Relationship Dissolution Planning, Part 1: Nuptial Agreements
The divorce rate in the U.S. is astronomical. Nearly half of recent first marriages end in divorce.1 In addition, the rate of domestic partner relationships is increasing. With the increase in such relationships, there is a concomitant rise in the dissolution of such relationships.
This article is written in two parts. Part I discusses prenuptial and postnuptial agreements in the context of relationship dissolution planning. Part II of this article will address the transfer and retitling of assets and revisions to estate planning documents in contemplation of a relationship dissolution.
Types of Nuptial Agreements
There are two types of nuptial agreements: prenuptial agreements and postnuptial agreements. Prenuptial agreements (also known as premarital agreements or antenuptial agreements) are agreements entered into by the parties contemplating marriage prior to marriage that set forth the rights and obligations of each party in the event of death or divorce, and during the marriage. Postnuptial agreements (also known as postmarital agreements) are agreements entered into by the parties after marriage that set forth the rights and obligations of each party in the event of death or divorce, and during the marriage. Postnuptial agreements can be used when no divorce is contemplated or when divorce is not imminent. When divorce is imminent, postnuptial agreements are referred to as separation agreements.
Purposes of Nuptial Agreements
There are three main purposes of nuptial agreements. The first purpose is to provide for the protection of assets in the event of divorce of the parties. In property division, Florida follows the theory of equitable distribution. In other words, the court will make an “equitable” distribution of the property and assets of the marriage based on the circumstances of the parties. F.S. §61.075 provides for the equitable distribution of marital assets and liabilities.
Until the landmark Florida case, Posner v. Posner, 233 So. 2d 381 (Fla. 1970), most courts refused to enforce the provisions of a nuptial agreement relating to divorce or separation, reasoning that nuptial agreements covering divorce encouraged divorce and violated legal principles requiring marriage until death. In Posner, the court began to eradicate the idea that nuptial agreements which focused on the possibility of divorce were not void per se.
A second purpose of nuptial agreements is to provide for the distribution of the parties’ assets in the event of the death of a party. Certain provisions should be included in a nuptial agreement to ensure that each party’s assets are protected in the event of such party’s death.
A third purpose of nuptial agreements is to delineate the obligations of each party during the marriage. For instance, the nuptial agreement may address which party is responsible for certain expenses during the course of the marriage. The nuptial agreement may also dictate whether the parties must file joint federal income tax returns, or must do so only at the request of one party.
Requirements of Nuptial Agreements
Florida has not adopted the Uniform Premarital Agreement Act.2 However, Florida statutes and case law provide that nuptial agreements that meet certain requirements will be enforced by a court.3 The requirements are as follows:
• Complete Financial Disclosure — Individuals who contemplate marriage are in a confidential relationship with each other. Florida case law provides that this confidential relationship gives rise to a duty to make a full and fair disclosure of the nature, extent, and value of the assets that each party holds so that the other party may make an informed decision as to what will be relinquished as a result of entering into the nuptial agreement.4 Notwithstanding the foregoing, F.S. §732.702(2) provides that while disclosure is required in connection with an agreement waiving rights in the event of death that is executed after marriage, no disclosure shall be required for such an agreement, contract, or waiver executed before marriage. It is strongly recommended, however, that each party provide the other with full and fair disclosure in order to avoid a Florida court concluding that the nuptial agreement is invalid.
Each party must disclose his or her net worth (all assets and liabilities, and the values and amounts thereof), as well as income.5 While the income tax returns of each party should certainly be reviewed and included as part of the agreement, the preparer of the nuptial agreement must be cognizant that such returns do not include nontaxable income.
Disclosure must be complete, but it need not be exact.6 The nuptial agreement should indicate what the value reflects (fair market value, book value, cash value, etc.). Information regarding such values, such as the party’s federal income tax returns for the three years prior to the date of the nuptial agreement, appraisals, and brokerage statements, should be provided to the other party and his or her attorney for review and inclusion as part of the agreement.
