A recent probate case out of California demonstrates the importance of foresight in estate planning. In that case, a couple had set up a trust in order to minimize estate taxes, and made use of a device called a formula clause, which allows typically divided the estate so that their children would get the amount of assets in the federal estate tax exclusion, with the rest going to a marital trust for the surviving spouse. The purpose of this arrangement is to allow the full exclusion amount to pass to heirs tax-free.
Because the assets passing to the spouse are usually free of estate tax, the formula clause avoids taxes for a widow or widower at the time of their spouse’s death. The problem with formula clauses is that they rely on the federal estate tax exclusion, which is a number that changes fairly frequently. At present, the exclusion amount is $5 million per person, but that number will drop to $1 million in 2013 unless Congress decides otherwise.
In the California case, the couple drew up their most recent trust agreement in 2008, when the exclusion amount was $2 million. In 2010, the exclusion amount became unlimited since there was no estate tax. When the wife died in April of 2010, problems arose, since the whole estate rather than the few million, effectively leaving the husband out of money.
Twelve days before her death, her attorney and financial advisors scrambled to get the matter addressed, but the couple’s adult daughters petitioned the court to invalidate the amendment on the grounds of forgery and incapacity. The father sought to uphold the trust’s modification. While the couple did eventually invalidate the amendment, it ultimately sided with the father on the grounds that the intent of the parties was not reflected in the trust instrument.
In our next post, we’ll continue looking at this story.
Source: CNBC.com, “Dramatic estate tax battle delivers fresh lessons,” July 31, 2012