Wisconsin Lawyer
Vol. 79, No. 11, November 2006

Life Partners, Legal Strangers: Estate Planning for Unmarried Couples

• Figure 1: Steps to Avoid a Legal Challenge
• Figure 2: Issues in Cohabitation Agreements
• Figure 3: Cohabitation Agreement Scenario: "A Taxing Trade-off"
• Figure 4: Investment Property Scenario: "Larry the Landlord"

by Sverre David Roang & Brian T. Larson

vents in the news often stir up interest in estate-planning topics. In 2005, many attorneys reported a "Terri Schiavo" effect on the demand for living wills and health care powers of attorney. In recent months, Wisconsin residents have heard arguments for and against a proposed constitutional amendment to prohibit same-sex marriage and deny legal recognition of any relationship "substantially similar" to marriage. As this issue of Wisconsin Lawyer goes to press, the fate of the proposed amendment is not known, but it has drawn attention to the legal issues confronting unmarried couples. Attorneys should prepare for an increase in questions from unmarried couples concerning their planning. This article provides an overview of issues to be considered in answering those questions.

Representing Unmarried Couples

The term "unmarried couple" applies to a diverse group of clients. Included are gay and lesbian couples, as well as opposite-sex couples who have chosen not to marry. Like married couples, many unmarried couples wish to make joint estate plans.

What all of these clients have in common is a need for imaginative and individualized legal counseling. Unlike married couples, unmarried couples do not have default rules governing the classification of their property. Numerous tax advantages are kept out of their reach - from the Wisconsin Real Estate Transfer Fee marital exemption¹ to the estate and gift tax marital deductions under the Internal Revenue Code (the "Code").² They may encounter legal obstacles when trying to visit hospitalized partners or arrange funerals for deceased partners. Their estate plans also may be more susceptible to a legal challenge from estranged family members, particularly in the case of same-sex partnerships.

In this environment, an attorney representing an unmarried couple must draw on his or her knowledge of many areas of the law, as well as a specialist's knowledge of certain techniques. The attorney first will draw on traditional estate-planning techniques. Meanwhile, the attorney also must employ general property and contract law to arrange for the ownership and distribution of the couple's assets and income, and for property rights and support obligations for the partners and, perhaps, their children. Finally, for as long as gift and estate taxes remain a consideration, the attorney will require knowledge of the Code's intricacies to minimize tax liability. Typical plans often will be insufficient because the attorney cannot rely on the unlimited marital deduction.

The attorney representing an unmarried couple also must remain aware of ethical considerations involved in the representation. The planning is likely to plunge unmarried partners into areas in which their interests potentially are adverse, often more so than for married couples. In addition to arranging for the disposition of property at death, unmarried partners may need to establish support obligations and attempt a balancing (read: outright transfer) of assets during their lifetime. The gift tax is far more likely to be a factor when trying to balance the estates than in the representation of married clients. One partner may take on significant gift-tax liability in order to even out the estates. Meanwhile, the unmarried couple may make decisions affecting one or both of the partners' respective income-tax liabilities. Yet, unlike married couples, they must continue to file individual returns.

Nonetheless, joint representation is appropriate when it will "result in more economical and better coordinated estate plans prepared by counsel who has a better overall understanding of all of the relevant family and property considerations."³ While each situation is different, disclosure, informed consent, and written waivers usually will allow attorneys to proceed with joint representation of an unmarried couple, provided the attorney reasonably believes that he or she can provide competent and diligent representation to both partners.⁴

Overview of a "Simple" Estate Plan for Unmarried Couples

Should an unmarried couple's estate plan be expected to look different from estate plans typically prepared for single individuals? At first glance, no. An unmarried couple's estate plan will include the same core documents familiar to most attorneys. Wills are essential. So, too, are financial and health care powers of attorney. Care must be taken to name the appropriate agents and personal representative to make sure the clients' goals are met. Beneficiary designations for nonprobate transfers such as life insurance and retirement accounts must be reviewed and might need to be updated. A revocable living trust might be appropriate. When gift and estate taxes are a consideration, the plan may employ certain tax-minimization techniques considered standard for unmarried wealthy individuals. These include charitable deduction planning opportunities, life insurance, and valuation-related techniques.

However, the story does not end there. Numerous legal issues affect unmarried couples that do not apply to married couples or single individuals who are not in a committed, cohabiting relationship. These issues are driven largely by three factors. The first is the need to prepare for a legal challenge to the disposition plan, especially in the case of same-sex partners. Second are the special problems in gift- and estate-tax planning, along with a few opportunities, that arise for unmarried couples. The third factor concerns the lack of default rules governing the classification and division of property of unmarried cohabitants, during the relationship and at death or dissolution of the relationship.

Planning for a Legal Challenge

Estate planners tend to rely on legal formalities as the best hedge against a challenge to an estate plan. The prospect of a legal challenge typically is slim, especially when the plan disposes of property in more or less the same manner as would the law of intestacy.

