In July 1983, the National Conference of Commissioners on Uniform State Laws promulgated the Uniform Marital Property Act (UMPA). Under the procedures of the Conference, promulgation constitutes approval of a proposed uniform law and a recommendation that it be adopted by all of the stated. The vote for promulgation was close. 

The Uniform Marital Property Act was the work product of a committee constituted in 1981. The committee's Prefatory Note to the Act described it as paralleling community property laws but following a sui generis approach utilizing useful common law as well as community property concepts. The note emphasized that the Act was rooted in the sharing ideal which is at the center of the historical community property approach to the ownership of property by married couples.

A group in Wisconsin had been working on a marital property legislation based on the sharing idiom prior to the formation of the UMPA committee. It continued that work throughout the drafting period of UMPA.

Those efforts continued after promulgation and Wisconsin adopted an act with many of the UMPA provisions effective in 1985. It is the only state to have adopted the basic substance of UMPA prior to 1998. Developments subsequent to the Wisconsin adoption led to Internal Revenue Service acceptance of that legislation as community property for Internal Revenue Code purposes and Wisconsin is now considered a community property state for income, estate, and gift tax purposes as well as for intraspousal property rights and obligations during marriage. Wisconsin thus joined the other eight American community property states of Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, and Washington. According to 1997 population estimates, some 76,011,000 people live in these states. This is slightly more than 28 percent of the estimated U.S. population of 276,636,000.

After the 1983 promulgation, there was interest in UMPA in a number of states other than Wisconsin. This occurred at the level of legislative committees, legislative study groups, or variously composed citizen groups. Included among these were Colorado, Utah, Nebraska, Kansas, Illinois, Michigan, Indiana, New York, and Connecticut. The National Organization of Women gave the legislation serious consideration, and there was a predictable flurry of activity among law reviews and in other professional literature. The American Bar Association gave the Act very limited approval and its Real Property, Probate, and Trust Law Section withheld approval of its provisions. In most quarters there were strong debates, mirroring those which had occurred before the commissioners. However one characterizes the advent and reception of the suggested Act, no legislation encompassing UMPA's scope developed in states other than Wisconsin, and after the late 1980s, interest in it waned and it became dormant until passage of the Alaska Community Property Act on May 28, 1998.

Encompassing much of the language of UMPA, but utilizing the semantics of community property, rather than marital property, the Alaska Act manifests a possible renewed interest in using sharing as the organizing principle of economics. However, it creates a new approach not a part of UMPA or the laws of any other community property state. That approach makes the application of the sharing principle wholly voluntary. It encourages the adoption of the Alaska regime by nonresidents as well as Alaska residents. It can be seen as a somewhat felicitous method for nonresidents to regulate their marital property rights, possible preferable to the use of highly detailed and often highly expensive pre- or post-marital agreements, with the potential of making some tax advantages available as well. 

Historically, community property is divisible into two types. One of these is known as a legal community and the other is a conventional community. A legal community constitutes a form of marital regime for all marriages in a discrete jurisdiction, decreed by governing statutory or constitutional provisions. A conventional community (probably better described as a contractual community) is one sanctioned by a particular jurisdiction but made voluntary for married persons in the jurisdiction. The UMPA provisions were those of a legal community. In North America, a modified form of conventional community property exists in Quebec, and such a system was used but quickly abandoned by Oklahoma in mid-century. 

With its provisions, Alaska has now adopted its particular form of conventional or contractual community property. Direct legislation establishing the permissive provisions of conventional community as the exclusive route to a sharing regime currently exists in no other jurisdiction in the United States.¹ The highly ingenious Alaska approach is well covered in the accompanying article by David G. Shaftel and Stephen E. Greer. A unique and challenging aspect of the Alaska legislation is its permissive application to property owned by spouses domiciled in other jurisdictions. This novel approach actually makes a good deal of the substance of the UMPA drafting available on a widespread but wholly voluntary basis. If in fact favorable tax interpretations should attach to the Alaska legislation, as described in the article, it is possible that the dual advantages of a sharing approach and favorable tax treatment could actually become available and useful in many estate planning situations not only in Alaska but in other separate property jurisdictions. Of significance is that domiciliaries of any separate property states who feel that a sharing approach is desirable will now have a statutory framework for adoption of such an approach that offers stability and structure.

William P. Cantwell

¹Formation of a conventional community by elective or voluntary action is not the only aspect of community property law that offers options to affected marital partners. For example, in making its transition, Wisconsin included voluntary "opt-in/opt-out" provisions which were necessary to protect pre-adoption vested interests. Similar protections would be necessary and appropriate in any other jurisdiction making a transition analogous to that made by Wisconsin. Another element of a voluntary election is or can be involved in changes in domicile involving community and separate property jurisdictions. In addition, the domiciliaries of existing community property states have certain opt-in opt-out privileges by contract

I. INTRODUCTION

In the past decade, the Alaska legislature has begun to look for ways to decrease the state's economic dependence on natural resources. In 1997, the Alaska legislature responded positively to the financial community's proposals that Alaska become a trust administration center. The result was the Alaska Trust Act, which authorized the formation of self-settled spendthrift trusts and abolished the rule against perpetuities. In 1998, the legislature continued this effort by enacting a variety of trust administration provisions, and the Alaska Community Property Act.²  

Prior to 1998, nine states had community property systems in effect.³ All of these existing community property states have mandatory community property systems where the default property system is community property. However, a married couple in such a state may opt-out of the community property system, with respect to some or all of their property, by executing a community property agreement.  

In 1998, Alaska became the tenth community property state and, in contrast, adopted an optional community property system. That is, the default property system is separate property. However, a couple may opt-in to a community property system. Both Oklahoma and Oregon adopted optional community property systems, and then subsequently repealed them.⁴ Quebec's community property system has been optional since 1970.⁵ The initial discussions of the approach for the Uniform Marital Property Act ("UMPA") considered an opt-in system. However, the draftspersons ultimately changed their approach to a mandatory community property system.⁶ 

Residents and nonresidents of Alaska may desire to elect the Alaska community property system for some or all of their property. This article first discusses the various issues involved in whether election of Alaska's community property system, by residents or nonresidents, will qualify the couple for the income tax benefit of full adjustment of basis at the death of the first spouse. A suggested upside/downside analysis is provided for the planner. Also, the non-tax property rights differences between community property and separate property systems are compared. Finally, the Administration's proposed legislative changes are analyzed.

