All Estate Plans with Marital Deduction Formula Documents Should be Reviewed

Making Use of Estate Tax Marital Deductions and Estate Tax Exemptions in 2010

As mentioned here, for the first time since 1915, until Congress acts to re-impose an estate tax, there will be no estate tax on estates of those who die in 2010. One of the problems created by Congress’s failure to deal effectively with this unique situation relates to the estate tax marital deduction. The purpose of this article is to alert you to problems that may exist with certain types of wills (and will substitutes such as revocable living trusts) that incorporate marital deduction planning.

Rules Applicable and Techniques Employed Before 2010

Except for the estate of a person who dies in 2010, married couples have estate planning options available to them that are not available to unmarried couples.

Under the pre-2010 federal estate tax rules (and Connecticut and New York estate tax rules), in computing the applicable estate tax, a deceased spouse’s estate is entitled to an unlimited marital deduction for certain property passing to or for the benefit of the surviving spouse if the surviving spouse is a U.S. citizen. In addition, the estate is entitled to a credit (the “unified credit”) against any federal estate tax due with respect to property not qualifying for any deduction.

In 2009, the unified credit was $1,455,800 and it sheltered $3,500,000 from the federal estate tax. In this article we use the term “exemption” as the amount that is sheltered from the estate tax as a result of the unified credit.

As this memo is being written on January 9, 2010, there is no federal estate tax. No one I know (or who I have read) believes this will be the case for long. Congress is expected to take some action early in 2010. Until Congress takes action (probably retroactively), however, for the estates of decedents who die in 2010 there is no federal estate tax. You can think of that as creating a temporary unlimited estate tax “exemption.”

In 2011 the federal estate tax is scheduled to return with a $345,800 unified credit which shelters $1,000,000 from the federal estate tax. Accordingly, under current federal estate tax law, the “exemption” is scheduled to be $1,000,000 in 2011 with tax brackets jumping back up to pre-2000 levels.

At the core of most planning for well-to-do married couples is the principle that a transfer from one spouse to a U.S. citizen spouse occurs free of any estate and gift tax. Such gifts, however, increase the estate of the donee (or surviving) spouse. As a result, if the survivor’s estate is then larger than the federal estate tax exemption, the assets given to the surviving spouse are exposed to estate taxation later at the time of the surviving spouse’s death.

At the state level, before and after 2010, the same principle applies except for the fact that state estate tax exemptions are frequently different from the federal estate tax exemption. Currently the Connecticut estate tax exemption is $3,500,000 and New York’s exemption is $1,000,000.

To make matters more complicated, as the federal tax provisions have been changed, state legislatures have responded with frequent changes to their estate tax laws. For example, Connecticut has changed its estate and gift tax provisions in significant ways more than six different times in the last five years. Within the last five years, the Connecticut General Assembly has repealed its succession tax, enacted an enhanced type of estate tax, repealed that estate tax, hastily adopted a unique new estate tax (containing obvious errors which it has chosen to perpetuate), adopted a new estate tax with a $3,500,000 exemption, and postponed the application of the $3,500,000 exemption while reinstating the $2,000,000 exemption. Governor Rell has vetoed the postponement and reinstatement. We are waiting to see whether the Connecticut lawmakers will override the Governor’s veto.  As matters currently stand (January 9, 2010), the Connecticut estate tax exemption is $3,500,000.

Although it is difficult to predict the actual amount of the federal and state estate tax exemptions that may apply at the time of your death, if an estate tax is then applicable at either a state or federal level, we can assume that an estate tax exemption in some amount will exist. If the surviving spouse receives all the property of the deceased spouse, the survivor’s estate tax could exceed the then existing exemption, thereby generating an estate tax obligation to pay.

The estate tax could be eliminated or reduced if the deceased spouse’s estate plan takes advantage of the marital deduction only to the extent necessary to minimize or eliminate the tax payable from his or her estate. This would mean that, before 2010 (and again in 2011) an amount roughly equal to the applicable exemption would pass to a trust for the benefit of the survivor (frequently called a “credit shelter trust,” “bypass trust” or “exemption trust;” for the purposes of this article, we will call it an “exemption trust”). The exemption trust would not be subjected to an estate tax when the survivor dies.

