Law Offices of James W. Mallonee, P.A.
Port Charlotte 941-206-2223
Venice 941-207-2223
Helping individuals & families across Florida with their legal matters since 2005

2010 Estate Tax Issues

Nobody ever thought in 2001 that Congress would allow the Estate Tax to actually terminate in 2010, but 2010 arrived and it happened. We should all be pleased but in reality the lack of an applicable exclusion (known as the unified credit) for purposes of establishing an estate tax threshold creates some potential pitfalls for those individuals with trusts that contain a credit shelter provision (also known as by-pass trust).

The applicable exclusion is the dollar amount of assets which can pass free of estate tax. In 2009, the applicable exclusion was $3.5 million following a person’s death. Thus, a person who died in 2009 and had an estate of $4.0 million could pass $3.5 million to others estate tax free. The remaining $500,000.00 would have been taxed at the estate tax rates in effect during 2009 unless the $500,000.00 passed to the surviving spouse or a charity.

Generally, estate planners prepare trusts for a husband and wife that place all of a person’s estate assets up to the amount of the applicable exclusion into a credit shelter trust with the balance going to a second trust or outright to the surviving spouse. The assets chosen for the credit shelter trust is generally determined by some formula up to the amount of the applicable exclusion. This process is put into place in an effort to maximize the passing of estate assets while minimizing Federal and State tax liabilities.

Generally speaking the corpus of a credit shelter trust generates income which is usually paid to the surviving spouse during his or her lifetime. At the surviving spouse’s death, the corpus of the credit shelter trust is then transferred to the decedent’s children or other devisees tax free.

Alternatively, the assets placed into a credit shelter trust might be delivered directly to named beneficiaries at the decedent’s death. In many cases the named beneficiaries might be the children of the decedent from a previous marriage. The idea being that the decedent wants to be certain that his or her offspring are taken care of following their death.

The looming problem today is that there is no estate tax from which to calculate the applicable exclusion. You might think this is great news, but in reality it creates the following potential problems for the unwary:

Scenario #1: Suppose your credit shelter trust provides for its funding to be the maximum amount that will pass free of estate tax. Because there is no estate tax, the decedent’s entire estate passes to the credit shelter trust. In addition, suppose the credit shelter trust also provides that the spouse is to be paid income from its corpus. Imagine the nightmare the surviving spouse will have once he or she learns that they will have to live solely on the income from the credit shelter trust for his or her health, education, maintenance and support. In essence, nothing but income passes to the surviving spouse, unless the credit shelter trust allows for principal to pass to him or her.

Scenario #2: Suppose your credit shelter trust provides for its funding to be the maximum amount that will pass free of estate tax. Your credit shelter trust also provides that the assets placed into the credit shelter trust are to pass directly to your children from a previous marriage. Your trust also provides that any assets that do not pass to the credit shelter trust are to pass directly to the surviving spouse. Your intent for this provision was to provide principal for your surviving spouse such that he or she could continue to live in the life style that they are accustomed. Because there is no estate tax, your entire estate passes to your children and nothing goes to your surviving spouse.

So what is the problem here? The problem is not knowing the intent of the decedent when he or she had his or her trust created. For example, was the decedent’s intent to truly avoid as much estate tax as possible and have it pass completely to the credit shelter trust? Or was the decedent’s intent to provide some funds for his children from a previous marriage, but certainly not to eliminate all funding to his or her spouse?

The only way to determine what was the decedent’s intent is provide extrinsic evidence to the Courts and allow the judicial system to determine what was the decedent really trying to do. As you can imagine this procedure could be an expensive and non-harmonious resolution.

What is the solution? In many cases it may simply be a codicil or amendment to a person’s estate document. The amendment or codicil may simply provide language instructing the administrator of his or her estate of their intent regarding where to place the estate’s assets upon death. That is, do they want to avoid estate tax at all costs or provide fixed percentages to various trusts for the purposes of transferring his or her wealth between a person’s children and the surviving spouse.

Another issue that will arise is the consequences of distribution of an estate’s assets by the trustee or personal representative if Congress revises the estate tax laws and makes them retro-active back through 2010. Imagine the potential problems for the trustee or personal representative who distributes the assets of an estate under the guise that there is no applicable estate tax only to find out later that Congress retro actively enacted it. What is the likelihood that the beneficiaries will be willing to give up their bequest to pay for any estate tax that is due? In this author’s experience, it is unlikely that the beneficiaries will be motivated to cooperate making the Trustee or Personal Representative potentially liable to the IRS.

Even more intriguing is how assets being transferred to beneficiaries of a decedent’s estate are being stepped up to a new basis. It used to be that assets transferring to beneficiaries through a decedent’s trust or Will received a stepped up basis consisting of the fair market value of such asset at the time of death or 6 months thereafter. That is not the case today. Congress made sure that the government would not lose out on all that lost estate tax revenue, so they put in place a limited adjustment of stepping up the basis of assets to $1.3 million ($4.3 million if passing directly to a surviving spouse). Presently, the stepped up basis is determined by comparing what the decedent paid for an asset versus its fair market value at the time of the decedent’s death (or 6 months thereafter). If the difference in the value paid versus the fair market value at the time of the decedent’s death (or 6 months thereafter) of all assets being transferred exceeds $1.3 million (or $4.3 million to a spouse), then capital gains tax will eventually be assessed. The Trustee or Personal Representative may have to carefully determine which assets are to pass to the surviving spouse and which are to pass to other devisees in order to maximize the stepped up basis of a decedent’s estate when such assets get transferred.

In light of this dilemma to the administrator of an estate, it might be wise to consider providing language exonerating the Trustee or Personal Representative from liability if the decision they make in allocating the $1.3 million stepped up basis among the beneficiaries causes tax implications to some family members and not others. It would also be a good idea to consider adding such exonerating language in the event Congress retroactively enacts the estate tax that could effect a decision made by the Trustee or Personal Representative that is conflict with a newly legislated statute.

As you can see from the above issues there are pitfalls that a creator of an estate administration document may leave upon his or her death for their family to correct. No doubt problems should be avoided if at all possible to maintain family harmony and prevent judicial intervention. If you are uncertain as to what will be the consequences of your estate administration documents as they presently read, you should visit your attorney and have an open discussion of what will happen upon death in 2010 or the following years. You should make your desires well known such that language can be prepared to carry out your intent. It may be the best discussion you have regarding the distribution of your estate following your death.

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