parents remaining married. If Samantha dies in a year other than 2010, all of the couple's assets above the exclusion amount will be taxable in her estate.

Estate Planning Options

Married couples can accomplish additional estate tax savings through proper estate planning. In our example, if Samantha dies in a year other than 2010 and both she and John have a will providing for the creation of two fractional portions, upon the death of the first spouse (John) one portion will be funded with the federal estate tax exclusion. This amount will be held in trust for the benefit of the surviving spouse (Samantha) during her lifetime and upon her death will pass, tax free, to her children and grandchildren. Samantha will receive all of the income from this trust and will also receive distributions of principal in the Trustee's discretion. The second portion, or marital portion, may either be given to Samantha outright or in trust for her lifetime benefit. In addition to benefiting from income generated from and appreciation of these assets, Samantha will be able to utilize these funds to make tax free gifts of up to $12,000 annually, further reducing the estate tax.

No estate tax will be due on John's death. When Samantha dies, her exclusion amount will be used, passing additional assets, estate tax free, to the couple's children, grandchildren or other beneficiaries. If Samantha dies in a year other than 2010, the estate tax will be 46% of $50 million, less John's exemption amount and Samantha's exemption amount. To implement the tax savings described above, John and Samantha's assets should be divided and titled in each individual spouse's name. These examples do not take into account any state death taxes that may be due or the costs of estate administration that are deducted from the gross estate.

The Postnuptial Agreement Alternative

As an alternative to divorce and to preserve the tax advantages married couples enjoy, including filing joint income tax returns, counsel should consider advising John and Samantha to remain married, to each reside in one of the homes, to execute a postnuptial agreement dividing the assets between them and to title these assets in their individual names. The parties must have full financial disclosure and, as a result of their confidential relationship, must be represented by separate counsel.

In New York, postnuptial agreements are a viable tool. Their validity is determined by the standard applicable to individuals who have a confidential relationship. Tremont v. Tremont , 35 AD3d 1046 (3d Dept. 2006). Although postnuptial agreements are carefully scrutinized by the courts, they will not be set aside as unconscionable unless they shock the conscience. Id. In Tremont, a postnuptial agreement was upheld even though the defendant did not have his attorney review a final version of the agreement before signing and even though the agreement compelled him to pay more than his current annual taxable income in child support, maintenance and expenses. The Tremont agreement was entered into in connection with the parties' purported reconciliation and because of a request by the defendant for the plaintiff to cosign business loan documents using jointly owned property as collateral. The defendant had had his attorney in the matrimonial action (whom he had stopped using) review previous versions of the agreement, was self-employed and could control the amount of his annual salary. As a result of all these factors, the agreement was held not to be unconscionable.

A postnuptial agreement has also been held valid and enforceable where its execution was a prerequisite to a wife transferring title of real property, which had been purchased by both parties prior to the marriage, to joint tenancy. Xenitelis v. Xenitelis , 241 AD2d 490 (2nd Dept. 1997). At the time the residence was purchased, the husband was in the process of divorcing his previous wife and title was solely in the prospective wife's name. After the husband's divorce was finalized and the parties married, they signed a postnuptial agreement, giving the husband a one-half share in the house, and waiving his rights to maintenance and his wife's retirement plans. The husband, upon divorce from his second wife, attempted to set aside the agreement on the grounds of fraud and coercion. The court held that any presumptions made by the husband were speculative and could not be the result of fraud or coercion.

In Clermont v. Clermont , 198 AD2d 631 (3d Dept. 1993), appeal dismissed , 83 NY2d 953 (1994), one paragraph of a postnuptial agreement was held void and unconscionable. It provided in its subparagraph (a) that the house and land already titled to defendant husband would remain his separate property. Subparagraph (b), however, purported to give defendant all real and personal property belonging to the plaintiff wife at the time of marriage or acquired thereafter unless plaintiff demanded a writing from defendant, within 30 days of her acquisition of such property, acknowledging that the property was hers. Thus, this provision granted defendant all of plaintiff's property acquired before the marriage, but not held solely in her name, and all property acquired by her subsequently but not acknowledged by defendant to be hers. The court reiterated the precedent that an unconscionable bargain is one 'no person in his or her senses and not under delusion would make on the one hand, and as no honest and fair person would accept on the other' (internal quotations and citations omitted). Finding that a provision granting defendant all marital property even if purchased with plaintiff's separate income was a term no rational person would agree to and no fair and honest person would accept, the court excised this provision from the agreement.

A postnuptial agreement in which a wife waived her right to any business property owned by her husband, whenever acquired, and in which the husband relinquished no rights to the wife's property, was found not binding for lack of consideration in Whitmore v. Whitmore , 8 AD3d 371 (2d Dept. 2004). Stating that a postnuptial agreement, just as any contract, requires consideration, the court found that the agreement recited neither mutual promises nor any detriment to the husband, rendering it non-binding for lack of consideration. The court dismissed the husband's argument that continuation of the marriage was sufficient consideration to validate the agreement.

In addition to avoiding a declaration of invalidity and reciting valid consideration, in New York a postnuptial agreement must also contain waivers of the spousal right of election in order to preserve use of marital and exemption equivalent trusts. New York's Estates Powers and Trusts Law (EPTL) 5-1.1-A(3) provides for a waiver of a spouse's right of election. To be effective, the waiver must be in writing, subscribed by the maker and acknowledged or proved in the manner required for the recording of a deed. The elective share, which in most cases is one-third of the net estate including testamentary substitutes as defined in EPTL 5-1.1-A, must be given outright to the surviving spouse.

Conclusion

Economically, John and Samantha should remain married and execute a postnuptial agreement. The agreement will divide the marital assets, which will be retitled in the respective spouse's name. As a result, their children and grandchildren will receive the benefits of deferring estate tax until the death of the surviving spouse; or as is possible in the very limited circumstances discussed, paying zero estate tax.

Judith E. Siegel-Baum, a member of this newsletter's Board of Editors, is a partner at Wolf, Block, Schorr and Solis-Cohen LLP, and heads the firm's New York office's Private Client Services Group. Gail Goldfarb is an associate at the firm, practicing with their Private Client Services Group in New York.