With the above in mind, estate planners often begin their analyses by asking: “Why give the surviving spouse any more as a marital deduction gift (which will be subject to tax on his or her subsequent death) than is necessary to reduce the deceased spouse’s estate tax to the lowest amount (usually zero), when the property not so given to the surviving spouse (for example, having the value of the exemption) can be placed in a trust (the exemption trust) for the benefit of the surviving spouse and escape tax entirely on his or her subsequent death?”

An Illustration: Consider the following example. Mr. Taxpayer has an estate of $1,800,000. His primary goal is the care and comfort of Mrs. Taxpayer. His secondary goal is the preservation of his estate for ultimate distribution to his descendants. Some reasonable alternatives for the disposition of his estate are:

(a) Give his total estate to Mrs. Taxpayer.

(b) Give his total estate to Mrs. Taxpayer but give her the opportunity to “disclaim” a portion of the estate. The “disclaimed property” would pass to a trust for Mrs. Taxpayer’s benefit (the “Disclaimer Trust”) and would not be subject to tax on Mrs. Taxpayer’s subsequent death. This alternative will be referred to as the “Disclaimer Plan.” [Note: A “disclaimer” is the irrevocable refusal to accept a gift of property. The general rule is that for a disclaimer to be effective for tax purposes the disclaiming party cannot have any interest in the disclaimed property following the disclaimer. There is, however, a special exception which allows a surviving spouse to disclaim property passing into a trust created under the deceased spouse’s Will for the benefit of the surviving spouse. Such a trust must, however, be narrowly drawn because the surviving spouse may not have any powers over trust principal.]

(c) Give part of his estate to Mrs. Taxpayer and the rest (equal to the exemption existing at the time of his death) to a trust (the “Exemption Trust”) for Mrs. Taxpayer’s benefit. The Exemption Trust would not be subjected to estate tax on Mrs. Taxpayer’s subsequent death. This alternative will be referred to as the “Formula Plan.”

Alternative (b), the Disclaimer Plan, is actually the same as alternative (a) but with the added flexibility which arises by giving to Mrs. Taxpayer the power to make the planning decisions, with the help of her advisors, after Mr. Taxpayer’s death. Alternative (b), the Disclaimer Plan, could produce tax results almost the equivalent of alternative (c), the Formula Plan. One important difference between the Disclaimer Plan and Formula Plan is that, under the Disclaimer Plan, tax savings will result only if the surviving spouse takes the necessary steps. The following discussion will relate only to the Disclaimer Plan and the Formula Plan.

The Disclaimer Plan: Suppose (i) Mr. Taxpayer dies in 2011 (when the federal exemption is $1,000,000) with an estate of $1,800,000, (ii) that when he drafted his Will he adopted alternative (b), the Disclaimer Plan, and (iii) that Mrs. Taxpayer’s separate assets have no value. Mr. Taxpayer’s Will provides that his total estate passes to Mrs. Taxpayer except for property she disclaims. If Mrs. Taxpayer did not disclaim, she would receive $1,800,000 (less some administration expenses) from Mr. Taxpayer’s estate, all of which would be subject to tax on her subsequent death. Because Mrs. Taxpayer’s estate, when she subsequently dies, would be approximately $1,800,000, and larger than the applicable federal estate tax exemption ($1,000,000), estate taxes would be payable from her estate. The tax would be significant. In 2011, once the taxable estate exceeds the exemption, the lowest applicable estate tax bracket would be 41%.

Mrs. Taxpayer’s estate tax liability could be significantly reduced by her use of the disclaimer shortly after Mr. Taxpayer’s death. Suppose, for example, that Mrs. Taxpayer decides that she does not need the total $1,800,000 outright from Mr. Taxpayer in order to be financially secure, or that, regardless of her financial security, the ultimate tax costs of outright ownership of the total $1,800,000 is too high. She might decide to disclaim a portion of Mr. Taxpayer’s estate having a value up to $1,000,000 (the exemption), which amount, according to Mr. Taxpayer’s Will, would pass into the Disclaimer Trust for her benefit. She might wish to pick $1,000,000 as the appropriate amount to disclaim because $1,000,000 (the 2011 federal estate tax exemption) would be the largest amount she could disclaim without generating a U.S. estate tax. The results of such a disclaimer would be as follows:

(a) Mrs. Taxpayer would receive outright from Mr. Taxpayer approximately $800,000. Her estate at the time of her subsequent death would consist of her own property (which we earlier assumed had no value) plus the $800,000 received from Mr. Taxpayer.

