Estate Tax Formula Clauses May Require Immediate Attention
The vast majority of estate plans drafted to take advantage of the estate tax exempt amount over the years have utilized a formula that directs the estate tax exempt amount to be funded into a Family Trust or Credit Shelter Trust with the balance passing outright to the surviving spouse and/or into a Marital Trust. As the exempt amount increased year by year, the estate assets in most instances also increased, which led to few adverse effects. However, now that the estate tax exempt amount in 2018 has doubled to $11,180,000 per person, almost all clients need to address the effects of the formula clause on their estates. The following is an example of a $9 million decedent's estate based on the exempt amounts in effect in 2006, 2011 and now in 2018.
Estate of $9,000,000
2006 Exempt amount $2,000,000 — Family Trust $2,000,000
Surviving Spouse or Marital Trust $7,000,000
2006 Exempt amount $5,000,000 — Family Trust $5,000,000
Surviving Spouse or Marital Trust $4,000,000
2006 Exempt amount $11,180,000 — Family Trust $9,000,000
Surviving Spouse or Marital Trust $0
In 2006, the surviving spouse would inherit the majority of the estate outright or in a Marital Trust, whereas now the surviving spouse and/or the Marital Trust would get ZERO. This example is further exacerbated if, in fact, the Family Trust was designed to benefit the children and further generations only, but could also cause family conflict if the Family Trust were drafted as a "spray trust" to distribute income and principal amongst the surviving spouse, children, grandchildren etc. based on "need."
In past newsletters, we have commented upon the advisability of having the exempt amount and the residuary estate pass into both the Family Trust and the Marital Trust with the surviving spouse as sole beneficiary, provided that the family's intent is that the husband and wife are to continue to receive all of the income and have access to discretionary principal distributions until the survivor dies. We have also recommended in many instances that the entire estate be held in a trust for the benefit of the surviving spouse with the personal representative or trustee having the discretion to elect to treat part or all of the trust as a Marital Trust under the Qualified Terminable Interest Property Rules (QTIPable Trust).
Please note that the intent here is only to highlight some of the very serious adverse affects that the formula clauses may cause without further timely attention.
The Estate Tax Exempt Amount
Use It or Lose It
The increase in the exempt amount for gift, estate and generation-skipping transfer tax purposes to $11,180,000 per person has a built-in cancellation clause effective January 1, 2026, unless the currently indexed increases are further extended. As a result of current political uncertainty, many advisors have opined that the odds are better than 50/50 that the exempt amount will regress to the 2017 indexed amount in 2026. Therefore, clients are advised to seriously consider using some or all of the increased exempt amounts via the various tried and true estate planning vehicles used in the past. These include family limited partnerships and/or limited liability companies, qualified personal residence trusts, grantor and non-grantor irrevocable trusts, spousal lifetime access trusts (SLATs) and other vehicles.
The standard income tax deduction per couple has increased to $24,000 in 2018. If your state tax deductions are capped at $10,000, then you would need to generate in excess of $14,000 of charitable contributions in order to take advantage of a deduction for those expenditures. If they do not, then you would simply rely on the standard deduction. However, if you could make charitable contributions in 2018 for the expenditures anticipated to be made over the next 5-10 years, you would then be able to deduct not only your state tax amounts, but also your total charitable gift deductions. In future years you could rely on your annual standard deductions. For example, if you typically contribute $10,000 a year but contributed $100,000 this year, then you could deduct not only that total amount, but also the $10,000 state tax deductible amounts.
This year, those deductions would not need to be contributed outright to 501(c)(3) charitable organizations, but instead could be contributed to a donor advised fund (DAF) from which you could expend amounts over the next several years directly to charities. Keep in mind that if you have a IRA and you are over age 72 ½, you can contribute amounts directly from your IRA to the charity to satisfy your annual minimum required distributions, and still take your standard deductions.
The rules governing charitable remainder trusts have not changed. If you wish to benefit charities primarily upon your demise, you could create a charitable remainder unitrust paying you a set percentage of at least 5% per year and generate a significant income tax deduction this year. If the payout is 5%, a 70 year old's deduction would be 52.487% of the amount funded into the trust. A couple aged 70 would generate a deduction of 41.255%. If instead you opted for a Charitable Remainder Annuity Trust, those same contributions' deductions would be 45.484% or 31.09% respectively.