Complete financial disclosure is unnecessary if the nuptial agreement makes a fair and reasonable provision for the other party or if the other party has a general knowledge of the character and extent of the other’s assets, liabilities, and income.7 However, complete financial disclosure is recommended in order to avoid a court’s later interpretation that the nuptial agreement does not make a fair and reasonable provision for the other party, or that the other party did not have knowledge as to the assets, liabilities, and income of the first party.
• Consideration — The nuptial agreement must recite the consideration for it. In the case of a prenuptial agreement, the consideration is the marriage.8 In the case of a postnuptial agreement, mutual promises encompassing various rights of the parties, in addition to disposing of property owned by them, have been considered sufficient consideration.9
• Formalities of Execution — If the nuptial agreement contains testamentary provisions, it should be executed in conformity with the requirements for a last will and testament (i.e., it must be signed in the presence of two witnesses who must also sign in the presence of each other).10
• Waiver of Equitable Distribution of Property and Interest in Marital Earnings and Appreciation of Separate Property — The court must uphold the intent of the parties as expressed in the agreement regarding the waiver of equitable distribution of property.11 If the parties intend to keep all income and earnings, including such income earned during the marriage, as separate property, such intention must be clearly stated in the nuptial agreement. Otherwise, income and earnings, and the assets acquired with such income and earnings, will be marital property subject to equitable distribution.12 In addition, if the parties desire to ensure that separate property, including all appreciation thereon, remains separate property, the nuptial agreement must clearly state such desire. Furthermore, the nuptial agreement should specifically refer to active appreciation on such separate property; otherwise, only passive appreciation on such property would remain separate property.13
• Waiver of Alimony — If intended, the nuptial agreement must expressly waive the party’s right to alimony.14 The waiver provision should include all types of alimony, such as rehabilitative, permanent, periodic, bridge-the-gap, and lump sum alimony. Note that in Florida, temporary alimony (during the divorce proceeding) cannot be waived.15
• Waiver of Interest in Homestead Property — A provision waiving a party’s constitutional right to homestead property may only be waived knowingly and intelligently.16 Accordingly, if each party intends to waive his or her homestead rights in the other party’s homestead property, the nuptial agreement should provide the following: 1) the definition of homestead property; 2) the homestead rights that each spouse would enjoy in the absence of the nuptial agreement; and 3) that each party knowingly and intelligently waives such homestead rights.
• Waiver of Interests in Retirement Plans — For many clients, the most significant asset is the client’s retirement plans. Accordingly, the preparer of the nuptial agreement must ensure that any waiver of retirement benefits complies not only with Florida law, but with federal law as well. Section 7 discusses the federal laws of which the practitioner should be aware in connection with the waiver of rights to retirement plans.
The Employee Retirement Income Security Act of 1974 (ERISA) was enacted to provide protection to employee retirement benefits. ERISA overrides state law. The Retirement Equity Act of 1974 (REA) amended ERISA to provide protection to spouses and descendants of employees. Under REA, a surviving spouse must receive certain benefits from a qualified plan of a spouse who was a plan participant even if the participant dies prior to retirement age. It is important to note that individual retirement account (IRA) benefits are not subject to REA.
Section 401(a)(11)(A) of the Internal Revenue Code of 1986, as amended requires that the surviving spouse receive a qualified preretirement survivor annuity benefit if the participant spouse dies before the annuity starting date or a qualified joint and survivor annuity benefit if the participant dies after the annuity starting date. A discussion of the “annuity starting date” is beyond the scope of this article.
Section 417(a)(2) of the Code provides that a spouse may elect to waive a right to a qualified plan benefit if the waiver meets the following requirements: a) the waiver is in writing; b) the waiver must designate a beneficiary that may not be changed without spousal consent (or the consent of the spouse expressly permits designations by the participant without any requirement of further consent by the spouse); c) the spouse’s consent must acknowledge the waiver’s effect; and d) the spouse’s signature must be witnessed by a plan representative or a notary public.