(b) The Disclaimer Trust receiving the disclaimed property would contain $1,000,000, less some other items (administration expenses). The Trustee would pay all income to Mrs. Taxpayer and also would have broad discretion to pay principal to Mrs. Taxpayer if she needed it. If desirable, the Trustee could be allowed to invade income and principal for the benefit of others although such provisions could make the disclaimer less attractive to Mrs. Taxpayer. The assets in the trust would not be taxed as part of Mrs. Taxpayer’s estate when she subsequently dies.

(c) Upon Mrs. Taxpayer’s subsequent death, U.S. estate taxes saved as a result of Mrs. Taxpayer’s disclaimer would probably exceed $250,000.

(d) State death taxes might also be saved by this plan because the assets in the trust (the disclaimed property) would not be subject to such taxes on Mrs. Taxpayer’s subsequent death.

The Formula Plan: Under the Formula Plan, the tax planning decisions are made in advance (at the time Mr. Taxpayer signs his Will) for Mrs. Taxpayer in favor of overall estate tax savings. The Formula Plan would be designed to bequeath to the Exemption Trust for the benefit of the whole Taxpayer family an amount equal to the estate tax exemption available at the time of Mr. Taxpayer’s death. The remainder of Mr. Taxpayer’s estate assets would pass either outright to Mrs. Taxpayer or in a trust which would qualify for the marital deduction (the “Marital Trust” or the QTIP Trust” referred to below). Although this may seem to achieve the same results as can be obtained by using the Disclaimer Plan, the most important advantage which the Exemption Trust has over the Disclaimer Trust is that the Exemption Trust can contain broad discretionary powers over principal which are exercisable by Mrs. Taxpayer, but the Disclaimer Trust cannot contain such powers.

In order to decide whether to adopt the Disclaimer Plan or the Formula Plan, Mr. Taxpayer would consider the following:

(1) Whether he believes the Formula Plan would provide his wife with sufficient benefits to make her feel comfortable and secure. One way to ask the question is: “Do I believe that, even though my wife may have control over less property, there should be placed in a trust for her benefit in all events the full amount of the exemption, knowing that to do so will lower death taxes at my wife’s subsequent death?” Of course, Mr. Taxpayer must at this point decide how he feels about trusts in light of the substantial tax savings which could result from the use of one or more trusts. If the answer to the question is “yes,” the Formula Plan is probably the one to adopt.

(2) The answer to the question posed above may depend upon the nature of the trust, and Mr. Taxpayer must decide whether the following powers, which are frequently included in the Exemption Trust under the Formula Plan (but are excluded from the Disclaimer Trust, except for the $5,000 or 5% withdrawal power), make the difference. These powers are: (i) Mrs. Taxpayer’s power during her lifetime to appoint trust principal to individuals other than herself (usually limited to descendants); (ii) Mrs. Taxpayer’s power to withdraw for her own use the greater of $5,000 or 5% of the trust principal each year, and (iii) Mrs. Taxpayer’s power upon her death to appoint trust principal to individuals (usually limited to descendants), other than herself or her estate, by appropriate provisions in her Will. On the other hand, both the Exemption Trust and the Disclaimer Trust would provide that income be paid to Mrs. Taxpayer and that the Trustee has broad discretionary powers to invade principal for Mrs. Taxpayer. As previously mentioned, the Disclaimer Trust could also include a right in Mrs. Taxpayer to withdraw the greater of $5,000 or 5% of the Disclaimer Trust principal.

(3) Mr. Taxpayer should also consider the fact that, if the Disclaimer Plan is adopted, the tax planning decisions will be left to Mrs. Taxpayer (with the help of her advisors) and must be made within nine months after his death under what could be stressful circumstances. If he believes his wife is capable of making the decision as to how much should be placed in trust so as to reduce taxes at her later death, even under such stressful circumstances, then the Disclaimer Plan would have greater appeal, even though the Disclaimer Trust is a less flexible trust. If Mr. Taxpayer believes that it would be unwise to leave this decision to Mrs. Taxpayer at a difficult time, or that the Disclaimer Trust is too inflexible, then the Formula Plan would have greater appeal.

