QUARTERLY INSIGHTS FOR CLIENTS: Prenuptial and Similar Property Agreements

Who has Prenups?

“Prenups” for the famous – movie stars, heiresses, and professional athletes – make exciting fare for movies and tabloid magazines. Yet for couples with less notoriety, prenuptial and similar property agreements are important financial roadmaps to help them navigate a range of financial issues. What they cover can be as unique as the personalities and dynamics of the couple’s family and financial circumstances.

Apart from those we can read about in the press, who uses these agreements? In California, some examples include:

• People with separate private or family businesses, start-up ventures, and investment assets wishing to keep them from becoming partly community property during the course of marriage.
• High-earning individuals who worry about economic loss when putting a successful career on hold while raising a family.
• Those bringing children by a prior marriage into a new marriage, who want to agree on how the couple will support them during life and in the event of death.
• Couples where one member is wealthier or earns much more than the other, who want to spell out financial support terms in the event of divorce or death.
• Those remarrying later in life with their own children and grandchildren, who want certainty that their estate plans for their descendants will not be undercut by laws giving part of an estate to a new spouse.
• Mobile couples wanting to avoid laws in states or nations that would change how their assets and liabilities are shared in the event they move out of California.
• Those involved in a risky business or profession who want to protect a spouse from potential liability.

A financial roadmap tailored for you

Property agreements allow couples to define the financial rules for their relationship, instead of the default rules California law imposes. Hammering out an agreement before marriage or a new long-term relationship (e.g.; cohabitation or a registered domestic partnership) allows a couple to address important financial issues. This can be a healthy process, since unresolved financial issues can damage a relationship. It can be worth the effort, given the high incidence of divorce, the presence of step-children in so many marriages, the sensitivity to financial risk exposed in the recent recession, and the inevitability of estates passing to family and others at death.

Designing around California’s default rules

California’s default rules on separate and community property can be surprising. Most know that community property is divided equally on divorce, with each person keeping his or her separate property. However, it’s less well known that the increase in value of a business or investment brought to a marriage can become community property if one works in the business. The business owner wishing to avoid this can handle it through an agreement, before or after marriage.

Our divorce courts order ex-spouses to pay spousal support (alimony) based on many factors, including need, ability to pay, standard of living, and length of marriage. Instead of leaving this to the vagaries of a future court proceeding in the event of divorce, couples can agree in advance to waive or change the rules that apply to them. As long as the terms aren’t “unconscionable” at the time of divorce, they should be respected.

California law gives surviving spouses all of a deceased spouse’s community property and a share of his or her separate property. It also gives priority to the surviving spouse as the one to handle the estate of the deceased spouse. Many couples avoid these default rules by waiving their marital rights to estates in their property agreements, and creating estate planning documents to provide for children and grandchildren of a deceased spouse’s prior marriage.

Many property agreements deal with a couple’s home. Sometimes they waive the right to reimbursement California law gives on divorce to a person who put separate property into a community property residence. There is something so personal about the home that leads some couples to agree that their home will be community property, even though they agree not to accumulate any other community property.

Property agreements can address tax issues. Sometimes tax rules penalize couples who provide for each other, if not done properly. For example, if a spouse isn’t a U.S. citizen, giving that spouse assets can trigger gift or estate tax if done the wrong way. Other tax issues covered in property agreements include whether to file joint income tax returns, how to provide life insurance without estate tax, how to provide for a spouse and family with the lowest tax cost, and how to capture a valuable income tax basis “step-up” at death for joint assets. However, since changing separate to community property to achieve tax benefits usually is binding at divorce as well as at death, the adage of not letting the tax tail wag the dog applies.

Seeing that your agreement is enforceable

It isn’t unusual to read in the press that someone wealthy and well-known is embroiled in a contest about whether a prenuptial agreement will stand up. It doesn’t have to be that way. There are steps that can reduce the risk that an agreement won’t be binding. Always start work on the agreement early. The more time a couple has to carefully and unemotionally work through their agreement, free of pressure from an impending wedding date, the more likely it will end up being fair (and enforceable). Each person needs to hire his or her own independent lawyer. This helps ensure that neither can later have the agreement set aside by showing coercion in signing it. Each person must make full written disclosure of his or her assets and liabilities, which helps avoid any claim that the agreement is unenforceable. Finally, agreements that use clear, simple language stand up better, as do those that identify any rights that are being given up in the agreement.

For more information, contact Ellen Kahn, Monica Mazzei, Hilary Pierce, Sandra Price, or Jean Ryan.

This publication is for informational purposes only and is not intended to provide legal or tax advice, or to create an attorney-client relationship.

Pursuant to IRS Circular 230, unless expressly stated to the contrary, any tax advice is not intended and cannot be used to (i) avoid penalties under the Internal Revenue Code or (ii) promote, market or recommend any transaction or matter to another party.