²This new 1998 legislation is discussed in Shaftel, New Developments in Alaska Trust Law, Estate Planning, February 1999.

³Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

⁴1939 Okla. Sess. Laws Ch. 62, art. 2, §2 (repealed 1945); 1943 Or. Laws ch. 440, §2 (repealed 1945).

⁵Que. Civ. Code art. 1964 (Y. Reynaud & J. Baudonin eds. 1974). Quebec's default system is the "legal regime of partnership of aquests," which is closer to its community property system than to its separate property system.

⁶As recalled by William Cantwell, Reporter, Uniform Marital Property Act Committee of the National Conference of Commissioners on Uniform State Laws. A thorough analysis of the history of the optional community property system, and the policy arguments in favor of states adopting this system, are presented by Professor Richard W. Bartke in Marital Sharing--Why Not Do It By Contract?, 67 Geo. L.J. 1131 (1979).

II.  THE TAX MOTIVE: FULL STEPPED-UP BASIS -- LACK OF PARITY BETWEEN SEPARATE PROPERTY AND COMMUNITY PROPERTY STATES.

After the death of the first spouse, residents of community property states have a distinct income tax advantage over residents of separate property states. Assume a couple's property is owned approximately equally between them. In a separate property state, at the death of the first spouse, the basis of the decedent's assets is adjusted to the fair market value of such assets at death.⁷ In a community property state, the decedent's one-half share of the community property is adjusted pursuant to I.R.C. §1014(b)(1), as described above, and then §1014(b)(6) provides a similar adjustment for "...property which represents the surviving spouse's one-half share of community property held by the decedent and the surviving spouse under the community property laws of any State...if at least one-half of the whole of the community interest in such property was includable in determining the value of the decedent's gross estate...." Therefore, at the death of the first spouse, the basis of all community property, regardless of whether held by the decedent or the decedent's spouse, is adjusted.⁸ 

This lack of parity can produce significant income tax differences if the surviving spouse sells the assets during the period between the first spouse's death and the surviving spouse's death. Furthermore, the sale of assets during this period of the surviving spouse's lifetime is likely. The family business may need to be sold due to the decedent's lack of participation, or pursuant to an existing buy-sell agreement. Real property may be considered burdensome to manage. Market conditions may dictate the sale of assets before an expected downturn.

Alaska's Opt-In Community Property System is designed to remedy the above-described inequity. The goal of the Alaska legislature is to allow taxpayers to obtain the above-described community property full "step-up" in basis, to the extent they so desire .⁹  

⁷I.R.C. §1014(b)(1). Income in respect of a decedent (IRD) is excepted from this adjustment. (I.R.C. §1014(c).)

⁸I.R.C. §1014(b)(6) was enacted in 1948 as part of Congress's effort to achieve geographical equalization of income, gift and estate tax treatment between the residents of separate property and community property states. Congress was responding to the argument presented by residents of community property states that generally the husband held title to all of the family assets. Therefore, if a husband died in a separate property state, all of these assets would receive a basis adjustment. However, if the husband died in a community property state, only one-half of the assets would receive such adjustment. Consequently, I.R.C. §1014(b)(6) was enacted to "equalize" the basis adjustment treatment for married couple's regardless of whether they lived in separate property or community property states. S. Rep. 1013, 80th Cong., 2d Sess. (1948), 1948-1 C.B. 285, 301-306; General Explanation of the Administration's Revenue Proposals, Dept. of the Treas., Feb. 1999.

⁹Sponsor Statement for H.B. 199, 1998 Alaska Legislature.

III. THE ALASKA COMMUNITY PROPERTY ACT 

Prior to analyzing the issues which this new Act presents, it is important to review the basics of Alaska community property.

A. The Act And Its "Election." The Alaska Community Property Act,¹⁰ effective May 23, 1998, is based upon the Uniform Marital Property Act,¹¹ which had previously been adopted only by Wisconsin. However, unlike the Uniform Act, the Alaska Act is an optional community property system. As a general rule, Alaska's established separate property system will apply to marital property.¹² However, spouses may elect to have some or all of their property treated as community property.¹³ If both spouses are domiciled in Alaska, the election occurs through the execution of a community property agreement or community property trust.¹⁴ If one or both spouses are not domiciled in Alaska, then this election can be made by the transfer of property to a community property trust.¹⁵ 

B. Community Property Agreement and Trust. The community property agreement and community property trust have many similar characteristics. The spouses may agree on (i) the rights and obligations in the property, notwithstanding when and where the property is acquired and located; (ii) the management and control of the property; (iii) the disposition of the property on dissolution, death or another event; (iv) the choice of law governing the interpretation of the instrument; and (v) any other matter that affects the property and does not violate public policy.¹⁶ In addition, in a community property agreement, the spouses may agree (i) on making a will, trust, or other arrangement to carry out their agreement; and (ii) that upon the death of either of them, the property passes without probate to a designated person, trust, or other entity by non-testamentary disposition.¹⁷ With a few exceptions, a community property agreement or community property trust can vary any of the provisions of the Alaska Community Property Act.¹⁸ Extensive provisions are included to protect the rights of creditors of a spouse, and bona fide purchasers dealing with the spouses.¹⁹ An agreement or trust may not be enforced against a spouse who proves that the instrument was unconscionable when made, was not executed voluntarily, or the spouse against whom enforcement is sought was not given a fair and reasonable disclosure of the assets and financial obligations of the other spouse.²⁰ The Act imposes a "good faith" conduct requirement on the spouses.²¹

In order to provide a nexus with Alaska for nonresidents who desire to use an Alaska community property trust, a number of additional requirements are added. At least one trustee must be an individual domiciled in Alaska, an Alaska trust company or bank.²² Other co-trustees may be nonresidents and may include the spouses. The Alaska trustee's powers must include maintaining records for the trust on an exclusive or a non-exclusive basis, and preparing or arranging for the preparation of any income tax returns that must be filed by the trust, again on an exclusive or non-exclusive basis.²³  