In nuptial agreement planning, most clients desire to waive their rights to the other party’s retirement benefits. However, the Treasury Regulations to the Code provide that an agreement entered into prior to marriage does not satisfy the applicable consent requirements of §§401(a)(11) and 417 of the Code.17 Accordingly, the nuptial agreement should require the nonparticipant party to sign the applicable waivers after the parties are married. In addition, the participant spouse (or the participant spouse’s attorney) must actually obtain the applicable waivers from his or her spouse after marriage.
The nuptial agreement should also provide that the nonparticipant spouse releases all claims to the retirement plan benefits. To the extent that the participant spouse fails to obtain the required waivers from the nonparticipant spouse, and the nonparticipant spouse fails to release his or her claims to the retirement plan benefits, the heirs of the participant spouse may have a cause of action against the nonparticipant spouse. Notwithstanding the foregoing, although federal law does not require that a nonparticipant spouse waive his or her rights in an IRA, some financial institutions impose such requirement.18
• Waiver of Rights Upon Death — If intended, the prenuptial agreement should provide that each party waives the following rights upon the death of the other party: a) rights to elect against the will or any other testamentary instrument of the other party (i.e., elective share rights); b) dower or curtesy rights; c) rights as intestate heir; d) rights as a pretermitted spouse; e) exempt property rights; f) family allowance rights; g) homestead rights (discussed above); h) right to qualify and serve as personal representative of the other party’s estate or trustee of any trust created by the other party.
It is important that the parties specifically waive the foregoing rights in the nuptial agreement, as illustrated in the recent case of Weisfeld-Ladd v. Ladd, 31 Fla. L. Weekly D340 (Fla. 3d DCA 2006). In Weisfeld-Ladd, the parties entered into a prenuptial agreement, which provided, in relevant part, that husband’s property which was in his sole name shall remain the sole and separate property of husband, and wife shall not claim any interest in any such property during the marriage or in the event of dissolution of the marriage. The prenuptial agreement further provided that it was husband’s intent that, in the event of his death, all of his separate property be given to his children, or as otherwise provided for in his last will and testament.
Upon husband’s death, wife filed her election to take elective share. Husband’s children filed an objection, stating that wife had waived her rights to husband’s separate property, and that pursuant to F.S. §732.702, the prenuptial agreement operated as a waiver of wife’s right to take elective share.
F.S. §732.702(1) provides an individual may waive in writing his or her right to an elective share. Additionally, §732.702(1) provides “[u]nless the waiver provides to the contrary, a waiver of ‘all rights’ or equivalent language, in the property or estate of a…prospective spouse…is a waiver of all rights to the elective share….” Wife argued that the prenuptial agreement did not specifically state that she waived her right to an elective share. Husband’s children argued that the prenuptial agreement contained “equivalent language” sufficient for wife to waive her elective share rights.
The Third District Court of Appeal determined that the prenuptial agreement in this case was ambiguous as to whether wife waived her elective share rights and, thus, that the trial court properly admitted parole evidence regarding the parties’ intent. While the court ultimately determined that wife waived her elective share rights after reviewing wife’s testimony regarding the intent of the parties, the case illustrates that it is critical that the parties specifically waive their elective share rights in the nuptial agreement, if intended.
• No Waiver of Child Support, Custody, and Visitation — Rights regarding child support, custody, and visitation cannot be waived under Florida law in a nuptial agreement and, therefore, should not be included in such agreement.19
• Timing of Execution — In the case of a prenuptial agreement, all meetings with the attorneys, the negotiations, and the execution of the prenuptial agreement should occur well in advance of the wedding in order to make it more difficult for a challenging spouse to assert duress or undue influence.20
• Separate Counsel — While not required under Florida law,21 it is recommended that each party obtain separate representation with regard to the nuptial agreement. Separate representation can help refute a claim that the nuptial agreement was entered into under duress or as a result of undue influence. Very often the party who requests the nuptial agreement will hire the attorney to draft the agreement. Sometimes the party will ask his or her attorney to recommend an attorney for the other party. The attorney should not give such a recommendation. Rather, the other party should independently locate and hire his or her attorney.
