Your Wills and Trusts May Need a Checkup

Submitted by Anton V. Dworak

After more than 10 years of tax chaos, the American Tax Relief Act (ATRA) of 2012 ended the uncertainty that swirled around estate and gift taxes. ATRA made permanent the $5,000,000 estate tax exclusion, generation skipping tax exemption and gift tax exclusion with all indexed for inflation ($5,340,000 in 2014). While this change should be heralded as excluding the vast majority of Americans from worrying about Federal estate and gift taxes, this change could make many wills and trusts executed before ATRA more difficult to administer or in some cases have a result that that decedent did not desire for their beneficiaries.

The problem is that when the estate tax exemptions were as low as $600,000, it was standard practice to create wills with formula clauses. These clauses employed a mathematical formula to determine marital and family bequests. Here’s an example: John and Jane are married, but John has 2 children from a prior marriage and Jane has none. John’s estate is $1,200,000 and Jane’s is smaller. John has a will done in 1990 that has a formula that says put the estate tax exclusion in effect in year of his death into a trust for the benefit of his children and put the rest into a marital trust for Jane for income only and some principal distributions, with the remainder passing to John’s children upon her death. In 1990 when the estate tax exclusion was $600,000, if John died this might have worked perfectly. $600,000 would go into a trust for John’s kids with the remaining $600,000 for Jane for her use during her life. If using those same numbers in 2014, the entire estate of $1,200,000 would go to the children in their trust and none to Jane because only assets over the $5,340,000 exclusion would go into Jane’s trust. Jane would get nothing from John’s estate and she would have to rely on her own estate to provide for herself or use some complicated legal proceedings to see if she could get more from John’s estate depending on how long they were married.

The point is that while all should celebrate the permanent solution to the estate tax dilemma, any person that had a formula or tax planned will or trust prior to ATRA should have it reviewed to ensure the changes in the tax law do not thwart the original intent of your estate plan.