C. What Is Alaska Community Property? A spouse has a present undivided one-half interest in Alaska community property.²⁴ The couple may "pick and choose" what property they desire to be community property. However, if a community property agreement provides that all property acquired by either or both spouses during marriage is community property, then the property of the spouses acquired during marriage and after the determination date²⁵ is presumed to be community property.²⁶ The Act does not require that each spouse's earnings be community property. When all property is agreed to be community property, the "income" earned or accrued by a spouse or attributable to property of a spouse during marriage and after the determination date is community property.²⁷ Unless varied by the agreement or trust, the following property is not considered community property: property acquired prior to the determination date; property acquired by gift or inheritance; appreciation or income from a spouse's separate property; or a recovery for damages to property or from personal injury.²⁸ Special provisions focus upon life insurance policies and proceeds.²⁹ Upon divorce, community property will be equitably divided between the spouses.³⁰ If the words "survivorship community property" are used, then on the death of a spouse the ownership rights of that spouse vest solely in the surviving spouse by non-testamentary disposition.³¹

D. Management and Control. The general management and control of Alaska community property depends upon title and agreement. A spouse acting alone may manage and control: community property held in that spouse's name alone; a policy of insurance owned by that spouse; deferred compensation benefits that accrue as a result of that spouse's employment; and community property held in the name of both spouses in the alternative ("or").³² Community property held in the names of both spouses other than in the alternative is managed and controlled by both spouses acting together.³³ Management and control of community property held in a trust is determined by the terms of the trust.³⁴ An individual's right to manage and control does not include the right to make gifts to third parties, except for relatively nominal amounts.³⁵ However, if both spouses report such a gift on their federal gift tax returns, or if the non-donor-spouse consents to "split gifts" on the donor-spouse's gift tax return, then this is treated as the spouses acting together in making the gift.³⁶ 

¹⁰New Chapter 75 of Title 34 of the Alaska Statutes.

¹¹9A U.L.A. 21 (1983).

¹²A.S. 34.77.030(a).

¹³Id.

¹⁴A.S. 34.77.060, .090, .100.

¹⁵A.S. 34.77.060(b).

¹⁶A.S. 34.77.090(d), .100(d).

¹⁷A.S. 34.77.090(d)(4) and (5).

¹⁸A.S. 34.77.020.

¹⁹A.S. 34.77.070, .080.

²⁰A.S. 34.77.090(g), (h), .100(f).

²¹A.S. 34.77.010.

²²Some reviewers of the Act have asked whether the community property character of the trust's property would change if the Alaska trustee subsequently resigns or is replaced, with the result that no Alaska trustee is in office.

²³A.S. 34.77.100(a).

²⁴A.S. 34.77.030(c).

²⁵The "determination date" is the later of the date of marriage, or the effective date of a community property agreement or trust. A.S. 34.77.900(7)

²⁶A.S. 34.77.030(b).

²⁷A.S. 34.77.030(d). However, "income" does not include wages and earnings unless specifically so defined in a community property agreement.

²⁸A.S. 34.77.030(f), (g).

²⁹A.S. 34.77.120. Careful funding of life insurance trusts holding policies on one spouse's life will be necessary under the new Act. I.R.C. §2036(a) could apply if the surviving spouse has a beneficial interest and if community property was contributed to the trust. To avoid this consequence, the settlor-insured should contribute separate property to the trust. If such property is not available, the couple should convert community property to the separate property of the settlor-insured. (Marital Property Law in Wisconsin, §10.35, State Bar of Wisconsin CLE Books (April 1995)).

³⁰A.S. 25.24.160(d).

³¹A.S. 34.77.110(e).

³²A.S. 34.77.040(a).

³³A.S. 34.77.040(b).

³⁴A.S. 34.77.040(c).

³⁵A.S. 34.77.040(e), .050.

³⁶A.S. 34.77.050(c).

IV. WILL ALASKA COMMUNITY PROPERTY QUALIFY FOR A FULL BASIS ADJUSTMENT UNDER I.R.C. §1014(b)(6)? 

A. A Present Vested Interest. There are varying forms of community property regimes across the world. There are also significant differences between the community property systems of the nine states of the United States which have adopted community property. In view of these differences, the United States Supreme Court has stated that the community property law of the jurisdiction in question must give each spouse a "present vested interest" in the property of the community before that property will be considered community property for U.S. tax purposes.³⁷

B. The United States Supreme Court Decision In Commissioner v. Harmon. The Internal Revenue Service agrees that the Wisconsin version of the Uniform Marital Property Act creates a community property system for federal income tax purposes.³⁸ However, Alaska has modified that Act by making it elective. Alaska's new opt-in community property system is the only such elective system presently in effect in the United States. Prior to the allowance of joint income tax returns, Oklahoma briefly experimented with a similar optional system during the period from 1939 through 1945. Oklahoma's legislature was motivated by the much larger income tax burden upon a wage earner spouse in a common law state than upon a couple in a community property state who could each report one-half of the income. Under Oklahoma's opt-in system, the Harmons elected to have that state's new community property law apply to them. They each reported one-half of their income on their separate returns. The I.R.S. challenged this splitting of income, arguing that the husband was taxable on all of the income derived from his earnings. The United States Supreme Court, in Commissioner v. Harmon,³⁹ upheld the Commissioner's position. The Supreme Court's main concern was that the consensual nature of Oklahoma's opt-in community property system in effect allowed the couple to assign one-half of the husband's income to his wife in violation of the principles established in Lucas v. Earl.⁴⁰ The majority found that the Harmons' agreed election of community property status under Oklahoma's opt-in system was so similar to the Earls' contractual agreement (that the husband's earnings would be joint property), that the assignment of income doctrine should be similarly applied. In its opinion, the majority emphasized the distinction between a consensual (opt-in) and a legal (opt-out) community property system. 

The key issue here is whether Harmon's consensual versus legal distinction should be limited to assignment of income situations. Certainly, a taxpayer's ability to shift the burden of income taxes by agreement must be controlled. The consensual versus legal distinction has served this purpose. However, the control of assignment of income is no longer necessary in the marital situation, since joint returns were allowed in 1948.  

More importantly, the consensual versus legal distinction becomes very tenuous in the community property area. This was pinpointed by Justice Douglas in his dissent in Harmon. He states that:  

"in some of the so-called "legal" community property states separate property of one spouse may be converted by contract or deed into community property or vice versa."⁴¹ This conversion ability allows residents of community property states to opt-out of or opt-into the state's community property system by execution of a community property agreement.⁴² The courts and the Internal Revenue Service have given tax effect to such community property agreement optional changes.⁴³ Even though residents of the nine community property states may opt-out of or opt-in to the system at will, the Service has not attempted to deny them the separate reporting of taxable income, nor the full basis adjustment of I.R.C. §1014(b)(6). It seems unfair for the Internal Revenue Service to acquiesce in this "consensual" characteristic of existing community property states, yet deny it to elective community property systems. 

