In today’s (October 15, 2009) Wall Street Journal, there is an article entitled “Is There a Trap Lurking in the Language of your Will?” written by reporter Laura Sanders. The article correctly points out that many semi-wealthy couples may have a serious problem in their Wills. By “semi-wealthy” I mean estates worth up to $4 million. Yes, I know for most people that is “superwealthy” but bear with me.
As the article explains it, the problem is that since 2001, the lifetime exemption, that is the amount of assets one could have at death before being subject to the estate tax, has increased from $675,000 to $3,500,000. With proper estate planning, a married couple is able to use the exemption of both spouses. What happens is that upon the death of the first spouse, the amount of the remaining exemption is set aside. This is generally done through what is known as a “bypass” or “credit shelter” trust, but sometimes can be given to the children directly or set up in a trust for their benefit.
The problem is that when an estate planning attorney drafts the will or the trust, they do not know what the exemption will be at the time of the client’s death, and they don’t know how much of the exemption the client will have already used up during their lifetime.
Estate planning attorneys draft around this problem by using formula clauses. A Will might leave as the article states, “the full amount of the estate tax exemption to go into the bypass trust when the first spouse dies.” If the will was drafted when the exemption was $675,000; with a $3.5 million exemption, a bypass clause could potentially and unintentionally deprive the surviving spouse of the entire estate! (Assuming there are no elective share rights).
However, not all credit shelter clauses are used to have the assets go in a manner that deprives the spouse of all use of them. Often the credit shelter trust provides the surviving spouse with all of the income, plus principal for his or her health, education, support, and maintenance. Each situation is different.
What the article didn’t mention is what I find the much more interesting scenario. As of right now, there is no estate tax next year. It is scheduled to expire, only to come back at a lower exemption and a higher rate in 2011. Now, I’m a firm believer that Congress will do something to prevent repeal from happening. Most likely, they will extend the 2009 levels for another year, to, as usual, put off making any decision for as long as possible.
But let’s say that they don’t; and it’s 2010 and there is no estate tax. Let’s also say that a person dies with a Will that leaves the “smallest pecuniary amount which, 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” to a marital deduction trust. If there is no estate tax, how much is the marital deduction trust funded with? If there is no estate tax, the smallest amount which if allowed as a federal estate tax deduction would result in the least possible federal estate tax is probably zero. Would we have to fund bypass trusts if there is no tax?
We live in interesting times.