In my practice, I often meet with individuals whose children have started to assist them with their finances. Although these individuals are capable of managing their financial affairs on their own, they want to involve their children in an effort to make things easier in the event they become incapacitated or die. These individuals want to make the administration of their estate as easy as possible for their children and are often interested in avoiding probate (probate is the legal process through which a deceased person’s estate is administered and distributed under court supervision). In exploring estate planning options and weighing the pros and cons of each strategy, I am often asked, “Why don’t I just add my child to my bank account, or to the deed for my home now? Then they won’t have to deal with it after I die.” While it may seem convenient to add children as joint account holders on bank accounts, there are several reasons why this approach can be problematic and potentially risky.
Downsides of Adding Your Children to Your Bank Account
To illustrate, let’s consider the fictional Jones family: John and Amy married and had three kids: Susan, Stephen, and Samantha. John passed away, leaving his entire estate to Amy; Amy is now the sole owner of a checking and savings account and the family home. Upon her death, Amy wants her estate to be distributed to her children in equal shares and wants to minimize taxes and avoid potential family conflicts. Amy has added Susan as a joint owner to her checking account, so Susan can pay her bills for her if needed.
Potential Issue #1: Equal Ownership and Access
The first issue with adding Susan as a joint owner, is that doing so gives Susan equal ownership and access to the funds even though only Amy contributes to the account. This means Susan can withdraw money without her mom’s permission. The Amys that I meet are never concerned by this issue; as their Susan would never take money without their permission and would only ever use the funds to pay for their bills.
Potential Issue #2: Potential Creditor and Legal Issues
The next issue arises from potential creditor issues or legal issues for Susan. Through no fault of her own, Susan could find herself in a lawsuit due to a car accident or in a messy divorce proceeding. In either case, the bank account would be considered an asset of Susan’s and could be reachable in a lawsuit.
Potential Issue #3: Estate Planning Goals Not Met
The third potential risk is that Amy’s estate planning goals of providing for her three children equally may be distorted by the addition of Susan to her assets. Let’s assume that upon Amy’s death she had $200,000.00 in her checking account, $50,000.00 in her savings account, and her family home is worth $650,000.00. This means her total estate is worth $900,000.00 and each child should receive $300,000.00. However, because Susan is a joint owner on the checking account, these funds legally belong to her, and she is under no obligation to share. This means Susan will receive the full $200,000.00 from the account, plus one-third of the savings account and the family home. Susan’s total inheritance will be approximately $433,000.00, while Stephen and Samantha will only receive 1/3 of the savings account and the family home each – this is not what Amy intended.
Potential Issue #4: Unintended Tax Implications
Again, the Amys that I meet are usually not concerned by this possibility, as their Susan would certainly share with her siblings. However, sharing could have unintended tax implications for Susan, who may now have to report the gifts to her siblings (which should actually be inheritances) to the IRS. Even worse, if Susan is receiving government benefits or is in a coma and has a power of attorney agent or a conservator acting on her behalf, there could be significant legal consequences to these gifts being made and consequences that a power of attorney agent or conservator may not be willing to risk. Properly designating assets to ensure they are subject to the terms of Amy’s estate planning documents will avoid these potential pitfalls and avoid these risks. Susan can still assist her mother with her finances by being an authorized signer on their account, instead of an owner, or through the use of a well-drafted Financial Power of Attorney document.
Downsides of Adding Your Children to Your Real Property Deed
Many of these same risks apply to adding a child to the deed to real property, but there are additional considerations with this type of asset. Under current tax laws, real estate receives what is known as the step-up in basis at the death of the owner, which is an adjustment of the value of the asset to its fair market value at the date of death.
Capital Gain Tax: Real Property Deed without Children Added
For example, let’s say Amy originally purchased her home for $150,000.00; this is Amy’s basis in the property. If she were to sell the home at the time it is valued at $650,000.00, this original basis is used to calculate capital gains taxes, and she may have to pay tax on the $500,000.00 gain (note there are some exceptions). By allowing her children to receive their property as an inheritance, Amy’s basis is “stepped-up” to the fair market value at the date of her death, meaning if the property is sold shortly after death, the heirs are likely to avoid capital gains taxes completely as they could only be taxed on the appreciation in value from the date of death to the time of sale.
Full Step-up Illustration (No Lifetime Gift):
Original basis: $150,000.00
Stepped-up basis: $650,000.00
Sale Price: $650,000.00
Gain: $0.00
Assuming Amy’s estate planning documents are in order, the children will share equally in the sale proceeds for the home.
Capital Gain Tax: Real Property Deed with Children Added
If instead, Amy adds Susan to the title of the property at the time when the fair market value is $650,000.00, Amy is making a gift of one-half the value of the property ($325,000.00) which she should report to the IRS. Susan also receives one-half of Amy’s original basis ($75,000.00) which is used to calculate capital gains. Let’s assume after Amy’s death Susan sells the property for $650,000.00, Amy’s portion will receive a step-up in basis meaning there will not be capital gains as to Amy’s half. However, on Susan’s half of the property, there will be:
Lifetime Gift of Half the Property Illustration:
Original basis: $75,000.00
Sale Price: $325,000.00
Gain: $250,000.00
Current capital gains rates are between 0-20%, we’ll assume Susan is subject to a 15% capital gain rate, meaning she will have a tax bill of approximately $37,500.00, which could have otherwise been avoided. Amy’s goal of minimizing taxes is frustrated by the addition of Susan to her home. In terms of the overall distribution of the estate this scenario also leaves Susan with a higher share than her siblings as only half of the property is considered estate property subject to division amongst the children. With Susan paying capital gains taxes, she may be less inclined to share her half with her siblings.
Consult an Estate Planning Lawyer in Vancouver, Washington
This article is not an exhaustive list of the potential issues that stem from adding children, or any party, to your bank account or deed, but the risks discussed here should encourage you to discuss your estate planning goals with an experienced estate planning attorney before you attempt to find your own work around to simplifying your estate.
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Disclaimer
Every legal issue is very unique. Accordingly, the information in this blog is intended as general education material and not as legal advice. If you think you may have a legal issue, you should consult an attorney.