Joint Revocable Trusts. The release of PLR 200101021 has stimulated considerable discussion concerning the use of joint revocable trusts in common law property states. The income tax goal of such trusts has been to try to obtain an adjusted basis of all of a couple's property at the death of the first spouse to die. To attempt to accomplish this goal, the couple in the PLR planned to form a joint revocable trust and fund it with jointly owned assets. The first spouse to die will have a testamentary general power of appointment over all of the trust's assets. At the death of the first spouse, assuming the power of appointment is not exercised, the trustee will fund the credit shelter trust up to the available applicable credit amount, and the excess would pass outright to the surviving spouse.

In PLR 200101021, the IRS reiterated its position that the use of such trusts in common law states will not provide for full an adjusted basis at the death of the first spouse. The Service reasoned that upon the death of the first spouse, the surviving spouse will make a completed gift of such spouse's entire interest in the trust. Section 1014(e) will apply to prevent the step-up basis for any trust property that is attributable to the surviving spouse's contribution to the trust and that is acquired by the surviving spouse, either directly or indirectly. Therefore, the Service concluded that this approach will not provide an adjusted basis of all the couple's property at the death of the first spouse. Interestingly, the Service also held that property passing to the credit shelter trust is treated as passing from the deceased spouse and not from the surviving spouse.

While the ruling does continue the Service's rejection of the use of this approach for adjusted basis purposes, it does encourage the use of joint revocable trusts in common law property states to accomplish several transfer tax goals. One commentator has pointed out that the theory of the ruling will allow for full funding of a credit shelter trust in situations where a couple does not own sufficient assets which, when divided equally for estate planning purposes, would allow for such full funding at the death of the first spouse. This full funding of the credit shelter trust is available because the joint revocable trust owns all of the family's property, and it is all included in the gross estate of the first spouse to die. (Pennell, Recent Developments in Estate, Gift and Income Taxation–2001, The Thirty-Sixth Annual Philip E. Heckerling Institute on Estate Planning.)

The Services' position in PLR 200101021 also supports the use of non-prorata funding at the death of the first spouse. Since all of the assets are owned by the joint revocable trust, the trustee may pick and choose among such assets when deciding which assets to use for funding of the credit shelter trust and the marital share or trust. The result is that the trustee can, in effect, fund the credit shelter trust with assets owned by the surviving spouse. This is similar to the non-prorata funding available to and used by trustees of joint revocable trusts in community property states. One apparent limitation is that the first-spouse-to-die's IRA probably cannot be owned by the joint revocable trust in the common law state. Therefore, that asset is not available for the above-described non-prorata funding.

Alaska Community Property Trusts. For residents of common law property states, Alaska's elective community property system is a superior alternative to PLR 200101021. Under this system, a resident of a common law property state may obtain two of the three above-described tax benefits: adjusted basis of all of the couple's community property at the death of the first spouse to die, and non-prorata funding. Further, the first-spouse-to-die's IRA may be used for such funding.

Non-residents may elect to use this system by forming an Alaska community property trust, which has an Alaska resident, bank or trust company as one of its trustees. An Alaska community property trust is really just a joint revocable trust, which holds the couple's designated community property. Joint revocable trusts are very common in all community property states. At the death of the first spouse to die, both halves of the couple's community property receive a full basis adjustment. Further, in 2001 Alaska adopted an amendment to its community property system to facilitate the use of non-prorata funding.

This new amendment clarifies that on the death of the first spouse to die, one-half of the community property reflects the share of the decedent and the other one-half reflects the share of the surviving spouse. Further, the Alaska Legislature adopted the aggregate form of ownership of community property. Upon the death of a spouse, the deceased spouse’s personal representative and the trustee of a community property trust each have the power to distribute property in divided or undivided interests and to adjust resulting differences in valuation. A distribution of community property in kind may be made on the basis of a non-prorata division of the aggregate value of the community property. This amendment was patterned after recent similar amendments adopted by California.

The goal of this new amendment is to allow for flexibility in the division of assets, after the death of the first spouse. For example, a couple’s assets may consist of an IRA account of approximately $1,000,000 plus an approximately equal amount of other assets. Assume that the spouses have designated all of the property as Alaska community property and the spouse who acquired the retirement assets dies first. A non-prorata division of the community property on an aggregate basis would allow the retirement assets to be transferred to the surviving spouse, as his or her one-half of the community property, and the other assets to be used to fund the bypass trust. The surviving spouse would rollover the IRA. If the spouse who was not the participant in the retirement account died first, the other assets would be used to fund the bypass trust, and the participant spouse would keep the retirement account as such spouse's one-half of the community property. Therefore, in either case the bypass trust would be fully funded, and the surviving spouse would own the IRA. Such ownership would allow for maximum tax-free growth and stretch-out of distributions. As a result, the non-prorata division would maximize both income tax and estate tax planning benefits.

Another new Alaska provision allows property such as IRAs to be transferred to an Alaska community property trust (and thereby characterized as community property) by designating the trust as the beneficiary of such property. This amendment will assist non-residents who are using Alaska community property trusts in characterizing such assets as community property.¹

1 Several thorough articles have been written describing Alaska's elective community property system and how it can be used by non-residents. M. Read Moore, “Coming Soon to Your State: Community Property,” The Thirty-Fourth Annual Philip E. Heckerling Institute on Estate Planning (2000). Shaftel and Greer, “Obtaining a Full Stepped-Up Basis Under Alaska's New Community Property System,” Estate Planning, March/April 1999, Vol. 26, No. 3. Blattmachr, Zaritsky and Ascher, “Tax Planning With Consensual Community Property: Alaska's New Community Property Law,” 33 Real Property, Probate and Trust Journal 615 (1999). These articles include a conflict of laws analysis of the use of Alaska's elective community property system by nonresidents. This analysis directly supports such use.