Sponsor Statement for HB 199

This Sponsor statement provides a summary of the income tax advantage of community property and a short overview of the Community Property bill. The bill is designed, among other things, to allow married Alaskans to obtain the income tax advantage available to residents of community property states and to produce business in Alaska.

Income tax advantage of community property

A person who owns assets with his or her spouse as community property in one of the nine community property states (Louisiana, Texas, New Mexico, Arizona, California, Nevada, Washington, Idaho, and Wisconsin) has a major income tax advantage over a married person who owns assets with his or her spouse but that are not community property. This advantage results from the incongruous operation of the step-up in basis rule. This rule is one of the few, if only, income tax advantages that a person’s estate receives upon his or her death.

The best way to explain the step-up in basis rule is to start with an example of a single person in Alaska on her death bed who twenty years ago paid $10,000 for a homestead that is presently worth $110,000. If the person sold the homestead before she died, she would realize a long-term capital gain of $100,000. The gain would be subject to a maximum capital gains tax of 28%, or $28,000. On the other hand, if the person decided not to sell the homestead and died the next day, the $100,000 profit would be forgiven. This means that her heirs could sell the homestead for $110,000 and pay no income taxes! This is because the original cost basis of $10,000 is "stepped-up" to $110,000, the fair market value of the homestead at death. If the homestead is sold for $110,000 with its new basis of $110,000, there is no gain and no income taxes will be owed.

The step-up in basis rule gets more complicated when a married couple is involved. If we assume that a married couple in Alaska bought the homestead twenty years ago for $10,000 and held title as husband and wife, then each would own one-half of the homestead. If the husband was on his death bed and the couple sold the homestead before the husband died for its current fair market value of $110,000, the couple would realize a $100,000 long-term capital gain just like the single person did. However, if the husband died and the wife inherited his half of the homestead and then sold it, she would only realize only a $50,000 long-term capital gain. This is because the profit in the husband’s half of the homestead would be forgiven by the step-up in basis rule. The husband’s half of the homestead would get a "step-up" in basis to $55,000. When the husband's half was sold for $55,000 there would be no gain. However, the wife would have a gain on the sale of her half of the homestead. Her half of the homestead would have a basis of $5,000 (one-half of the original cost basis of $10,000). When this half was sold for $55,000, the wife would realize a $50,000 long-term capital gain and would pay a maximum of $14,000 of income taxes (28% of $50,000).

If, on the other hand, the couple lived in a community property state like Washington, the income tax savings would be even greater. If the homestead was community property under Washington law, for example, the wife would get a step-up in basis in both halves of the homestead to $110,000. After her husband’s death when she sold the homestead for $110,000 she would pay no income taxes! In contrast, in the prior example of the married couple in Alaska who owned the homestead that was not community property, the wife who sold the homestead after her husband died would pay $14,000 of income taxes. In this way the income tax laws favor spouses in community property states who own assets as community property over spouses in non-community property states like Alaska who as a general rule cannot own assets as community property.

Overview of HB 196

This bill will allow married Alaskans to execute a written agreement to recharacterize their assets as community property. Unlike other states which have a community property form of ownership for married persons, Alaskans would have their assets treated as community property only to the extent they execute a written agreement and elect into a community property system under Alaska law. In contrast, community property states mandate the married couple’s assets to be community property unless the spouses elect out.

The bill not only allows Alaskan couples to enter into an agreement to have some or all of their assets treated as community property, but it also permits married persons who do not reside in Alaska to have their assets treated as community property under Alaska law by executing an Alaskan Community Property Trust. Such a trust must have an Alaskan trustee. It is anticipated that many married persons who reside outside of Alaska will wish to label a portion, or all, of their assets as community property because they believe that it is a more appropriate method of owning their assets and they wish to obtain the income tax advantages which are available to community property upon the death of the first spouse.

Some believe that community property represents a more fair and rational system of sharing the ownership of property during marriage because it essentially treats the marriage like a partnership; as assets are earned during the marriage, they are treated as owned 50/50 by the two partners (the husband and wife). Others believe community property is not a fair or rational system. Regardless of one’s beliefs, it seems appropriate to allow Alaskans, and residents of other states, the freedom to choose the arrangement that is most appropriate for them.

It should be emphasized that no asset would be labeled as community property under the bill. Rather, the bill merely authorizes married persons to execute a written agreement or trust in which they expressly elect to treat some or all of their assets as community property under Alaska law.