TAX NEWS - 2010

Estate Tax Negotiation

With its attention focused intensely on health care and financial reform, Congress failed last year to renew the estate tax, which taxed multimillion-dollar estates and expired at the end of 2009.

This was an important piece of legislation for both consumers and federal coffers. How important? If someone died last year, the portion of their estate that's over $3.5 million would be subject to a 45% tax. If someone dies in 2010, no matter how large their estate, it all passes on estate-tax-free. For the government, that could add up to some $26 billion in lost revenue, according to the Internal Revenue Service. Legislators have proposed a number of bills to rectify the situation ranging from reinstating the tax for the rest of 2010 to making the estate tax retroactive to Jan. 1, 2010.

A year with no estate tax might sound like a potential windfall, but the situation can present pitfalls.

"Anyone who's retiring should be looking at this anyway – even if Congress was on the ball," says David Sloan, an estate planning attorney with Holland & Knight in Boston.

Here's how you might be affected.


Marital bequest

Most estate plans have trusts that contain a formula clause that outlines which assets go to a spouse exclusively and which go to children. Most estate planners base the formulas on whatever estate-tax exemption exists at the time of death. Once there is no estate tax, it reverts to zero. As a result, what appeared to be a well-considered plan may have an unanticipated result because the calculation was based on an exemption which doesn't exist.

For example, a typical estate plan includes a will that distributes everything to a trust. The trust often further divides the estate into two shares, says Sloan. One share is whatever amount that can pass estate-tax-free ($3.5 million last year) that would fund the family trust. The other share would be the balance of the assets, which would go into a marital trust, for the surviving spouse. (The tax on that money is deferred until the surviving spouse dies.)

Now, if that person dies in 2010, the formula says that his estate has to be divided into family and marital trusts. With no estate tax, the maximum amount that can pass into the family trust is all of it, which means the marital trust gets nothing, says Sloan. "If the surviving spouse isn't a beneficiary of that family trust, they get nothing under the plan, much to everyone's surprise," he says.

The surviving spouse can make a claim (every state has a statute in one form or another that says you can't disinherit a surviving spouse). But hiring a lawyer and bringing an action against the estate can become an expensive hassle.