Therefore, Harmon, and its consensual versus legal distinction, should probably be limited to the assignment of income context. This may well be the Service's position. In Revenue Ruling 77-359,44 a Washington couple agreed to convert their separate property to community property. The Service ruled that such conversion was effective for federal tax purposes, and then added: 

To the extent that the agreement affects the income from separate property and not the separate property itself, the Service will not permit the spouses to split that income for Federal income tax purposes where they file separate income tax returns. (See Comm'r v. Harmon, 323 U.S. ⁴⁴ (1944), 1944 C.B. 166.)⁴⁵ 

The conservative planner may wish to "draft around" Harmon's assignment of income issue. A provision could be included in the community property agreement or trust requiring the couple to file joint income tax returns during the existence of such instruments. 

In summary, the expansion of Harmon to the basis adjustment area seems unwarranted. Assignment of income is not involved, and the consensual versus legal distinction is not viable in the community property context.<sup>46 

37</sup>See, Poe v. Seaborn, 282 U.S. 101 (1930), where the court held the community property laws of Washington gave each spouse a present vested interest in the other's earnings and thus income splitting was permitted; Hopkins v. Bacon, 282 U.S. 122 (1930); Bender v. Pfaff, 282 U.S. 127 (1930); Westerdahl v. Comm'r, 82 T.C. 83 (1984); Rosenkranz v. Comm'r, 65 T.C. 993 (1976); Zaffaroni v. Comm'r, 65 T.C. 982 (1976); Angerhofer v. Comm'r, 87 T.C. 51 (1986); see and compare U.S. v. Robbins, 269 U.S. 315 (1926), where the court held the community property laws of California at the time gave the wife a mere expectancy in the community property and this was insufficient to permit a splitting of income for federal income tax purposes.

³⁸Rev. Rul. 87-13, 1987-1 C.B. 20.

³⁹323 U.S. 44 (1944).

⁴⁰281 U.S. 111 (1930).

⁴¹323 U.S. at 54.

⁴²Justice Douglas was referring to Washington and California. (323 U.S. at 54.) However, it appears that all states with a community property system allow conversion between community property and separate property (except for Texas which only allows an opt-out)(802 Tax Mgmt. (BNA) at A-3 to A-4, and A-13 (1995)).

⁴³Massaglia v. Comm'r, 286 F.2d 258 (10th Cir. 1961) involved a New Mexico couple who entered into an agreement converting community property to separate property. The 10th Circuit upheld the I.R.S.'s denial of a full step-up in basis to the surviving spouse. Crosby v. Comm'r, 20 T.C.M. (CCH) 1422 (1961) held similarly in regard to a Washington agreement. Fleming v. Comm'r, 47 T.C.M. (CCH) 1281 (1984), held that a New Mexico agreement validly reclassified the husband's community property income into his separate income for tax purposes. Revenue Ruling 73-390, 1973-2 C.B. 12, and Revenue Ruling 73-391, 1973-2 C.B. 13, held that California couple's may by agreement reclassify earned income and investment income, respectively, from community property to separate property.

⁴⁴1977-2 C.B. 24.

⁴⁵Proponents of the Alaska Community Property Act have asserted other arguments for not applying Harmon to the basis adjustment area. (See Jonathan G. Blattmachr, in "The New Alaska Community Property Act and Other Important Changes That Affect Our Clients," Alaska CLE entitled "Tax Planning With Consensual Community, Alaska's New Community Property Law," Anchorage, AK (Aug. 4, 1998), page 29).

⁴⁶There is one case in which a U.S. district court in Oklahoma allowed a full adjustment in basis for a period which overlapped both Oklahoma's opt-in and opt-out community property systems. In 1943, the couple acquired property as joint tenants and elected into Oklahoma's consensual system. In 1948, after Oklahoma had changed to a mandatory community property system, the husband died. The court evidently relied upon the 1943 election to characterize the couple's joint tenancy property as community property under the mandatory system. (McCollum v. United states, 58-2 U.S.T.C. §9957).

V. MUST "EARNINGS" BE INCLUDED TO QUALIFY AS COMMUNITY PROPERTY?

Another issue confronting the Alaska Act is whether the absence of a vested property interest in the other spouse's earnings precludes community property recognition for tax purposes. Our community property roots lie in the "ganancial" Spanish system which defines community property as the community of acquests and gains during marriage.⁴⁷ Fundamental to any understanding of the ganancial system of community property is the need to differentiate between lucrative title and onerous title. Property acquired by lucrative title is acquired through gift and inheritance.⁴⁸ Unless transmuted, this property is not community property. Property acquired by onerous title is received in exchange for the time, labor, effort or skill of the spouses or for other valuable consideration.⁴⁹ Unless elected out, property acquired onerously during marriage is community property and lies at the heart of the Spanish community property system and hence our own.⁵⁰  

Comparison of the Uniform Marital Property Act and the Alaska statute indicates a significant difference in the definition of "income." UMPA includes a spouse's wages and earnings; the Alaska Act does not.⁵¹ Alaska residents may execute a community property agreement in which they agree that their earnings will be community property. Nonresidents may only elect community property status through formation of a trust and contribution of assets to the trust. Thus, they cannot commit to future earnings being classified as community property. At most, they can voluntarily contribute their net earnings to the trust after such earnings accrue. 

Does the absence of a vested property interest in the other spouse's earnings preclude community property recognition for tax purposes? In his dissent to the Harmon decision, Justice Douglas, wrote: 

The distinctive feature of the community property system is that the products of the industry of either spouse are attributed to both; the husband is never the sole "owner" of his earnings; his wife acquires a half interest in them from their very inception. 1 de Funiak, Principles of Community Property (1943) §239.⁵² 

The 10th Circuit in Hammonds v. Commissioner stated "It is a fundamental postulate of the community property system that whatever is gained during coverture, by the toil, talent or other productive faculty of either spouse, is community property. Indeed, the sole source from which the community estate must arise is the toil, talent or other productive faculty of the spouses and the earnings and income from community property itself."⁵³ Also the Service apparently thinks earnings are of some importance. In ruling favorably on the community property status of the Wisconsin Act, the Service noted that under the Act marital property (community property) included income derived during marriage.⁵⁴ Finally, a leading commentator concludes that a system of acquests and gains making the earnings and gains of the husband community property but not those of the wife is nothing more than a pretense of being a community property system.⁵⁵ Therefore, an argument can be made that a system which by its default rules does not give each spouse an immediate vested ownership interest in the other's wages and earnings is not a community property system. 