There are certain tax-related issues surrounding nuptial agreements of which practitioners should be aware. Specifically, there are income tax and gift tax issues that may affect the provisions of the nuptial agreement.
The first income tax issue is the income tax effect of alimony payments. Cash payments of alimony are generally taxable to the recipient spouse and deductible by the payor spouse. Specifically, §71(b) of the Code provides that a stream of cash payments to or on behalf of a spouse or former spouse pursuant to a divorce or separation instrument, whether for support or as part of a property payout, is taxable to the payee and deductible to the payor if the liability for payment ceases upon death of the payee, is not fixed as child support, the divorce or separation instrument does not designate such payment as a payment which is not includible in the gross income under §71 of the Code, and not allowable as a deduction under §215 of the Code.
Both parties must be aware of the recapture rules applicable to excess spousal support payments, and care must be taken to avoid the imposition of such rules in the nuptial agreement. Section 71(f) of the Code provides that if during the first three postseparation years there is impermissible front loading of a cash payment determined under the Code to be alimony, phantom taxable income could be attributable to the payor, and a deduction could be created for the payee, in the third postseparation year. This rule is intended to prevent spouses from characterizing nondeductible property settlement payments as deductible alimony payments.
The second income tax issue deals with the filing of income tax returns by the parties. The nuptial agreement may mandate that the parties file joint or separate federal (and state) income tax returns. Alternatively, the nuptial agreement may mandate that the parties file joint or separate income tax returns if either party makes such a request of the other party. The latter option is generally preferred, as it provides for maximum flexibility each year. The parties should be aware that the filing of a joint tax return imposes joint and several liability on both spouses.22
There are also gift tax issues related to nuptial agreements of which the practitioner should be aware. First, transfers incident to a divorce may be considered gifts for purposes of the federal gift tax. Section 2512(b) of the Code provides that any transfer for less than “full and adequate consideration in money or money’s worth” is a gift. The following are exceptions to the treatment of a transfer incident to a divorce as a gift.
1) Section 2516 Payments — Section 2516 of the Code provides that the transferor spouse will be deemed to have received full and adequate consideration if the payment is made from one spouse to the other pursuant to a written agreement and the divorce occurs within the three-year period beginning on the date one-year before such agreement is entered into. The agreement must be signed within the prescribed period of time, but the transfers may occur at any time.
2) “Harris Rule” Payments — Under the Harris rule, payments made pursuant to an agreement incorporated into a court decree or under a court order for divorce or support do not have to be made for full and adequate consideration.23
3) Payments Made in Satisfaction of Legal Obligation to Support — Payments made in satisfaction of a legal obligation to support a spouse and minor children are not gifts, because the release of such legal obligation is deemed to be adequate consideration.24
4) Annual Exclusion Payments and Qualified Transfers — Annual exclusion payments made pursuant to §2503(b) of the Code and qualified transfers made for certain educational and medical expenses under §2503(e) of the Code are not treated as gifts.
5) Waivers of Pension Rights — Waivers of pension rights under §2503(f) of the Code are not treated as gifts.
