Written by Jeffrey Skatoff • January 18th, 2010
With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRA), estate planners were on notice that there would be no estate tax in 2010. Unfortunately, very few estate plans have been drafted to take into account this one-year repeal.
Prior to the passage of EGTRA, the estate tax rate was 55%, and the exemption amount was $675,000. During the decade, the estate tax rate was gradually lowered to 45% by 2009, and the exemption amount was gradually raised, to $3.5 million by 2009. Under EGTRA, there is no estate tax in 2010. In 2011, however, the estate tax springs back with a vengeance - a 55% estate tax rate, and an exemption amount of only $1 million.
For deaths that occur in 2010, the repeal is important because the level of federal estate taxation can control bequests in a will or trust. For a married couple with a taxable estate under the pre-2010 law, the goal was to take advantage of the estate tax exemption amount to the maximum extent possible, while leaving the remainder of the estate to the surviving spouse (directly or in a marital trust). A standard will or revocable trust would establish two trusts for this purpose. The first is the Family Trust, into which the maximum estate tax exemption amount would be allocated. The second trust would be the Marital Trust, into which the balance of the estate would pass, free of estate tax. A will or revocable trust would contain an allocation clause to fund each trust. For example:
I give to the Marital Trust the smallest pecuniary amount that, if allowed as a federal estate tax marital deduction, would result in the least possible federal estate tax being payable by reason of my death, with the remainder to the Family Trust.
If there is no estate tax, this allocation clause could fairly be read as allocating none of the estate to the Marital Trust, and all of the estate to the Family Trust. If the Marital Trust and the Family Trust have the same disposition plan, same beneficiaries and same trustees, there is likely no problem. Such would often be the case in a first marriage / common children situation.
If there are children from a first marriage and a second spouse, the Marital Trust and the Family Trust will often look quite different. For example, although only a surviving spouse can be a beneficiary of a Marital Trust while alive, the Family Trust may or may not include the surviving spouse as a beneficiary. Or, if the surviving spouse is a beneficiary of the Family Trust, there may be more severe limitations on distributions. Sometimes, a surviving spouse will control who gets the assets in the Marital Trust upon death, while a Family Trust would not typically contain such a provision.
A surviving spouse who receives a Marital Trust of zero as a result of the spouse passing away in 2010 will have some recourse - the elective share, which would allocate to the surviving spouse a portion of the overall estate. (The elective share in Florida is 30%.) The elective share, however, may be less than what the passing spouse may have intended to pass to the surviving spouse. Moreover, the expense of claiming the elective share could be considerable - especially when property is located both inside and outside of Florida. In other words, the surviving spouse could be significantly harmed by the obsolete allocation clause. The beneficiaries of the Family Trust may also have cause to complain, given the chaos which will have been unleashed on their situation.
Whether estate planning documents drafted after the passage of EGTRA in 2001 which do not take into account the 2010 estate tax environment create malpractice for the drafting attorney is an open question. Certainly any person with an outdated estate plan should seek review and guidance at once.
How Should Obsolete Estate Planning Documents be Fixed?
One way to fix an estate plan's funding formula will be an override provision. For example, the following clause could be added after the funding formula.
Notwithstanding the foregoing, not less than 50% of the residuary estate shall be allocated to the Marital Trust.
Notwithstanding the foregoing, not less than $2 million of the residuary estate shall be allocated to the Marital Trust.
There are likely a number of ways in which to protect an estate plan from the situation that Congress has placed the American public. The important point is to do something.