In response, and in defense of the Alaska system, the argument is that the scope of inquiry should be limited to an examination of the spouses' rights in the subject property. In other words, if the spouses' rights in the Alaska community property are similar to the rights enjoyed by spouses in the nine other community property states, then there is no meaningful reason for denying the classification of the property as community property. Furthermore, as discussed above, all nine other states allow a couple to agree that certain property, such as their earnings, will not be characterized as community property. Such flexibility does not prevent them from being recognized as valid community property systems for federal income tax purposes.

⁴⁷William Q. de Funiak and Michael J. Vaughn, Principles of Community Property, §1 (2d ed. 1971).

⁴⁸Id., §62.

⁴⁹McClanahan, Community Property Law In the United States, §6.1 (1982).

⁵⁰de Funiak et al., supra note 43, at §66.

⁵¹Compare A.S. 34.75.900 (12) with UMPA §1 (10). By purpose or coincidence, by excluding earnings from the definition of income, the Alaska legislature effectively removed the Alaska Act from the principal holding of Harmon; i.e., the elective nature of the Oklahoma system equates to a transfer of rights constituting an "assignment of income" governed by Lucas v. Earl.

⁵²Comm'r v. Harmon, 323 U.S. 44, 56 (1944).

⁵³106 F.2d 420, 422 (10th Cir., 1939).

⁵⁴Rev. Rul. 87-13, 1987-1 C.B. 20.

⁵⁵de Funiak et al., supra note 46.

VI. WILL PROPERTY CONTRIBUTED BY NONRESIDENTS TO AN ALASKA COMMUNITY PROPERTY TRUST QUALIFY? 

If nonresidents of Alaska who reside in a state with a common law property system contribute property to an Alaska community property trust, which state's property law system should apply to the trust and its assets? Analysis of this issue is based upon the principles provided by the Restatement (Second) of Conflict of Laws, in its general principles, and sections discussing marital property, contracts and trusts. 

The trust property will normally be intangible personal property, broadly characterized in Restatement terminology as "movables."⁵⁶ In the absence of a choice of law provision, the classification of movables is usually determined by the law of the domicile at the time of acquisition.⁵⁷ However, couple's utilizing an Alaska community property trust will invariably include a choice of law provision indicating their intent that the property be classified as community property under Alaska law. The relevant issue is whether the couple's choice of law will be upheld. Assuming there is no local statute which requires the forum to apply its own laws in the decision of the issue, the Restatement lists seven factors to consider in deciding the applicable rule of law. One of these factors is the need to protect the justified expectations of the parties using the law chosen by the parties to govern the instrument.⁵⁸ The Restatement notes in the case of contracts and trusts of movables, protection of the parties' expectations comes to the fore.⁵⁹  

Section 187, the Restatement provision regarding contracts, provides that the parties' choice of law will be refused only to protect a fundamental policy of the domiciliary state, provided the domiciliary state has a materially greater interest than the state of the chosen law in the determination of the particular issue. Interestingly, the Restatement provides "The more closely the state of the chosen law is related to the contract and the parties, the more fundamental must be the policy of the state of the otherwise applicable law to justify denying effect of the choice of law provision."⁶⁰ It is difficult to imagine a closer relationship of a state's law to a contract than the case of Alaska law as it relates to the Alaska community property trust.

Section 270, the Restatement provision regarding trusts of movables, is very similar to the choice of law provision found in contracts. This section provides that the parties' choice of law will be upheld unless found violating a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship.

Section 258, the Restatement provision concerning marital property, applies a test similar to contracts and trusts of movables. However, comment (d) of this section states it is not applicable if a valid contract between the spouses provides otherwise. In other words Section 187, involving contracts, has priority. 

In summary, pursuant to the principles of the Restatement, the couple's choice of Alaska law should control unless it is found to have violated a fundamental or strong public policy of laws of their domicile. It is difficult to imagine this circumstance. It would seem that the domiciliary state would be most interested in protecting the non-propertied spouse. Analysis of the non-tax consequences of electing Alaska community property⁶¹ demonstrates that the non-propertied spouse is generally better off under a community property system than a common law system. 

The above analysis and conclusion are supported by the recent Tax Court decision in Estate of Victor W. Richman, Deceased v. Commissioner.⁶² This case involved a factually similar situation to that confronting a nonresident using an Alaska community property trust and upheld the settlors' choice of law although it differed from the law of the state where the settlors were domiciled. In this case, a Texas couple used community property to purchase beneficial interests in a Massachusetts business trust. The trust had a standard account application and the couple chose to hold their beneficial interest as a joint tenancy with rights of survivorship (JTROS). The trust had a choice of law provision which stated that Massachusetts law, which recognized JTROS accounts, would govern the validity and construction of the trust. The husband died and his estate claimed a marital deduction for his interest in the account which passed by operation of Massachusetts law to his wife. The Service denied the marital deduction and contended under the law of Texas at the time, the account could not be held as JTROS, with the result that the decedent's interest in the account passed under the terms of his will to individual's other than his wife. The issue for the court was whether the account should be characterized as community property under Texas law or as a JTROS account under Massachusetts law. The court, after examining Sections 6 and 187 of the Restatement, upheld the couple's choice of Massachusetts law and the right of the estate to claim a marital deduction, and concluded the JTROS designation did not contravene a fundamental policy of Texas.<sup>63

56</sup>It might be wise to transfer real estate to an LLC or limited partnership, in order to have the trust property characterized as a movable. Otherwise, the law of the situs usually determines the classification of real estate. (Restatement (Second) Conflict of Laws §278 (1971)).

⁵⁷Restatement (Second) Conflict of Laws, §258 (2) (1971); Zaffaroni v. Comm'r, 65 T.C. 982, 987 (1976); Seizer v. Sessions, 915 P.2d 553 (Wash. App. Div. 2, 1996).