A second gift tax issue related to nuptial agreements involves gift splitting. If a practitioner represents the wealthier spouse, he or she may suggest the wealthier spouse include language in the nuptial agreement that provides the other spouse must consent to split gifts under §2513 of the Code if the wealthier spouse makes such a request of the other spouse. requiring such a consent, the wealthier spouse could double the amount of annual exclusion gifts he or she makes during the year. The gift tax annual exclusion amount is the amount an individual can gift per year/per donee without using a portion of his or her federal gift tax exemption or incurring gift tax.25 Such amount is currently $12,000 annually per donee, or $24,000 annually per married couple per donee.26 Including such a provision in the nuptial agreement would also enable the wealthier spouse to gift up to $2 million during the marriage, which is two times the lifetime gift tax exemption amount (currently $1 million per person).27
1 Matthew D. Bramlett & William D. Mosher, First Marriage Dissolution, Divorce, and Remarriage: United States, 323 Advance Data 5 (May 31, 2001), available at www. cdc.gov/nchs/data/ad/ ad323.pdf. The National Center for Health Statistics released a report which found that 43 percent of first marriages end in separation or divorce within 15 years. The study is based on the National Survey of Family Growth, a nationally representative sample of women ages 15 to 44 in 1995.
2 The Uniform Premarital Agreement Act, adopted by the National Conference of Commissioners on Uniform States Laws (1983).
3 Fla. Stat. Ch. 61.052(5) provides that the court may enforce an antenuptial agreement to arbitrate a dispute in accordance with the law and tradition chosen by the parties. See also Casto v. Casto, 508 So. 2d 330 (Fla. 1987), in which the court made no distinction between prenuptial agreements and postnuptial agreements executed prior to the filing of a divorce action for purposes of determining the validity of such agreements.
4 See, e.g., Doig v. Doig, 787 So. 2d 100 (Fla. 2d D.C.A. 2001); O’Connor v. O’Connor, 435 So. 2d 344 (Fla. 1st D.C.A. 1983).
6 See, e.g., Waton v. Waton, 887 So. 2d 419 (Fla. 4th D.C.A. 2004).
7 See Casto, 508 So. 2d 330.
8 Akileh v. Elchahal, 666 So. 2d 246 (Fla. 2d D.C.A. 1996).
9 See, e.g., Abbott v. Kiser, 654 So. 2d 640 (Fla. 4th D.C.A. 1995).
10 Fla. Stat. Chs. 732.701 and 732.502.
11 Del Vecchio v. Del Vecchio, 143 So. 2d 17 (Fla. 1962).
12 Irwin v. Irwin, 857 So. 2d 247 (Fla. 2d D.C.A. 2003).
13 Doig v. Doig, 787 So. 2d 100 (Fla. 2d D.C.A. 2001).
14 White v. White, 617 So. 2d 732 (Fla. 2d D.C.A. 1993).
15 Belcher v. Belcher, 271 So. 2d 7 (Fla. 1972).
16 Hartwell v. Blasingame, 584 So. 2d 6 (Fla. 1991).
17 Treas. Reg. §1.401(a)-20, Q and A-28.
18 The following are financial institutions that require a spouse to execute a waiver if he or she is not named as the primary beneficiary of his or her spouse’s IRA: Bernstein, Comerica Bank, Legg Mason, and Salomon Smith Barney. In addition, JP Morgan Private Bank and Raymond James request, but do not require, that such a waiver be signed.
19 See, e.g., Ervin v. Chason, 750 So. 2d 148 (Fla. 1st D.C.A. 2000); Feliciano v. Feliciano, 674 So. 2d 937 (Fla. 4th D.C.A. 1996).
20 See, e.g., Hjortaas v. McCabe, 656 So. 2d 168 (Fla. 2d D.C.A. 1995), in which the court set aside a prenuptial agreement executed two days prior to the wedding.
21 Casto, 508 So. 2d 330.
22 I.R.C. §6013(d)(3).
23 Harris v. Comm’r, 340 U.S. 106 (1950).
24 Rev. Rul. 68-379, 1968-2 C.B. 414.
25 I.R.C. §2503(b).
26 Rev. Proc. 2005-70, 2005-47 IRB 979 (November 21, 2005). It will be indexed for inflation in increments of $1,000 in future years. The 1997 Taxpayer Relief Act, P.L. 105-34, §501(c).
27 I.R.C. §2505.