Marital Trust Options: Both the Disclaimer Plan and the Formula Plan take advantage of the marital deduction. The different ways in which property may pass and qualify for the marital deduction can be used in either plan. If the surviving spouse is a U.S. citizen, the forms of marital deduction gifts are (i) the outright gift, (ii) the traditional Marital Trust which gives the surviving spouse the absolute power to control by Will the disposition of trust principal upon the surviving spouse’s death, and (iii) the qualified terminable interest property trust (“QTIP Trust”). Unlike the traditional Marital Trust, the QTIP Trust may irrevocably designate descendants (or any other person or class of persons) as the ultimate recipients of the marital deduction property (or prohibit the surviving spouse from appointing such property to persons other than a particular class of people). If the surviving spouse is not a U.S. citizen, the marital deduction will not be available except for property which passes to a trust known as a qualified domestic trust (“QDOT Trust”).

Considerations Relating to the Use of Trusts: The planning techniques discussed above require the creation of trusts. Factors to consider regarding the use of trusts are:

(1) Trust assets are managed by a Trustee (a person or bank) for the benefit of others. The beneficiaries, therefore, do not have control over the trust assets. A Trustee, however, must account to the beneficiaries for its actions. It is generally preferable to give a Trustee broad discretion (limited, however, by prudence) regarding investment decisions. Often, depending on circumstances, a Trustee may also be given broad discretion to decide how benefits will be divided among members of a class of beneficiaries.

(2) The most important decision regarding the use of a trust is the identity of the Trustee. The Trustee must, among other things, be meticulous about keeping separate and complete records, prudent with respect to investments, sensitive to the needs of the beneficiaries and fair in its dealings with both the trust and all beneficiaries.

(3) The management of trusts involves some expense relating to the Trustee’s compensation, court costs and legal fees.

(4) Trusts are not merely tax-saving devices. A trust may be the best way to provide a benefit for someone who is not up to managing assets. Particularly when tax considerations are not of primary concern, a trust can be drafted containing an endless variety of provisions to accomplish many different goals.

The Effects of Repeal in 2010 (Current Law as of January 9, 2010)

Federal Exemption Uncertainty: Many of you have estate planning documents which contain provisions referring to the federal estate tax exemption (the Formula Plan described above). If your death occurs in 2010 when the federal estate tax does not apply, there may be questions regarding how the documents will be interpreted. For example, documents which our firm prepared using the Formula Plan will be interpreted to maximize the value of the Exemption Trust with the result that the Marital Share might be reduced or eliminated. Such a result is not necessarily bad depending on how assets are titled and beneficiary designations for retirement accounts, life insurance and other similar assets are prepared.  To avoid surprises, however, and to assure proper coordination between the terms of the Will (or Will substitute) and beneficiary designations, it is important for you to review such plans. 

Different attorneys take different approaches to the preparation of Formula Plans. How each provision will be interpreted in light of the federal estate tax law changes will depend on the language employed by the drafting attorney. Some drafting approaches may be interpreted as maximizing the Marital Share with the result that the exemption trust would not be funded. In that case, an opportunity to use the exemption trust to shelter assets from an estate tax (that might be imposed when the surviving spouse dies) would be lost.

We suggest that everyone who has estate planning documents that use the Formula Plan ask their attorneys to review their documents and the assets comprising their estates.

State Exemption Uncertainty: As mentioned above, Connecticut’s General Assembly enacted a $3,500,000 exemption which is effective on January 1, 2010, but then postponed its effective date for two years. The postponement was vetoed, however, by Governor Rell. Unless the General Assembly overrides the veto, Connecticut will have a $3,500,000 exemption.

Other states have smaller exemptions. New York and Massachusetts, for example, have $1,000,000 exemptions. New Jersey and Rhode Island have $675,000 exemptions.

Estate plans that use the type of Formula Plan that maximizes the size of the exemption trust could result in an unexpectedly high state estate tax when the value of the property passing to the exemption trust (in 2010 this could be 100% of the estate) exceeds the value of the state exemption.

We suggest that everyone who has estate planning documents that use the Formula Plan ask their attorneys to review their documents, and the assets comprising their estates, to determine whether the size of the exemption trust should be limited to the state exemption.

Marital Deduction Uncertainty: As mentioned above, if the surviving spouse is a U.S. citizen, the forms of marital deduction gifts are (i) the outright gift, (ii) the traditional Marital Trust which gives the surviving spouse the absolute power to control by Will the disposition of trust principal upon the surviving spouse’s death, and (iii) the qualified terminable interest property trust (“QTIP Trust”). If the surviving spouse is not a U.S. citizen, the marital deduction will not be available except for property which passes to a trust known as a qualified domestic trust (“QDOT Trust”).

