2010 Tax Law Leads to 2012 Litigation

This month’s Alert focuses on the increased trust litigation arising from the unintended consequences of the temporary repeal of the estate tax in 2010.

The estate tax was repealed for much of the year in 2010. While taxpayers with large estates benefited from the lack of the estate tax, the change in the law has caused litigation with inconsistent results. Estate planning attorneys have traditionally employed a strategy for married clients with large estates: dividing the contribute share of the first spouse to die at his or her death. There are several variations on the formulae used to divide the trust estate. Most formulae used to divide the trust estate either 1) distribute the amount of the deceased spouse’s trust estate that can pass free of estate tax to a sub-trust commonly referred to as the bypass, credit-shelter, or exemption trust, or 2) distribute the maximum amount of the deceased spouse’s trust estate that qualifies for the unlimited marital deduction and can pass without estate tax to a sub-trust commonly referred as the survivor’s trust or the marital trust.

In one case before a Southern California court, the trustee sought instructions as to how he should divide the trust assets. The deceased spouse had children from a prior relationship who were the beneficiaries of the bypass trust. The decedent’s spouse was the beneficiary of the survivor’s trust. The trust provided that the amount that could pass free from estate tax was to be allocated to the bypass trust. This meant, under one interpretation of the trust, that all the decedent’s share of the trust would pass to the deceased spouse’s children and his widow would receive nothing. An alternate interpretation would give all the trust assets to the surviving spouse and the children would take nothing until her death (assuming she did not exercise her power of appointment and give the assets to another beneficiary at her death).

The drafting attorney testified that it was the deceased spouse’s intent to benefit both his spouse and his children at his death. The decedent, according to the testimony of the drafting attorney, wanted some of the trust to be set aside for his wife, but he didn’t want his children to have to wait until her death to benefit from at least a part of the estate. The attorney indicated the deceased spouse would have never wanted either side to benefit totally to the exclusion of the other parties. Had the decedent died in 2009 rather than 2010, the trust as drafted would have worked to benefit both parties, consistent with the decedent’s intent as expressed by the drafting attorney. The judge ruled that, since he was being forced to either interpret the trust to benefit the spouse to the exclusion of the children (at least until her death) or the children to the exclusion of the wife, that he was going to hold that the trust assets should all be distributed to the survivor’s trust to be used for her benefit. The judge believed, based on the testimony, this ruling was the interpretation which the deceased spouse would have chosen if he had been given that choice.

In another Southern California case with very similar facts, the children sued to force the trustee to distribute the decedent’s trust assets to them. After a lengthy trial with various family members and friends testifying as to the decedent’s intent and expert witnesses testifying to what the trust language meant, the judge ruled that the decedent’s trust assets should all be distributed to the deceased spouse’s children. The judge in this case appeared to be more of a constructionist and less concerned about the welfare of the decedent’s widow. Perhaps he thought she was adequately taken care of with her share of the trust estate and that it would be unfair for the children to have to wait until her death to benefit in from the trust.

Unfortunately, for decedents who died in 2010, the formula language traditionally used by attorneys for decades can have unintended consequences, unduly benefitting one family member over another. As more families and trustees discover this fact, it is likely this type of trust litigation will increase. Had the deceased spouse understood the provisions in his or her trust or had the estate planning attorney alerted him or her of a potential problem if death occurred in 2010, these lawsuits, and many others, may have been avoided.

The estate tax law is once again scheduled to change on January 1, 2013. The amount that can be given free from estate tax at death will be lowered from $5,120,000 to $1,000,000. Persons who have not had their estate plans reviewed for years should schedule an appointment with a knowledgeable estate planning attorney to assure that his or her estate plan will function as intended when the new law becomes effective. In addition, for persons with substantial wealth, they may wish to take action before year-end to lock in the provisions of the current law and preserve the ability to pass up to $5.12 million to his or her heirs free from estate tax.

Our office focuses on estate planning strategies for clients of all wealth levels, including clients who will be subject to estate tax at death. We also offer trust administration and probate services. As a member of the American Academy of Estate Planning Attorneys, our firm is kept up to date with information regarding tax developments as well as cutting edge planning strategies for persons of all wealth levels. You can get more information about a complimentary review of your clients’ existing estate plans and our planning and administration services by calling our office.