When it comes to estate planning, how you hold property with others can have significant tax implications after you have passed on. Internal Revenue Code Section 2040 governs how joint ownership of property with right of survivorship is treated for federal estate tax purposes. The rules can catch even the most astute investors off guard. Whether it’s a stock portfolio shared between siblings or a family home owned with a spouse, the tax outcome hinges on various factors including who paid what for the asset, whether in the case of spouses both are U.S. citizens and whether there are well-maintained records tracing contributions.
This article will look at a real-world example involving property owned as joint tenants with right of survivorship. Joint ownership without the right of survivorship (for example, tenancy in common) is not the same as JTWROS and is governed by different rules. Other issues will also be explored, such as special provisions for married couples, including the nuanced case when both spouses are not U.S. citizens.
Joint Tenancy With Right Of Survivorship
JTWROS is a common ownership arrangement where, upon one owner’s death, the property passes automatically to the surviving joint tenant(s). Property owned in JTWROS avoids probate, which is the legal process of transferring a deceased person’s property to their designated beneficiaries. When one owner in a JTWROS passes away, that property does not go through probate and the JTWROS controls. What this means for example, is that provisions in a Will do not affect the survivor’s absolute right to the joint tenancy property.
Joint Ownership: The Case of Two Sisters and a Stock Portfolio
Imagine two sisters, A and B, who own a stock portfolio as joint tenants with right of survivorship. Sister A funded the entire portfolio with her own money, contributing 100% of the purchase price, while Sister B did not contribute at all. This was intended for estate planning purposes. Sister B passes away first when the portfolio is valued at $1 million. What happens to the portfolio for U.S. estate tax purposes?
Under the relevant provision of the tax law, IRC § 2040(a), the default rule is that the entire value of jointly held property is included in the estate of the first joint tenant to die, unless the surviving tenant can prove they contributed to its acquisition from their own funds. The law calls this “tracing” the consideration, and it’s all about documenting who paid what. Here, if it can be shown that Sister A provided 100% of the funds, none of the portfolio’s value, $1 million at the time of B’s death, is included in Sister B’s estate. Sister A inherits the portfolio via survivorship, and B’s estate tax is not impacted whatsoever by this asset.
An example from Treasury Regulation § 20.2040-1(c) adds clarity: “If the decedent furnished no part of the purchase price, no part of the value of the property is [included in their estate.]
.” The Regulation makes clear that the decedent’s estate must be able to demonstrate that the decedent furnished no part of the consideration. If the estate is armed with bank statements or brokerage records, Sister A’s complete funding of the stock portfolio ensures that Sister B’s estate remains shielded from federal estate tax liability on this asset.
Joint Ownership: Unclear Contributions Result In Messy Estate Administration
The “consideration furnished” rule under § 2040(a) applies to most joint ownership scenarios, for example property owned jointly with right of survivorship amongst siblings, business partners, or friends. The result is proportional inclusion in the deceased joint tenant’s estate. If Sister B had contributed 20% to the stock portfolio and A the remaining 80%, then 20% of the portfolio’s value would be included in B’s estate upon her death.
The IRS presumes the full value belongs in the decedent’s estate unless evidence proves otherwise, placing the burden on survivors or executors to dig up receipts, canceled checks, or other proof. No documentation? The entire asset could get taxed, even if the decedent did not contribute or barely pitched in.
This rule ensures fairness by taxing only what the deceased actually “owned” economically. While promoting fairness, the rule can, and often does, complicate estate administration. The complications can be avoided if the parties keep good records. For high-value assets such as real estate or investment accounts, meticulous record-keeping is critical.
Joint Ownership: Spouses Are Treated Differently
What if the joint owners are a married couple? Code Section 2040(b) offers a simpler, more taxpayer-friendly approach for so-called “qualified joint interests” between spouses. Unlike the tracing complexity of Section 2040(a), the rule here is straightforward: only one-half of the property’s value is included in the estate of the first spouse to die, regardless of who paid for it.
A “qualified joint interest” is property held by a husband and wife as either joint tenants with right of survivorship or tenants by the entirety (this is a similar property ownership arrangement recognized in the laws of some states).
Thus, for example, if the husband provided all of the funds upon creation of a joint bank or brokerage account with his spouse, and he was the sole contributor of additional funds thereafter, upon death, only one-half the value of the account is included in his estate even though the wife did not contribute any funds whatsoever.
In order for this rule to apply both spouses must be U.S. citizens and they must be the only joint tenants of the property.
A Big Nuance, Joint Ownership With A Non-U.S. Citizen Spouse
The rules change and become complicated again when the surviving spouse is not a US citizen. This should not come as a surprise. Many areas of U.S. tax law become highly complicated when both spouses are not U.S. citizens. It is often for this reason that such couples keep most assets separate if possible.
The simple 50% rule does not apply if the surviving spouse is not a citizen of the United States at the time of the decedent’s death. Instead, the decedent’s estate must employ the “tracing rule” mentioned earlier to determine the amount includible in the deceased spouse’s estate. The burden of proof is on the estate executor to prove the amount of contributions by each spouse.
Without adequate records and proof, the jointly-owned (non-community) property passing to a non-U.S. citizen spouse is generally fully includible in the deceased spouse’s estate. The unlimited marital deduction will not apply if the surviving spouse is not a U.S. citizen and cannot minimize the estate tax bite! This is one to watch out for.
Summary Points for Estate Planning
Joint ownership can be a convenient way to pass assets without a will, but IRC § 2040 reminds us it’s not tax-neutral. For non-citizen spouses, or non-spouses like Sisters A and B, keeping records of who paid what is critical to minimizing estate tax exposure. For married couples when both spouses are U.S. citizens, the 50% rule simplifies matters.
There are a few lessons here. First, whether you’re sharing the purchase of stocks with a sibling or a home with a spouse, consult a tax professional to align your ownership structure with your estate goals. Second, good record-keeping tracking contributions is very important. Code Section 2040 doesn’t forgive sloppy paperwork—or missed opportunities.
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This communication is for general informational purposes only. It is not intended to constitute tax advice or a recommended course of action. Professional tax advice should be sought as the information here is not intended to be, and should not be, relied upon by the reader in making a decision.
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