⁵⁸Restatement (Second) Conflict of Laws, 6 (1971).

⁵⁹Id. Because the trust is in the nature of a postnuptial agreement, an initial inquiry must be whether the domiciliary state recognizes postnuptial agreements. Most states do, but provide that a duty of disclosure is owed the other party, the agreement must be signed voluntarily, and each party must have the opportunity to consult with counsel. (Alexander Lindey and Louis I. Parley, Lindey on Separation Agreements and Antenuptial Contracts, §91.02.) The protections afforded each spouse under the Alaska Act most likely satisfy these standards. (A.S. 34.77.100(b) and (f)).

⁶⁰Restatement (Second) Conflict of Laws, §187, comment g.

⁶¹See the discussion of non-tax consequences, below.

⁶²68 T.C.M.(CCH) 527 (1994).

⁶³For other decisions in which courts have engaged in a conflict of laws analysis for tax issues, see: Hammonds v. Comm'r, 106 F.2d 420 (10th Cir. 1939), real estate acquired in Texas in exchange for personal services rendered by nonresident is community property; Comm'r v. Porter, 148 F.2d 566 (5th Cir. 1945), income received by Texas resident from New York trust held to be community property unless trust language clearly indicates intent that New York law apply to issue; Estate of Lepoutre, Deceased v. Comm'r, 62 T.C. 84 (1974), character of property acquired in France and transferred to Connecticut determined by French law, thus community property characteristics retained and only half included in decedent's estate under I.R.C. §2033; Zaffaroni v. Comm'r, 65 T.C. 982 (1976), U.S. source income earned by Uruguayan citizens residing in Mexico was community property. A thorough discussion of this subject is provided in the materials for "A Short Course on the Transitory Community," presented by M. Read Moore and Malcolm A. Moore at the 1998 Annual Fall Estate Planning Practice Update, ALI-ABA Video Law Review.

VII. GIFT TAX CONSEQUENCES REQUIRE CAREFUL IMPLEMENTATION 

A. Potential Gifts Upon Execution of Agreement Or Trust. If the property which is the subject of the agreement or is contributed to the trust is owned unequally between the spouses, then a gift will occur upon execution of the agreement or transfer of the assets to the trust.⁶⁴ If the gift occurs upon execution of a community property agreement, then it is important that this gift qualify under the Federal Gift Tax marital deduction provisions. Therefore, the property cannot be terminal interest property, and both spouses must be U.S. citizens.⁶⁵ If the gift occurs upon contribution of assets to a community property trust, an unusual dispositive plan could result in a terminable interest which would not qualify for the gift tax marital deduction.⁶⁶ Consequently, it is important to draft the trust so that this gift will so qualify.⁶⁷

B. Gifts to Other Parties Upon the Death of the First Spouse. When Wisconsin adopted the Uniform Marital Property Act, the Wisconsin legislature included a new feature added by UMPA: the ability of a couple to make a nontestamentary disposition under a community property agreement.⁶⁸ Alaska enacted the same provision originally added by Wisconsin.⁶⁹ The new Alaska community property trust will similarly provide nontestamentary dispositive provisions.⁷⁰ In 1985, the Seventh Circuit decided Pyle v. United States,⁷¹ which involved an Illinois joint will. The court held that upon the death of the first spouse the surviving spouse made a taxable gift to the residuary beneficiaries who would inherit after the surviving spouse's death. The court's decision rested on the fact that after the death of the first spouse the surviving spouse could no longer amend the joint will. Therefore, the gift was complete. Wisconsin practitioners became concerned, and the Wisconsin legislature amended its statute to create a default rule that a surviving spouse may unilaterally amend the community property agreement with respect to property to be disposed of at the death of the surviving spouse.⁷² The Alaska statute does not contain this type of express unilateral amendment authority for either a community property agreement or trust.⁷³ Rather, the statute contains language that an agreement and trust "...may not be amended or revoked unless the agreement itself provides for revocation on a particular date or on the occurrence of a particular event...."⁷⁴ 

The Pyle result should not occur of the agreement or trust gives the surviving spouse the unrestricted ability to withdraw or consume the property in question. In addition, to avoid the Pyle issue, the drafter of an Alaska community property agreement or trust may provide express authority allowing the surviving spouse to amend the agreement with respect to property to be disposed of at the death of the surviving spouse. An argument can be made that the surviving spouse's act of amendment is the "occurrence of a particular event," and therefore allowed by the existing Alaska statutory language.⁷⁵ The 1999 Alaska legislature is considering a technical amendment which would enact a default rule similar to that enacted by Wisconsin. 

⁶⁴This gift results from the fact that the community property will be owned equally between the two spouses. (A.S. 34.77.030(c)). See Rev. Rule 77-359, 1977-2 C.B. 24.

⁶⁵I.R.C. §2523(b) and (i). See also, I.R.C. §2056(b) and (d)(1).

⁶⁶Reg. §25.2523(b)-1(a)(3). See Estate of Boydstun v. Comm'r, 48 T.C.M. (CCH) 311 (1984), which held that a marital trust was a non-deductible terminable interest in the estate tax context (involving a pre-1981 fact situation). A similar estate tax holding was reached by the Tax Court in the 1998 decision in Estate of Walsh v. Comm'r, 110 T.C. 393. In Estate of Hedrick v. Comm'r, 1994 U.S. App. LEXIS 20641 (9th Cir. 1994), the Ninth Circuit strained to find a right to revoke, so as to qualify the trust assets for the estate tax marital deduction.

⁶⁷The trust may be structured as a QTIP trust. (I.R.C. §2523(f).) However, for every calendar year when property is contributed to the trust, a federal gift tax return will need to be filed and a QTIP election will need to be made. (I.R.C. §2523(f)(4).) If the clients forget to do this in the year of formation or in a future year, then they will be faced with a taxable gift. Alternatively, the trust may be designed as a general power of appointment marital trust. This type of marital trust does not require the filing of a gift tax return or making of an election. (I.R.C. §2523(e).) Therefore, it avoids the risk of an inadvertent taxable gift. This may well be the preferable way to structure the marital deduction. (Blattmachr, supra note 46.) The spouse must be entitled to all of the income, payable annually. (I.R.C. §2523(e).) The regulations provide that the income does not, in fact, have to be distributed to the spouse. Rather, it is enough if the spouse has the right exercisable annually to require distribution to herself or himself of the trust income. Otherwise, the trust income may be accumulated and added to corpus. (Reg. §25.2523(e)-1(f)(8).) Equally important, the donee spouse must have the power to appoint the property, whether during life or by will, in favor of the donee spouse or such spouse's estate. (I.R.C. §2523(e).)

