Texas Asset Protection with Separate Property Agreements
Estate Planning Attorney • Serving Austin & Lakeway, Texas
"You are only half (1/2) as rich as you think you are"
There are many different ways you can hold title to assets. Here are just a few:
- Separate Property
- Community Property
General Rule in Texas: If you are married and reside in Texas, the general rule is that everything is equally owned 50/50 unless you can prove otherwise. This is because Texas is one of only 8 community property (CP) States in the United States. The other CP States are Arizona, California, Idaho, Louisiana, Nevada, New Mexico and Washington. The basic premise of the community property system is that each spouse in the marriage has an equal one-half interest in the property accumulated as the result of the efforts of either during the marriage. Therefore, CP is the default form of property ownership in Texas.
Where did this concept of Community Property (CP) originate?
The concept of community property has its roots in our Spanish heritage which explains why most of the CP States are located in southwestern US. CP was originally a means of protecting the family (i.e. the "community"). CP also enjoys favorable income tax advantages under the tax code in that when one spouse dies, the surviving spouse receives a new, increased cost-basis equal to the market value of the assets as of the date of death. This can result in the elimination of capital gains taxes to a surviving spouse.
Is CP ownership a problem in a lawsuit?
Yes. The drawback to community property in the context of Asset Protection Estate Planning (APEP) is that what is considered "ours" is also considered "theirs" if one of the spouses is sued by a creditor and the community assets are subject to attachment or seizure. When a malpractice judgment is rendered against the physician-spouse, the judgment creditor can seize and attach the following assets:
- the physician-spouse's 1/2 interest in the community estate
- the innocent-spouse's 1/2 interest in the community estate
- the physician spouse's separate property
There is no "Innocent Spouse Defense" in Texas. You lose both halves of the CP.
What can I do to protect my spouse's assets?
Protect the innocent-spouse's assets by converting them into his or her separate property (SP). The Texas Family Code provides that a malpractice judgment against the physician-spouse has no cause of action against an innocent-spouse's SP.
You have to do more than just title the account in the innocent-spouse's name as their separate property. You need to have a "written" agreement between spouses … a "Separate Property Agreement".
Also, for innocent spouses who already have SP (i.e. inheritance or assets brought into the marriage and kept separate), in Texas the interest and income produced by separate property is deemed community property without an agreement to the contrary. Therefore, if the CP income is left to commingle with the SP asset, the SP asset can be tainted and converted into CP which makes the entire asset subject to seizure from a lawsuit judgment.
In asset protection estate planning (APEP) this concept of asset titling is very important in create an estate plan and for funding various trusts or creating partnerships, equalizing estates for tax purposes and in the concept of protecting the estate in general.
What is a Separate Property Agreement?
A SP Agreement is merely a contract between Husband and Wife that decides how the spouses wish to hold title to assets (i.e. CP or SP). This Agreement can cover both existing assets as well as future assets or income, salary, etc. It is now possible in Texas to have a marriage without any community property. Many times the Agreement will also contain other provisions such as buy-out provisions in the event of divorce or dissolution of the marriage.
Can the agreement be changed or terminated later?
Yes. The Agreement is very flexible. It can either be amended or terminated. It only requires the written consent of both spouses. We draft our Agreements to provide property exhibits so that the exhibits can be easily changed in the future without the need to change the entire agreement.
- Exhibit "A" - Community Property
- Exhibit "B" - Wife's Separate Property
- Exhibit "C" - Husband's Separate Property
How will this affect my "Income Taxes"?
No affect. You can continue to file joint or separate returns as you desire.
Is there a gift tax problem in transferring assets between spouses?
No. The tax code provides for unlimited transfers between a husband and wife without gift tax.
Does the division of assets between spouses have to be "Equal"?
No. The division can be equal or unequal so long as the parties both agree; however, see below in the event of divorce.
What are the "downsides" of a Separate Property (SP) Agreement?
If you get divorced, a divorce judge has no jurisdiction over separate property. Therefore, if there are concerns with a future divorce, then you would only want to make the division 50/50.
You only get the "stepped-up" basis upon death on any community property plus any separate property of the deceased spouse. You do not receive a new basis on the surviving spouse's separate property.
How effective are the Agreements?
It is critical that the parties recognize that a court has no jurisdiction over a person's separate property in the event of divorce. It is also important to understand that a properly drafted and executed document entered into (1) voluntarily and (2) by fully informed parties with (3) full and complete disclosure is difficult to challenge in Texas. The agreements are, of course, amendable or revocable upon agreement of the parties. Merely destroying the document (you may be surprised how many clients try this) is insufficient to revoke the agreement.
What if the "Innocent-Spouse" gets sued?
In the event that the non-physician, innocent-spouse is the victim of a lawsuit judgment, then we have also preserved the separate property assets of the physician-spouse. The SP Agreement is not a 100% solution but merely a 1st step towards an APEP. Coupled with other techniques such as Family Partnerships, Childrens' Trusts, etc., complete protection can be had.
How does a SP Agreement work in conjunction with my Family Limited Partnership (FLP)?
A Texas FLP provides the maximum in asset protection on a domestic basis; however, if you have a malpractice judgment against you, with an FLP you still face the problem of the limitations of a "Charging Order" ("CO"). A CO allows the judgment creditor to seize any income that is distributed to the Partner against whom the CO is assessed.
The SP Agreement prevents the CO from being assessed against both spouse's interest in the FLP; otherwise, income could not be distributed to either spouse. The combination of a SP Agreement with a "PREFERRED" FLP allows distributions of income to one spouse but not necessarily both spouses in the event of a CO.
The information provided in this article is not to be construed as legal advice and should not be relied upon without the specific consultation with a professional.