Amending Documents? Do Not Forget to Adjust Plan for Estate Taxes…

With the applicable exclusion amount of $5.490 million, many individuals’ estates will not be subject to estate tax. However, if you have a taxable estate, then determining whom will pay the estate taxes is critical. The recent case, Bandy v. Clancy, featured the estate of Tom Clancy, the famous novelist. Bandy illustrates the importance of the  estate tax apportionment clause in estate planning documents, especially, with a second spouse and children of the second spouse and prior spouses.

Tom Clancy (“Tom”) died October 1, 2013 with a surviving spouse, Alexandra, their minor daughter and 4 adult children from a Tom’s prior marriage. At his death, pursuant to his Last Will and Testament, his estate was divided in 3 shares:

1. Marital Trust for benefit of Alexandra wife (qualified for the marital deduction) ;
2. Non-Exempt Family Residuary Trust (the “Family Trust”) for Alexandra and their minor child (did NOT qualify for the marital deduction); and
3. Trusts (“Older Children’s Trust”)  for Clancy’s older children (did NOT qualify for the marital deduction).

In Tom’s original Last Will and Testament, the estate taxes were to be paid from the Family Trust and the Older Children’s Trust. The Marital Trust would pay NO estate taxes. This plan is common as an unlimited marital deduction is allowed for assets distributed to or for the benefit of a spouse. Thus, the marital deduction trust does not “contribute” to the imposition of the estate tax. If estate taxes are apportioned to a marital trust, then an interrelated calculation is necessary, as estate taxes reduce the marital trust, which reduces the marital deduction which increases the estate taxes. This interrelated calculation is avoided if estate taxes are apportioned AWAY from the marital trust.

Tom signed a codicil to his Last Will and Testament which provided terms to permit the Family Trust to qualify for the marital deduction. “Savings language” in the codicil provided that both the Marital Trust and the Family Trust were to qualify for the marital deduction. The estate tax apportionment provisions were not changed. As the Family Trust qualified for the marital deduction, the issue was whether  estate taxes of $11.8 million were apportioned AWAY from the Family Trust and paid only by the Older Children’s Trust.

The spouse asserted that all estate taxes were allocated to the Older Children’s Trusts and NOT to either the marital trust or the Family Trust because both trusts qualified for the marital deduction and the original Last Will and Testament apportioned all estate taxes away from any marital deduction trust. She argued that the “savings language” in the codicil prevented the executor from allocating ANY estate taxes to those trusts.

The executor argued that the “savings language” only indicated the desire that the Family Trust qualify for the marital deduction. The “savings language” did not state that estate taxes would be apportioned AWAY from the Family Trust and only to the Older Children’s Trust.

The court determined that the Family Trust, as amended to qualify for the marital deduction,  was EXEMPT from any estate tax apportionment and all estate taxes were apportioned to the Older Children’s Trust.

The dissenting opinion stated that the majority’s opinion skewed the testator’s intent as to the ultimate disposition of the assets. The codicil, amending the Family Trust to qualify for the marital deduction, achieved a  significant reduction in tax liability (from $26 million to $15.7 million). If estate taxes were apportioned between the Family Trust and the Older Children’s Trust, then Tom’s original distribution (50% – 50%) plan would be implemented.

The dissent noted that the majority opinion’s interpretation achieved an additional tax reduction (from $15.7 million to $11.8 million), but would “cast aside the plan for equal distributions from the residual despite the fact that the language of the will directing equal distributions was not amended — and skew the distributions from the residual in her [the spouse’s] favor (63% – 37%)”.

ADVICE: Whenever codicils or amendments are prepared be sure that, if you change the dispositive provisions in the documents, that the estate tax apportionment clause is consistent with the testator’s intent. ANY time there are stepchildren and a subsequent marriage be very careful drafting to be sure that the intent of the testator is met. Review the Florida tax apportionment statute. The statute is very well drafted and you may want to default to that statute in your estate planning documents.

WORD OF THE WEEK:   Apportionment is the allocation of expenses to different shares. Generally, the term in estate planning relates to estate taxes but the term can also apply to other expenses. For example, real estate expenses can be apportioned to a life interest in a trust and capital improvements can be apportioned to the remainder person’s interest in the trust.

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