⁶⁸Wisconsin Statutes, Section 766.58(3)(f), based on UMPA §10(c)(6).

⁶⁹A.S. 34.77.090(d)(5).

⁷⁰A.S. 34.77.100(d)(3).

⁷¹766 F.2d 1141. (7th Cir., 1985).

⁷²This issue is discussed in Marital Property Law In Wisconsin, §10.48, State Bar of Wisconsin CLE Books (April 1995).

⁷³See A.S. 34.77.090(e) and .100(e).

⁷⁴Id.

⁷⁵Id.

VIII. NON-TAX PROPERTY CONSEQUENCES OF ELECTING ALASKA COMMUNITY PROPERTY.

Conversion of a spouse's separate property into Alaska community property has significant non-tax consequences, which are summarized as follows. 

A. Management And Control. This right is broadly defined under the Act.⁷⁶ In most common law states, the separate property owner, alone, would have all of these management and control rights. Under the Alaska Community Property Act, often the spouses will share this right. 

B. Gifting. In many common law states, the owner would be allowed to unilaterally make gifts. Under the Alaska Community Property Act, the fact that a spouse has the right to manage and control does not permit gifts of community property, except in very limited circumstances.⁷⁷ Both spouses together may make gifts.  

C. Sale. In common law states, in most circumstances the owner has the power to sell for full and adequate consideration, without the consent of his or her spouse. Under the Alaska Community Property Act, the spouse or spouses with management and control will have this right.⁷⁸  

D. Disposition at Death. In common law states, the separate property owner may dispose of property in such owner's individual name. In many such states, the surviving spouse has the right to an elective share.⁷⁹ Under the Alaska Community Property Act, the deceased spouse may dispose of his or her one-half of the community property.⁸⁰ The surviving spouse does not have the right to elect against such community property.⁸¹ Because the elective share may be less than one-half, the separate property owner may have the right to dispose of more property than his or her community property counterpart.  

E. Liabilities. In many common law states, the property would only be subject to the contracts or liabilities of the owner.⁸² Generally, neither spouse is liable for the separate debts of the other.⁸³ Under the Alaska Community Property Act, an obligation incurred by a spouse during marriage, including an obligation attributable to an act or omission during marriage, is presumed to be incurred in the interest of the marriage or the family.⁸⁴ After the determination date, an obligation incurred by a spouse in the interest of the marriage or the family may be satisfied from community property and the separate property of that spouse.⁸⁵ Therefore, the converted property may become subject to the obligations incurred by the other spouse during marriage.

F. Divorce. In Alaska, the court may divide the parties' property, whether joint or separate, acquired during marriage, "in a just manner and without regard to which of the parties is in fault...."⁸⁶ The court is directed to consider a number of factors. The new community property act provides a similar "just and equitable" standard, with similar factors.⁸⁷ The spouses may agree in a community property agreement or trust on the disposition of their property upon dissolution of their marriage.<sup>88  

76</sup>A.S. 34.77.900(13).

⁷⁷A.S. 34.77.040(e); A.S. 34.77.050(a).

⁷⁸A.S. 34.77.090(d)(2), .040(c), .100(d)(2). Community property purchased by a bona fide purchaser from a spouse having the right to manage and control the property is acquired free of any claim of the other spouse. (A.S. 34.77.080(b).)

⁷⁹For example, A.S. 13.12.201 et seq., which provides for an elective share of one-third of the augmented estate.

⁸⁰A.S. 34.77.030(c)

⁸¹A.S. 13.12.208(d).

⁸²For example, A.S. 25.15.010.

⁸³A.S. 25.15.050.

⁸⁴A.S. 34.77.070(a).

⁸⁵A.S. 34.77.070(c).

⁸⁶A.S. 25.24.160(a).

⁸⁷A.S. 25.24.160(d).

⁸⁸A.S. 34.77.090(d)(3), .100(d)(3).

IX. TAX PLANNING.

A. What Will the IRS Response Be? In the Administration's Revenue Proposals issued in February of 1999, the Department of the Treasury has proposed elimination of the I.R.C. §1014(b)(6) basis adjustment for the one-half of the community property owned by the surviving spouse. Treasury introduced its reasons for change by stating that "at present, there are nine community property states and at least one other state with an elective community property regime." Then, the General Explanation states: 

When enacted in 1948, the stepped-up basis for community property was premised on the fact that "the usual case was that practically all the wealth of the married couple was the property of the husband." S. Rep. 1013, 80th Cong., 2d Sess. (1948), 1948-1 C.B. 285, 304. Societal changes and changes to the estate tax treatment of jointly held property in 1981 have undermined the premises on which section 1014(b)(6) was based. Consequently, surviving spouses in community property states now enjoy an unwarranted tax advantage over those in common law states. 

The Treasury Department's concern is the unequal treatment of residents of community property and separate property states. Treasury does not explain the "societal changes" upon which it is basing its proposal. One may speculate that these changes are the more equal ownership of family assets between spouses, often resulting from increased parity in earnings, and from sound estate planning advice. However, even if such ownership changes are occurring, elimination of the full basis adjustment is only one remedy for the disparity of treatment between community property and separate property states. That remedy may not be the wisest.

As discussed above, after one spouse dies, it is often necessary for the surviving spouse to sell certain assets. The family business may need to be sold due to the decedent's lack of participation, or pursuant to an existing buy-sell agreement. Real property may be considered burdensome to manage. Market conditions may dictate the sale of assets before an expected downturn. Assets may need to be sold in order to raise funds to replace the decedent's earnings. The full basis adjustment of I.R.C. §1014(b)(6) alleviates the post-death tax burden resulting from these necessary sales.

At present, there is a significant push for tax relief. The nation has a budget surplus. In these circumstances, there is an alternative remedy which would both achieve equality between community property and separate property states and provide needed tax relief. This remedy would be to extend the full basis adjustment to any form of jointly owned property which is equally owned by only husband and wife. Such property would include community property, joint tenancy, tenancy by the entireties, and tenancies in common.

