More Potential Pitfalls of the New Estate Tax Law

     As we discussed in our last post, the increase in the applicable exclusion to $5,250,000, which dramatically reduced the number of estates with estate tax liability, also has the potential to create large problems for surviving beneficiaries if older estate plans are not updated. This is especially true in plans where the existing non-marital share primarily benefits other than the surviving spouse. This situation arises most commonly where clients want their children to receive something immediately upon the death of the first spouse or where the client wanted to provide for the children of a first marriage after remarrying. This strategy may have made sense at the time, because in prior years the applicable exclusion was smaller resulting in a smaller non-marital share and thus leaving sufficient assets to provide for the surviving spouse in the marital share. 

     With the new larger applicable exclusion, existing trusts will allocate significantly more assets to the non-marital share, potentially resulting in an inadvertent disinheritance of the surviving spouse. Some alternatives for protecting the surviving spouse in a situation such as this, while still achieving the goals of older trusts include the following modifications to the trust provisions: 

• Revise the non-marital share to provide the spouse is the sole beneficiary of distributions of income during the spouse's lifetime with the remainder going to children. 
• Revise the non-marital share to include the spouse as a beneficiary or co-beneficiary of income and/or principal together with the children, within the discretion of the trustee. 
• Revise the non-marital portion of the trust to limit the size of the non-marital trust for children and descendants (such as the figure that the client originally intended as the highest estate tax exemption) while providing the remainder of the non-marital portion be used for the exclusive or primary benefit of the surviving spouse. The amount of this cap will depend on the goals of the client and the needs of the surviving spouse. 

     Keep in mind that merely placing an arbitrary cap on the non-marital share, with the remainder going to the marital share will increase the surviving spouse's taxable estate by increasing the marital share. This increase could cause the surviving spouse's estate to be subject to estate taxes where the combination of the surviving spouse's separate assets and the enlarged marital share exceed the surviving spouse's applicable exclusion amount. The permanent adoption of portability has the potential to alleviate this problem in many situations. Portability is a complex topic that we will address in a separate post in the near future. 

     What is important to know is that with careful planning it is possible to provide a surviving spouse with extensive rights in and powers over the trust funds without causing the entire trust fund to be included in the surviving spouse's gross estate. Such rights and powers would include: 

• The right to all income, distributed currently. 
• The right to withdraw or require distributions of principal in such amounts and at such times as are necessary for the surviving spouse's health, education, support, or maintenance. 
• The right to receive distributions of principal in such amounts and at such times as the trustee (other than the surviving spouse) deems appropriate for any or at least a broader purpose. 
• The noncumulative annual right to withdraw the greater of 5% of the value of the trust fund or $5,000 dollars. 
• A testamentary power to appoint the trust fund to a class of beneficiaries that does not include the surviving spouse, his or her creditors, his or her estate, or its creditors. 
• The right to serve as the sole trustee or as a co-trustee or to remove and replace other persons serving as trustees. 

     As you can see, failing to review estate plan documents after tax law changes can lead to significant problems. Those problems can be remedied easily making changes to documents so that they again will reflect the intentions of the clients.

Alan Ferrara