Many of you have estate planning documents which include a QTIP trust or a QDOT trust that is drafted like a QTIP trust. Property passing to such a trust qualifies for the estate tax marital deduction only if an election is made. In 2010, when the federal estate tax is not applicable, there is no way to make the federal QTIP and QDOT elections. Connecticut law allows a QTIP election (but is silent on the QDOT election) even when there is no federal estate tax in effect (referred to as a “state-only election”). Other states may not allow a state-only election. For example, New York, New Jersey and Vermont (among other states) do not allow a QTIP election when no federal election is made.

Accordingly, if your death occurs in 2010 when the federal estate tax does not apply, and you own property in a state which does not allow a “state-only” QTIP election (similar to New York), and if that property passes to a QTIP type trust, no estate tax marital deduction will be available under that state’s estate tax law.  As a result, estate taxes imposed by that state may by unexpectedly high.

In addition, it appears that, during 2010 (when no federal estate tax applies), no Connecticut estate tax marital deduction will be allowed for any type of transfer at death to a spouse who is not a U.S. citizen because there is no provision for making a QDOT election at the state level.  As a result, a surviving non-citizen spouse may be surprised by unexpectedly high state estate taxes.

Income Tax Basis and Capital Gains Tax Uncertainty: You might expect that the absence of the U.S. estate tax would make life simpler. Look a little under the surface, however, and you begin to understand that absence of the U.S. estate tax leaves behind certain provisions relating to capital gain taxes which will adversely affect everyone who has assets (and I literally mean everyone) while the estate tax, before repeal, adversely affected only a very small group.

Before capital gains can be taxed, the size of the gain must be computed. Generally, the gain is the difference between what you receive in exchange for the asset and your tax basis in the asset. When you purchase an asset, your tax basis in the asset is generally what you pay for it. Before 2010, when you inherited an asset from a decedent, your tax basis in the asset was adjusted to its value as of the date of the decedent’s death. Accordingly, inherited property (there are exceptions, however) usually could be sold shortly after the decedent’s death free of capital gains tax. In 2010, however, that changes. When you inherit property from someone who dies in 2010, there will not be the automatic adjustment to basis; rather, you will receive the same basis the decedent had in the property immediately before the decedent’s death (referred to as a “carry over basis”) subject to certain valuable (but limited) adjustments that must be made by your Executor.

For every decedent’s estate (whether married or single), 2010 law provides that the tax basis of inherited property may be increased to its date of death value, but the increase is limited to a total adjustment of $1,300,000. We do not yet know the mechanics of making such adjustments. Nevertheless, we expect that a very large proportion of decedent’s estates will be affected by this provision (a much larger proportion than those who are affected by the federal estate tax). Many (a vast majority?) who would not have had to file any federal estate tax return now will be required to file tax forms with the IRS to make the adjustment.

For an estate of a married decedent, an additional $3,000,000 adjustment to tax basis may be available for certain property that passes to a surviving spouse or to a qualifying trust for the benefit of the surviving spouse. Very few current estate planning documents take this $3,000,000 adjustment into account. Many exemption trusts will not qualify for this adjustment. Accordingly, unless the terms of the exemption trust are modified, an opportunity to take advantage of the $3,000,000 adjustment may be lost.


All estate plans with marital deduction formula documents should be reviewed. The review should include a review of all assets and beneficiary designations.

Posted on 12/30/2009 by Richard S. Land, Member, Chipman, Mazzucco, Land & Pennarola, LLC.

January, 2010, Copyright Richard S. Land

Note:  To comply with U.S. Treasury Department rules and regulations, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction, tax strategy or other activity.

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2 Comments on “All Estate Plans with Marital Deduction Formula Documents Should be Reviewed”

  1. […] Our January seminar will help you determine whether you should review your estate plan to take into account the tax changes that have already been made and the changes that will be coming.  Some of the effects of repeal of the federal estate tax are explained here: January 10, 2010, article on repeal and the need for a review. […]


  2. […] (1) Credit Shelter Trusts (a/k/a “B Trusts,” “Family Trusts,” and “Bypass Trusts”). Many more clients will regard credit shelter trusts, which are established when one spouse dies for the benefit of the surviving spouse, as a real necessity instead of just possibly advantageous. For background details, see our article entitled “All Estate Plans with Marital Deduction Formula Documents Should Be Reviewed.” […]


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