There is direct legislative precedent for this alternative approach on very similar facts. In the mid 1940s, one-earner families in separate property states were required to report all of their income on a single return. In contrast, couple's in community property states could each report one-half of the family income. As a result, Oklahoma, Oregon, Michigan, Nebraska, and Pennsylvania all switched to community property systems. Congress became concerned about the lack of geographical equalization in the treatment of the income of married couple's. The remedy was not to deny the ability to split income to couple's in community property states, but rather was to allow all couple's to split income by filing joint return. S. Rep. 1013, 80th Cong., 2d Sess. (1948), 1948-1 C.B. 285, 301.

The above-described alternative remedy to the Treasury's perceived tax inequality seems wiser tax policy than elimination of a benefit which the residents of community property states have received for over 50 years. In short, if a legislative change is to be provided, then the full basis adjustment of I.R.C. §1014(b)(6) should be extended, not eliminated.

Absent a legislative change, the Service may decide not to challenge couple's who have executed Alaska community property agreements or trusts.⁸⁹ The significance of the non-tax aspects of opt-in community property, and the rational weaknesses of applying Harmon to situations other than those involving assignment of income, may direct such a decision. Alternatively, the Service may argue that Harmon applies equally to a basis adjustment as it did to splitting income. If so, the Service may cling to Harmon until it is overruled or found inapplicable by the Supreme Court.

B. Fractional Interest Discount. I.R.C. §1014 adjusts the basis property to "the fair market value of the property at the date of the decedent's death...." Therefore, from an income tax standpoint, it is in the recipient's interest to have the fair market value as high as reasonably possible. However, it is important to recognize that a spouse's one-half interest is a fractional interest. A series of cases have held that such community property interests are subject to minority interest discount and lack of marketability discount.⁹⁰ This fair market value reduction will limit the basis adjustment of both spouse's halves of the community property. 

C. Upside/Downside Analysis. Estate planning for an income tax basis adjustment at the death of the first spouse to die will generally focus upon property which the spouses will hold in their individual names or revocable trusts. Such property will usually not be the subject of other transfer tax reduction approaches. Consequently, there does not seem to be a "lost opportunity" downside effect on transfer taxes when planning this area. 

In separate property states, most planners use the "guess who" approach. That is, the planners and their clients try to decide which spouse is going to die first, and they transfer appreciated property to that spouse's ownership. I.R.C. §1014(e) must be considered^.91 The obvious disadvantage of this "guess who" approach is that the guess may be incorrect. 

If there is no significant information indicating which spouse will die first, many planners may revert to a "hedge" approach. Appreciated property is split approximately equally between the spouses so that one half of such property will receive a basis adjustment at the death of the first spouse to die. 

Instead of using the "guess who" or "hedge" approaches, the planner may encourage the execution of an Alaska community property agreement or formation of an Alaska community property trust. Guessing and compromise are eliminated. It does not matter which spouse dies first.⁹² If the full basis step-up tax consequences withstand scrutiny, then the full basis adjustment is obtained no matter which spouse dies first. If the Service challenges the basis adjustment and is successful, then the result would probably be treatment of the property as equivalent to a tenancy by the entireties or tenancy in common for basis adjustment purposes.⁹³ Consequently, the worst result appears to be a fall-back to the one-half basis adjustment of the "hedge" result. 

Therefore, the planning choice appears to be between the "guess who" approach and the Alaska community property agreement or trust. If the planner and clients conclude there is a high probability that one spouse will die first, the "guess who" approach is preferable. The full step-up in basis is relatively assured. However, if such predictability is not present, then the Alaska community property agreement or trust becomes quite attractive.

⁸⁹The court in Angerhofer v. Comm'r, 87 T.C. 51 (1986), footnote ⁴, stated that the government in its brief conceded that the optional elect-in German marital regime, known as gutergemeinschaft, was a community property regime. It is uncertain whether the Harmon issue was discussed or the extent of recognition given for tax purposes.

⁹⁰Propstra v. United States, 680 F.2d 1248 (9th 1982) (15% discount for one-half community property interest in real estate); Estate of Lee, 69 T.C. 860 (1978) (minority discount allowed for one-half community property interests in common stock and all outstanding preferred stock); Estate of Illa Jean Anderson, 56 T.C.M. 78 (1988) (20% discount for one-half community property interest in real estate); Estate of Thomas A. Fleming v. Comm'r, T.C.M 1997-484 (minority discount and lack of marketability discounts allowed for one-half community property interests in outstanding stock of closely-held corporation); see Estate of Bright v. United States, 658 F.2d 999 (5th Cir. 1981) (court refused to attribute surviving spouse's community property interest to the deceased spouse in regard to the IRS's control premium agreement); and see Estate of Wayne-Chi Young v. Comm'r, 110 T.C. No. 24 (1998) (no discount for jointly owned property that was not community property; case includes recent discussion of community property discount cases and rationale).

⁹¹This section provides that if appreciated property is acquired by the decedent by gift during the one-year period ending on the decedent's death, and such property is acquired from the decedent by (or passes from the decedent to) the donor, then the basis of the property will not be adjusted. Since no regulations have been issued under this provision, it is unclear whether a basis adjustment would be denied if the property was distributed to a bypass trust or marital trust rather than directly back to the donor-spouse.

⁹²However, I.R.C. 1014(e) may apply if one spouse converts separate property to community property, and the donee-spouse dies within one year.

⁹³See generally, 7 Powell & Rohan, Powell on Real Property, ¶¶601-609 (tenancy in common), and ¶¶620-624 (tenancy by the entirety); I.R.C. §2033 and §2040(b) (for joint interests created after December 31, 1976).

X. CONCLUSION: THE ABILITY TO CHOOSE. 

The drafters of the Uniform Marital Property Act were convinced that the sharing and equality characteristics of community property provided a superior property ownership system. This conclusion is directly supported by the worldwide popularity of community property. However, four-fifths of the states in the United States, with their English heritage, have not made this system available to their residents. They should have that choice. 

Alaska's community property trust, when properly implemented, makes this choice available to the residents of all separate property states. In addition, Alaska's Act may be the catalyst which encourages other separate property states to give their residents the ability to choose the marital property system which they desire