Coastal Senior is a monthly periodical published in Savannah, Georgia and circulated throughout the Georgia and South Carolina low country. Bob Mason is its legal columnist.
Is your will from another century? Maybe even the first year or two of this century? If so, your older model estate plan may be getting poor mileage . . . and might even be unsafe to drive.
People typically update their wills and trusts for one of three reasons: Something personal has changed (a divorce, a marriage, a child joined Al Qaeda), an estate has changed (mother won the lottery, daddy invested in Enron back in ’01), or the law has changed (constantly).
Most people come to see me for the first two reasons, but very few come to see me because the law has changed. In both law and life in general, however, the only thing that doesn’t change is change. The law relating to estate tax has changed (much) since 2000 and my guess is will remain unsettled until after the next election cycle.
Here is a typical situation. A couple comes to see me with 1990’s “tax planning” wills that divide everything, using some formula, into two parts. One part called a marital or spousal share and one part called a family trust or credit trust. The couple may have had an estate of between $600,000 and $2 million when the will or trust was completed.
Everything in the couple’s life may feel the same and look the same, but things have changed. The law has changed. The surviving spouse may be headed for an unpleasant surprise. Here’s why.
First, you need to understand just a bit about how the estate tax works.
- General rule: All estates are taxable at death unless an exception applies.
- Exceptions:
- Transfers to a spouse (unlimited in amount)
- Charitable transfers
- Transfers that are “sheltered” by what used to be called the “unified credit” and are now called the “applicable exclusion” amount. Those transfers could NOT be used for another type of exclusion. For example, a transfer to a spouse could not also count as a “sheltered transfer” under the unified credit. The “sheltered” transfers historically kept smaller estates from being taxed.
- Sheltered transfers:
- In 2000 the amount that anyone could shelter was $675,000; it had been going up consistently for a few years before that from $600,000.
- In 2007 that number is $2,000,000.
How it works/worked: The year is 2000. Alex and Betty, a married couple, each have $750,000 in their own names ($1,500,000 total). Alex had a will that left everything to Betty. Alex died. Because Alex’s will left everything to Betty, there was no tax because of the unlimited nontaxable transfer to the spouse. However, none of Alex’s “credit” or “shelter” amount of $675,000 was used because everything was given to Betty by will. Alex wasted all of his $675,000.
Here’s the problem: While there was no tax when Alex died, Betty now has an estate of $1,500,000 (her $750,000 and the $750,000 she inherited from Alex). Let’s say Betty died later in 2000, when the credit amount was still $675,000. Her will said “leave it all to the kids if Alex has died”. Because Betty also had a $675,000 credit amount, then $825,000 of her estate would be subject to estate tax ($1,500,000 – $675,000). BAD planning. All tax could have been avoided.
How taxes were avoided. Enter the 1990’s “tax planning” will. Alex and Betty would each have wills that directed the executor to divide the estate into two shares. One share equaled whatever the “credit” or “shelter” amount was on the date of death ($675,000 if Alex died in 2000). The other share was the rest of the estate. The first share ($675,000) went to a trust that would NOT be meant to qualify as a marital transfer – that way Alex used his credit amount (usually the trust would allow income and perhaps some principal to be paid to the surviving spouse for her life). The rest ($75,000 in Alex’ case) would go to Betty. No tax.
Now Betty had an estate of $825,000 (her own $750,000 and the $75,000 inherited from Alex). Everything else was in the trust. If Betty died in 2000 she would have a taxable estate of only $150,000 ($825,000 – $675,000). A taxable estate of $150,000 was MUCH better than one of $825,000; and simple planning fixed the problem.
The Problem Is Getting Bigger. So far I’ve talked about $675,000 credit amount in 2000. As I mentioned, it is now at $2,000,000. If someone with an old 1990’s (or even early 2000’s) tax planning will dies in 2007 or 2008, up to $2,000,000 would go into the Credit Shelter trust (that may have all kinds of restrictions) and nothing outright to the surviving spouse. In Betty and Alex’s case, ALL of Alex’s $750,000 would go into trust, and nothing would go to Betty outright.
What made sense a few years ago, makes no sense now. Betty and Alex may want to redraft their wills.