With unmarried clients, that slim chance of legal challenge simply is not the case. Same-sex couples face will contests at a much higher rate than the population as a whole.⁵ In many situations, the money involved is of secondary importance.⁶ As a result, even clients with modest estates should be pressed to assess the likelihood of a challenge from their families. Figure 1 presents a list of steps that can be taken in anticipation of a legal challenge in high-risk situations.

Creation of a revocable living trust is a particularly useful step to take to protect against a challenge. On paper, trusts may be as susceptible to attack as wills.⁷ Yet in practice, a trust provides additional layers of protection and privacy that can frustrate a legal challenge. A court may be reluctant to declare a trust invalid if there is an established record of its use for managing property during life.⁸ After a client's death, a trust remains a private document. Thus, each of the beneficiaries is informed only of the amount of his or her share, not the total estate or the identity of the other beneficiaries, except in rare situations when estate-tax apportionment requires disclosure among them. Finally, in the event of a client's incapacity, a revocable trust can provide better protection against an unwanted guardianship proceeding. The trustee may be given a special power of attorney to transfer property into the trust, if necessary. Because a power of attorney may not be used to make testamentary dispositions, however,⁹ the client must have either executed a pour-over will or modeled the dispositive trust provisions to match those of the will.

Note also that unmarried couples may not avail themselves of the husband_wife privilege, which spouses may use to bar incriminating testimony as to private communications made during marriage.¹⁰ One commentator cautions estate planners with unmarried clients to "[i]magine the government's attorney examining the companion on the stand in a tax case about what the taxpayer has told him regarding various estate-planning techniques used to minimize taxes."¹¹ The best practice is to assume that conversations between unmarried partners are not privileged and to produce complete records that describe the steps in the planning process that clients may reference when facing such questioning.

Special Problems and Opportunities in Gift- and Estate-tax Planning

If the unmarried couple's combined estate is large enough to be subject to federal estate taxes, or significant Wisconsin estate taxes, a balancing of the estates may be required to take advantage of each partner's lifetime estate tax exemption. The goal of equalizing the couple's two estates is no different than similar planning for married couples. In this situation, however, a marital property agreement cannot be used to simply reclassify the property, nor is a deduction available for gifts between the unmarried partners. Therefore, equalization typically requires one party to make gifts to the other. The clients must understand that these gifts are final and irrevocable. Of course, valuation techniques will play an important role in the equalization process.¹²

A popular technique is to use joint tenancy to transfer assets at death, but problems lurk beneath the surface of this seemingly simple technique. For example, if one partner owns real property and simply adds the other partner's name to the deed, he has just made a gift of one-half of the property to the joint tenant. Or, if an unmarried couple purchases a home as joint tenants, but only one person pays the mortgage, each and every payment will result in a gift.

An additional trap lies in the estate-tax rules applying to joint tenancies between nonspouses. The Code presumes joint tenancies between spouses to be owned 50-50.¹³ However, the Code is not so kind to nonspouses: if a joint tenant dies, the entire value of property held in joint tenancy is included in his or her estate unless the personal representative can prove that the surviving joint tenant actually contributed to the acquisition of the asset.¹⁴ If this proof cannot be made, the asset then will be taxed twice: once in the decedent's estate and again in the estate of the surviving joint tenant. Thus, clients must be counseled to keep meticulous records of contributions to the joint property.

Also, unmarried couples cannot pool their exclusion amounts for purposes of the Code provisions concerning the exclusion of gain from the sale of a personal residence.¹⁵ They may need to restructure ownership of their home to take full advantage of both exclusions.

Despite these hurdles, a limited number of tax-planning opportunities are available to unmarried couples that are denied their married counterparts. These opportunities involve planning under Chapter 14 of the Code using techniques such as grantor remainder annuity or income trusts.¹⁶ Generally, these techniques are avoided when the remainder interest is held by a family member because special valuation rules effectively destroy the tax benefits of this planning. However, because a nonspouse partner is not considered a family member under the Code,¹⁷ these techniques can be very useful to transfer assets between unmarried partners, especially when interest rates are relatively low.

Contracts Between Legal "Strangers"

In addition to potential legal challenges and gift- and estate-tax considerations, unmarried couples face another layer of complexity in their estate plans. This third factor concerns the fundamental area of property rights. Of the three areas of complexity, the property rights factor carries the potential to affect the broadest array of clients; virtually all unmarried couples who choose to engage in joint estate planning do so because they have formed an economic unit together. Rarely will the economic unit entail a 50-50 division of assets and liabilities because no counterpart to the marital property regime exists for neatly classifying the property of unmarried couples. Nonetheless, unmarried couples find that their economic lives are entwined. They cohabitate. They buy groceries together. They raise children.

These couples must understand that they are, indeed, legal strangers. The Wisconsin Supreme Court has refused to extend legal protections to unmarried cohabitants under the state's "Family Code."¹⁸ In the absence of default rules, each unmarried couple must craft its own framework of protections and obligations. They must apply principles of property law and contract law in ways not normally considered relevant to an estate plan.

