On January 1, 2009, many existing wills and revocable trust agreements, especially those involving married couples, will, in effect, be rewritten, even if no one touches them. Who gets what may significantly change. Some couples will also see a substantial increase in state estate taxes, even though state estate tax brackets and exemptions generally have not changed. Some people can benefit from the changes by retitling a portion of their assets.
How can this happen?
Under the federal estate tax law now in effect, on January 1, 2009, the federal estate tax exemption (in addition to what one leaves to—or, in a permissible manner, for—one’s spouse [the “marital deduction”] or charity [the “charitable deduction”]) increases from $2 million to $3.5 million. The same occurs as to the exemption from the federal tax on generation-skipping transfers (the “GST tax”). For many, that will be good news. For others, it will change who gets what, and for some, it will result in more estate tax being payable on a state level, even though less tax—or even no tax at all— was payable before.
For those whose net assets do not exceed $2 million in value and who have not used any of their exemptions in connection with lifetime gifts, these changes may be largely irrelevant. For others the effects may be significant.
Suppose that a married person has all of his or her net assets, worth $3.5 million or more, in his or her own name (with no surviving designated beneficiary), or in his or her revocable trust. Suppose that this person, like many others, has a will or trust agreement (hereinafter, collectively, a “testamentary instrument”) that leaves the maximum amount free of federal estate tax to a trust (hereinafter, an “exemption trust”) which does not qualify for the marital deduction or the charitable deduction, with the balance to pass to his or her spouse. If that person dies on or before December 31, 2008, the exemption trust potentially receives $2 million, and anything above that amount passes to the spouse. If that person dies on or after January 1, 2009, however, the exemption trust potentially receives $3.5 million, and only assets in excess of that amount pass to the spouse.
What if the same person has a testamentary instrument that leaves the maximum amount free of federal estate tax to his or her descendants, or to a trust for them, and the balance to his or her spouse? Starting on January 1, 2009, the descendants potentially receive $3.5 million, not $2 million, and the spouse potentially receives everything over $3.5 million, not everything over $2 million.
If, instead, the same person leaves the maximum amount free of GST tax to his or her descendants, to a trust for them or to a multi-generational or dynasty trust, with the balance going to his or her spouse, again the first portion grows by up to $1.5 million (potentially from $2 million to $3.5 million), and the second shrinks by an identical amount. All of this may occur without any change in that person’s testamentary instruments.
Although many will regard this change as positive, those for whom the change will skew who gets what in an undesirable manner need to amend or replace their testamentary instruments to ensure that they still carry out their wishes and that they will still do so in a tax-efficient manner.
If one spouse has assets worth appreciably more than $3.5 million, and the other has assets worth appreciably less, consideration should be given to transferring some assets from the wealthier spouse to the less wealthy spouse, outright or in an appropriate trust, so as to take advantage of the new $3.5 million federal estate/GST tax exemption, no matter which spouse dies first.
What does any of this have to do with state estate taxes?
Earlier this decade, most states had estate tax exemptions identical to the federal estate tax exemption, typically $1 million. An estate that paid no federal estate tax usually paid no state estate tax either. When the federal estate tax exemption increased, some states, such as New York, kept their exemptions at $1 million, and a few, such as New Jersey and Ohio, set theirs even lower. Others, such as Illinois and Connecticut, increased theirs to the 2008 federal exemption level of $2 million. Still others, such as California, Florida and Missouri, wound up with no state estate tax at all.
What does all of this mean if one lives in, or has real estate in, a state with an estate tax and with an exemption smaller than the new federal exemption? Absent updated planning and, in many cases, amended or new testamentary instruments, it means that one’s estate may have to pay a state estate tax even if there is no federal estate tax to pay, and that tax may be hefty.
If a person with a testamentary instrument that governs all of his or her assets dies in 2009, leaves the maximum amount free of federal estate tax to an exemption trust and leaves everything else in a manner that will qualify for the marital deduction or the charitable deduction, in some jurisdictions there may be up to $250,000, or even a bit more, in state estate tax to pay. Jurisdictions in which this may be the case include Connecticut, the District of Columbia, Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Oregon, Rhode Island, Vermont, Virginia and Washington. In 2008, the state estate tax applicable to the estate of a person with such an estate plan who lives in a state with an estate tax exemption of $1 million or less may already be up to about $100,000, but, in 2009, the tax may increase by up to 250 percent, a huge increase. The additional state estate tax may also reduce the assets available to support the family, for the balance of the surviving spouse’s lifetime, by up to about a quarter million dollars.
Those who have provisions in their testamentary instruments tied to the federal estate tax exemption or the GST exemption who do not want their estate plans adjusted by the changes in those exemptions that take effect on January 1, 2009, should consider making timely and appropriate modifications to their wills or trust agreements and, if appropriate, making inter-spousal transfers.