News Briefings - Estate Planning

The following article was taken from the March 2010 issue of Estate Planners Alert.

3/1/10 -- Continued inaction on estate tax poses dilemma for some testators

We're into the third month of 2010, and there still has been no further action on the part of Congress to undo the estate tax repeal that applies for individuals dying in 2010. As we pointed out in an earlier article on this subject, repeal doesn't necessarily mean that taxes will be lowered for heirs of a decedent dying in 2010. That's because, estate tax repeal includes changes to the income tax basis rules for property acquired from a decedent. As a result of these income tax changes, some heirs could face higher combined estate and income tax costs if their loved one dies in 2010 than would have been the case if death had occurred in 2009. This is explained in detail at Estate Planners Alert, February 2010.

Apart from the concern that some heirs will face increased tax costs if Congress does not take action, another concern is gaining stature as more time elapses--wills using formula clauses that work well when the estate tax is in force may produce unintended tax consequences when there is no estate tax--such clauses could be construed to leave spouses with far less than the testator intended, and in some cases, even nothing, as shown in the simplified example that follows.

RIA illustration: An individual has a $6.5 million estate. His will leaves the "exempt amount" (stated as a formula) to his children from his first marriage and the balance to his current spouse. Had he died in 2009, the children would have received $3.5 million and his spouse would have gotten $3 million. The marital deduction coupled with unified credit, which sheltered $3.5 million for 2009 transfers, would have prevented any estate tax from being owed. Now assume he dies in 2010. The formula clause could be interpreted as giving everything to the children and nothing to his spouse.

There is also concern that these formula clauses could operate to increase state death taxes. Returning to the foregoing Illustration, the amount that could be construed as going to the children could exceed the state exemption in those states that impose death taxes.

Fortunately, some states already have begun to tackle this issue. They have started the process of enacting laws that would provide that a formula for calculating transfers or devises based on federal estate or generation-skipping transfer tax law contained in a will or trust of a decedent who dies after December 31, 2009, and before January 1, 2011, will be construed to refer to the tax law applicable on December 31, 2009.

Sample state legislation. Legislation in the works in Virginia illustrates the approach states may take in dealing with the problem. It would provide that:

A will or trust of a decedent who dies after December 31, 2009, and before January 1, 2011, that contains a formula referring to the "unified credit," "estate tax exemption," "applicable exemption amount," "applicable credit amount," "applicable exclusion amount," "generation-skipping transfer tax exemption," "GST exemption," "marital deduction," "maximum marital deduction," "unlimited marital deduction," "inclusion ratio," "applicable fraction," or any section of the Internal Revenue Code relating to the federal estate tax or generation-skipping transfer tax, or that measures a share of an estate or trust based on the amount that can pass free of federal estate taxes or the amount that can pass free of federal generation-skipping transfer taxes, or that is otherwise based on a similar provision of federal estate tax or generation-skipping transfer tax law, shall be deemed to refer to the federal estate tax and generation-skipping transfer tax laws as they applied with respect to estates of decedents dying on December 31, 2009. This provision shall not apply with respect to a will or trust that is executed or amended after December 31, 2009, or that manifests an intent that a contrary rule shall apply if the decedent dies on a date on which there is no then-applicable federal estate or generation-skipping transfer tax. If the federal estate or generation-skipping transfer tax becomes effective before that date, the reference to January 1, 2011, in this subsection shall refer instead to the first date on which such tax becomes legally effective.

RIA recommendation: Practitioners should consider sending a letter to their clients apprising them of the current uncertain state of the federal estate tax. They also may want to consider apprising affected clients of the potential dilemma posed by a formula clause.

RIA recommendation: Practitioners also should check the status of any state law fixes that may be in the works and evaluate how they would impact particular clients and continue to monitor federal developments in this area. They should then be in a position to determine whether to recommend that a particular client amend or redo his will or take a "wait and see approach" given that a federal law change or a state law fix may be forthcoming.

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