Old Wills
With New Problems
Bob Mason
Originally
published in Coastal Senior
(November 2007)
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.
To read this article in its
entirety please go to the
November 2007 issue of
Coastal Senior by clicking
HERE. You can
read the
entire issue by clicking the
front page image above!