Cohabitation Agreements. A number of protections and obligations desired by a couple forming an economic unit may be established with an enforceable cohabitation agreement. This agreement may address issues of ownership, management, and control related to any or all of the couple's financial dealings. Provisions may be made for the sharing of some or all income and expenses. Typically, the agreement also addresses the rights of the parties when the relationship dissolves or when a partner dies or becomes incapacitated. Figure 2 lists some of the considerations that attorneys should take into account when crafting a cohabitation agreement.

Cohabitation agreements are enforceable under ordinary contract law rules.¹⁹ Generally, such agreements require fewer formalities than marital property agreements. Certain equitable considerations that are specific to the enforcement of marital property agreements, such as substantive fairness,²⁰ do not apply to agreements between unmarried parties. Also, even though best practices (and in the case of joint representation, ethical considerations) might dictate otherwise, cohabitation agreements can be enforced even if full financial disclosure is lacking.²¹ The movement toward applying marital-agreement-like standards to cohabitation agreements has not yet reached Wisconsin.²²

Nonetheless, the attorney preparing a cohabitation agreement should pay particular attention to issues of enforceability because developments in this area are relatively recent. Historically, cohabitation agreements were vulnerable to attack in Wisconsin for lack of consideration.²³ Services rendered under the agreement were presumed gratuitous.²⁴ In 1980, however, the Wisconsin Supreme Court made this presumption "irrelevant where the plaintiff can show either an express or implied agreement to pay for those services, even where the plaintiff rendered them `with a sense of affection, devotion and duty.'"²⁵ Thus, an exchange of household or business services will provide sufficient consideration for enforcement.²⁶

It is still true, however, that agreements violating public policy may be unenforceable. Consideration for sexual services will be inadequate on public policy grounds.²⁷ Also, if Wisconsin voters pass the constitutional amendment, the ban on any relationship "substantially similar" to marriage would create a new argument against cohabitation agreements. Attorney General Peg Lautenschlager underscored this point in her August 2006 explanatory statement outlining the effect of a "Yes" vote on the amendment. She stated that "[w]hether any particular type of domestic relationship, partnership or agreement between unmarried persons would be prohibited … would be left to further legislative or judicial determination."²⁸

From the attorney's perspective, an even greater challenge than trying to ensure the enforceability of the cohabitation agreement may be determining what it should say. The answer will vary depending on the clients' priorities and on tax considerations. When one partner has forgone economic opportunities for the benefit of the economic unit, the attorney might suggest that the agreement contain explicit protections on a termination of the relationship. Many unmarried couples assume that neither partner may receive support on termination of their relationship. They certainly have no right by statute, but support rights may be established by contract. If the agreement will include such provisions, the attorney should strongly advise the parties to have separate counsel because of the inherent conflict.

Unmarried partners may want to include a provision attempting to grant one another funeral decision rights, at least until a statutory method of appointing an agent for such purpose is available in Wisconsin.²⁹

The cohabitation agreement also should address taxation and other liabilities. Many couples unknowingly face gift-tax liability when one partner contributes more assets or income to the economic unit than does the other. If the difference is greater than the annual gift-tax exclusion (currently $12,000), the higher wage earner will incur gift-tax liability on the transfer. To make matters more complicated, Wisconsin has recognized an unjust enrichment cause of action for an unmarried cohabitant who contributes property and services to a relationship without adequate consideration.³⁰ Thus, care must be taken that the consideration is fair and adequate for both parties.

The contractual support obligation, which, much like alimony, may continue past termination of the relationship, comes at a significant cost: payment for services leads to income-tax liability for the service provider. This likely will be viewed by the couple as unfair double taxation of income and can create self-employment tax liability. For this reason, unmarried couples may want to balance the support "obligation" between income (which is a contractual obligation) and gifts (which, of course, are purely gratuitous). Figure 3 provides an example of unmarried partners balancing various tax considerations in forming their cohabitation agreement.

Investment Strategies. As an alternative to a support arrangement, a couple can use investment strategies to balance their estates. Finding the best approach is a fact-driven process.

One relatively simple method of achieving balance in an unmarried couple's estate is investment in income-producing property. Figure 4 provides an example of a couple using a real estate investment as a basis for their economic partnership. The couple may avoid the double taxation described earlier and channel income in the direction it is needed. Unmarried couples also can enter into a partnership to manage their investments. A valid business purpose is essential, because the Internal Revenue Service will not recognize a joint undertaking that is used merely to share expenses.³¹ If the couple establishes a business purpose, however, the partnership can offer significant flexibility over investments as well as some limited protection against creditors.

Conclusion

Much is the same in estate planning for unmarried couples as for married couples, but numerous aspects are different. This article is by no means an exhaustive discussion of the issues involved in developing plans for unmarried couples, but it highlights some of the principal concerns. As attorneys do for any other clients, perhaps the most important advice attorneys can give these "legal strangers" is to do one simple thing: plan.

Endnotes

Wisconsin Lawyer