February 15, 2018

In our recent Wealth Advisory Newsletter, we noted that readers should review their estate planning documents to determine if and how the new tax law (the "Act") impacts their planning.  In the following weeks we will issue brief bulletins illustrating some of the consequences and recommended courses of action that readers should consider in light of the Act.
As has been widely reported, the Act increases the estate and gift tax exemption to $11.2 million per person and continues to allow for a step up in basis to date of death value for assets includible in the decedent's estate (excluding retirement plans and IRAs).

One likely effect of the Act is that married readers will need to reconsider the effect of the formula clause in their Will. For example, to minimize the federal estate tax, many Wills provide that the largest amount that can pass free of federal estate tax be left to a “credit shelter” or exempt trust. Under the prior law, when the exemption was $5 million (indexed) the amount that would be left to such trust was $5 million which was often also the state estate tax exemption amount. Under the new law such formula provision will result in a funding of the credit shelter or exempt trust in the amount of $11.2 million which may significantly exceed the state estate tax exemption amount.

ACTION STEP: If your Will contains a formula clause which defines the "exempt amount" or the "optimum marital gift" with reference to the federal (and not the state) exemption amount, your estate may be subject to state estate tax that can easily be avoided if your Will is changed appropriately.  More specifically, utilizing the higher federal exemption amount of $11.2 million will result in a state estate tax liability at the first spouse’s death of up to $1,258,800 in New York.

EXAMPLE 1: Let's assume our decedent, who is a New York resident, has a Will providing for the funding of the credit shelter or exempt trust equal to the federal exemption and has more than $5,500,000 in his estate.  If he changes the funding formula to be equal to the lower New York state exemption ($5,250,000 in 2018) there will be no federal or New York state estate tax due upon his death. The unused federal exemption can be used by his spouse either by making lifetime gifts or upon her death thus resulting in no loss of the federal or state exemption. 

Another effect of applying a formula provision with the higher federal exemption is the less common and likely unintended disposition of the estate assets away from the surviving spouse.

EXAMPLE 2: Let’s assume our decedent has a $10 million estate and wants to leave his children from a prior marriage an amount equal to the federal exemption ($5 million at the time the Will was executed) and provides for such bequest by formula.  Assuming our decedent does not change his Will, now that the exempt amount has been increased to more than $11 million, his children will get the entire $10 million resulting in his wife being disinherited, which is not likely what he intended.  In order to avoid this result he must revise his Will to limit the funding to the amount he intends to leave to each family member.

As demonstrated by the foregoing examples, existing documents may no longer provide the intended results when drafted and as a result readers are urged to contact one of our trust and estate attorneys to review their current Will provisions and make the appropriate changes.

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