I get a lot of questions from clients about how asset protection strategies interact with the marital property rules in Texas. This article is intended as a brief overview of when you are liable for your spouse's actions. Please note that this article is not applicable to Michigan residents.
First, I'll discuss the 5 types of marital property, and then I'll discuss common liability situations. Please note, that this discussion is from an asset protection perspective, and not from a potential-divorce perspective. This article is also only about the liability of living spouses. The rules change greatly during administration of a probate estate. The following discussion assumes that there is no pre-marital or post-marital agreement in place.
The five types of marital property in Texas are the following:
- Husband's Separate Property
- Wife's Separate Property
- Joint Management Community Property
- Husband's Sole Management Community Property
- Wife's Sole Management Community Property
These types of property are the same in a same-sex marriage as well; "husband" and "wife" can easily be "spouse 1" and "spouse 2".
Generally, per Texas Family Code Section 3.001, separate property in Texas is property of one spouse that was:
- owned by that spouse before marriage;
- acquired during marriage by gift;
- the recovery for personal injuries sustained by the spouse during marriage, except any recovery for loss of earning capacity during marriage;
- capital gain on separate property, such as appreciated stock;
- acquired during marriage by inheritance; and
- partitioned to separate property by a valid partition agreement between spouses during marriage
There are other ways to acquire separate property in TX, but they are complicated and can lead to hiring a forensic accountant to trace, so I won't be discussing that here.
Community property is defined negatively in Texas Family Code Section 3.002:
All property other than separate property is community property.
There is also a presumption that all property is community property unless proven to be separate property by clear and convincing evidence, which is the highest civil-law evidentiary standard.
However, the law makes a distinction between "joint management" community property and "sole management" community property. Texas Family Code 3.102 defines sole management community property as "During marriage, each spouse has the sole management, control, and disposition of the community property that the spouse would have owned if single..."
Also, Texas Family Code 3.102 discusses "joint management" community property: "...If community property subject to the sole management, control, and disposition of one spouse is mixed or combined with community property subject to the sole management, control, and disposition of the other spouse, then the mixed or combined community property is subject to the joint management, control, and disposition of the spouses, unless the spouses provide otherwise by power of attorney in writing or other agreement..."
Texas also recognizes a concept of "quasi community property", for those couples who lived in a common law (non-community property) state but then later moved to Texas. This concept of quasi-community property causes property that "would have been community property" had the spouses lived in Texas when they acquired the property, to be subject to division in a Texas divorce.
However, in a Texas probate proceeding, there is no concept of quasi-community property and it can cause a large hardship on the surviving spouse if many or most of the marital assets of the estate were the separate property of the deceased spouse; and especially when there are children from a prior marriage of the deceased spouse.
Note, the following scenarios are simplified and don't take into account exempt property such as the homestead exemption, certain retirement accounts, and other exempt property.
If you have a joint credit card where you both signed the credit agreement, all of your 5 categories of non-exempt property are available to the credit card company to collect on the debt.
Your spouse's separate property, joint management community, and your spouse's sole management community property would be available to the credit card company. Your separate property, and your sole management community property would not be available to the creditor.
The law makes a distinction between necessaries (typically food, shelter, clothing, medicine, medical care, but can be more) and non-necessaries. Since a spouse has a duty to care for the other spouse, all five categories are available to the creditor.
Every category is available to the car-wreck plaintiff except for your separate property.
An asset protection lawyer may recommend separating community property into separate property in order to provide more protection from creditors, particularly from tort and contract creditors for non-necessaries. But, this can have large consequences in the family-law context and for tax purposes.
First, once the property is separated, one spouse can't force the other to turn it back into community property unless the other spouse agrees in a valid property agreement. This is particularly worrisome to some spouses who are worried that their spouse will immediately file for divorce after partitioning property.
Second, separate property does not get the same favorable "step up" in tax basis that community property gets at the death of the first spouse. For example: if you own a rental property as community property that you purchased for $20,000, but is worth $100,000 at time of the first spouse's death, then the surviving spouse gets a new tax basis of $100,000. This can save enormously on future capital gains taxes.
If the rental property was owned as one half of each spouse's separate property with each have a basis of $10,000, there would be a step-up in basis at the time of the first spouse's death but only of the amount owned by the deceased spouse. The surviving spouse's portion would not step up in basis. In other words, $20k total basis, of which $10k is deceased's and $10k is surviving spouse's. If the house is worth $100,000 at time of the first spouse's death, the surviving spouse's basis would be $60,000.00 ($10,000 original basis plus one half of the $100,000 value as of date of death). Why is this important? If the surviving spouse sold the community-property house immediately, she would owe only capital gains on the amount over $100,000.00 if it was community property. In the one half each separate, she would owe capital gains tax on any amount over $60,000! Assuming a long-term capital gains rate of 20%, and 20% x $40,000 = $8,000, that's a potential $8,000 capital gains tax savings in this scenario between the two.
Because of this, sometimes asset protection lawyers will only partition into separate property two "nest eggs" to make sure not all is lost in a worst-case scenario, but using other techniques to protect the community assets so that there is the favorable step-up in basis at time of the first spouse's death.
Third, if you and your spouse lived in a common law (non-community property) state for a long time before moving to Texas, it's important to look at the characterization of your assets. For spouses concerned about asset protection, it might make sense to keep separate property "separate", or transfer separate of one spouse to become separate property of the other spouse to shelter assets from creditors. On the other hand, it may make sense for spouses who are more concerned about the favorable tax step-up in basis for the deceased spouse's community property to convert their separate property into community property. Depending on net worth, a combination of separate property "nest-eggs" plus the bulk in community property may also be advisable (see above).