Listen up, married Texas residents. Because you are in a community property state, you need to know about the inception of title rule.
This general rule determines whether your interest in an asset is considered separate or community property.
Why should that matter? Because if it is separate property, then the asset is entirely yours to bequeath upon your death. Your will can leave the asset to anyone, and your spouse has no say in it.
(Having made that sweeping statement, allow me to add a small qualifier. If the asset is your home, then your spouse will have a right to continue to live in it after you die.)
On the other hand, if the asset is community property, then you own only an undivided one-half interest. That is all that you can bequeath in your will. Your spouse continues to own the other one-half interest.
That can obviously set up some interesting, and potentially uncomfortable, situations for both the devisee and your surviving spouse.
Under the inception of title rule, the character – separate or community- of the property is based upon the time and manner in which you first acquire your interest. You must take a deep-dive into the type of property you’ve acquired to make that determination.
Characterization of Business Entities
One type of property can be especially difficult to characterize. That is a business entity.
Limited Liability Company
There are several common types of business entities. The most popular one is the Limited Liability Company, known as an LLC. The membership interests in an LLC vest into the initial members at the time of creation of the LLC. In Texas, an LLC is created by filing a certificate of formation with the Texas Secretary of State. Filing equals immediate ownership.
If you are an initial member and are married when the certificate of formation is filed, then your membership interest in the LLC is community property. When you die, you can leave an undivided one-half of your interest in your will.
Contrast that to another popular type of business entity – the corporation. A corporation is a separate legal entity, and it must issue shares to its shareholders before they have an ownership interest. There is always a lag time between corporate formation and ownership of the corporation. Sometimes that can be a long time.
If you are married when your corporate shares are distributed to you, then the corporate shares are community property. If you are not married, then the shares are separate property.
A lot of businesses are formed by individuals who do not want to end up in business with another co-owner’s spouse. For this reason, many business owners use a buy-sell agreement to force the buy-out of a spouse when the co-owner dies. A buy-sell agreement can provide a formula for pricing the deceased member’s interest, require the purchase of a life insurance policy so the surviving co-owner has the money to fund the buy-out, and put in place deadlines for the purchase.
Partition and Exchange Agreement
Many business owners also have a marital agreement in place with their spouse so that the characterization of the ownership interest is clear. The couple can agree to characterize the property as community or separate. A partition and exchange agreement converts community property to separate property and a conversion agreement converts separate property to community property.
Hammerle Finley Can Help
If you are a business owner and need estate planning assistance, schedule a consultation with one of the experienced attorneys at Hammerle Finley to discuss your options. Don’t forget to bring your entity documents to the meeting. They are critical to the formation of your estate plan.
Virginia Hammerle is an attorney with Hammerle Finley Law Firm. She is entering her 40th year in the practice of law. She is Board Certified in Civil Trial Law by the Texas Board of Legal specialization. Contact firstname.lastname@example.org to receive her firm’s newsletter.