Estate Tax Apportionment in Kansas - Out With the Old, in With the New
| Publication year | 2001 |
| Pages | 28-36 |
| Citation | Vol. 70 No. 9 Pg. 28-36 |
70 J. Kan. Bar Assn. 9, 28-36 (2001). Estate Tax Apportionment in Kansas - Out With the Old, in With the New
70 J. Kan. Bar Ass'n, October 2001, 28-36 (2001)
I. Introduction
Effective July 1 of this year, the law of estate tax apportionment in Kansas underwent a fundamental change. That's when the new Kansas Estate Tax Apportionment Act[1] went into effect. This article first explains what estate tax apportionment is. After describing the respective roles that state and federal law play in this area, it then details how the new legislation operates. In doing so, it compares the new act to Kansas' former method of estate tax apportionment. Finally, the article concludes with some advice on how the legislation affects the drafting of estate planning documents and what practical steps estate planning attorneys should take in light of this change in the law.
II. "What Is Estate Tax Apportionment (And Why Should I Care)?"
Most attorneys have at least a passing familiarity with estate taxes in general. In addition, the majority of practitioners who do any estate planning work at all are familiar with the basic concepts and tools of estate tax minimization. However, surprisingly few practitioners know much about estate tax "apportionment," let alone how it operates. Therefore, before describing the new Kansas legislation, it is worthwhile to discuss briefly precisely what estate tax apportionment is, and why practitioners who ignore it do so at their peril.
Simply put, estate tax apportionment is the allocation among the beneficiaries of an estate of the ultimate liability for estate taxes. In other words, this area of the law determines which recipients of a decedent's assets must contribute what amounts to the estate tax "kitty."
At first blush, this definition may seem somewhat anomalous. After all, an estate tax is, by its very nature, imposed on the taxable estate as a whole and not on any particular legacy or distributive share.[2] Moreover, as the Internal Revenue Code makes abundantly clear, it is the executor, and not the beneficiaries, who is primarily responsible for paying the tax to the IRS.[3]
That being the case, why should apportionment between beneficiaries ever be an issue? Since the tax is on the estate as a whole, and the executor must pay it, doesn't the executor simply compute the tax, pay it, and then distribute whatever's left to the beneficiaries? And if that is the case, isn't the estate tax effectively borne proportionately by all the beneficiaries of the estate?
A couple of examples will quickly illustrate why this analysis is too simplistic. Suppose a will makes a number of specific gifts to certain individuals and then leaves the entire residuary estate to others. If the executor simply computes the tax, pays it, and then distributes the remaining assets to the beneficiaries, the recipients of the specific legacies will receive their bequests in full, completely tax free, and the residuary beneficiaries will bear the entire estate tax burden. After all, the residuary beneficiaries' gifts are, by their very nature, whatever remains after the payment of specific gifts and the estate's obligations, including taxes. In this example, then, the entire estate tax burden is borne by the residuary beneficiaries. In contrast, the specific legatees receive their gifts tax-free, even though the assets that comprise those gifts generated part of the tax.[4]
Suppose an estate consists of both probate and nonprobate property. If the executor pays the estate tax with the assets under his or her control, i.e. the probate property, the beneficiaries who receive the nonprobate assets will pay none of the taxes. Instead, the beneficiaries of the probate estate will pay all of the taxes, including those generated by the non-probate assets.
The important point for present purposes is not whether these results are fair or just, or even whether they accord with the average decedent's intent. The point is simply that the seemingly neutral method of computing the estate tax owed and then paying it "off the top" directly impacts the amount of property the respective beneficiaries receive from the estate. After all, someone's share of the gross estate must be reduced to pay the estate taxes. Just whose share or shares that should be, and in what amounts, is the subject of the law of estate tax apportionment.
III. Federal v. State Law
Before discussing Kansas' new legislation, it is important to clarify the respective roles that federal and state law play in this area. First, both the federal and Kansas governments impose their own estate taxes.[5] By far the largest of these is the federal tax - indeed, the Kansas estate tax is limited to the relatively small amount the federal government allows as a credit against the federal tax for state death taxes.[6]
Given the relative size of the federal and state estate taxes,[7] one might expect that estate tax apportionment, especially the apportionment of the federal estate tax, would be primarily a matter of federal law. That, however, is not the case. While Congress has enacted a number of statutes that regulate specific aspects of estate tax apportionment, for the most part estate tax apportionment is governed by state, not federal, law.[8]
The estate tax apportionment statutes Congress has enacted are relatively narrow. For example, the Internal Revenue Code specifies that, unless the decedent has provided otherwise, the executor[9] is entitled to recover from the recipients of the following types of property their proportionate share of the estate tax:
1. Life insurance;[10]
2. Property over which the decedent held a power of apportionment;[11]
3. Qualified terminable interest property ("QTIP") trusts;[12] and
4. Property in which the decedent retained a life estate.[13]
Subject to these limited exceptions, the allocation of the ultimate estate tax liability among the beneficiaries of an estate is governed by state law.
IV. The Kansas Estate Tax Apportionment Act
The most significant feature of the new Kansas legislation is that it adopts the so-called "equitable apportionment" method of allocating estate tax liability.[14] Under equitable apportionment, each beneficiary bears his or her own pro rata share of the tax.[15] Thus, for example, a person who receives $50,000 from a $2.5 million estate that generates $700,000 in taxes, would pay 2 percent ($50,000/$2.5 million) of the $700,000 tax, or a total of $14,000. Under this method of apportionment, it makes no difference if the property in question is probate or non-probate property, a specific bequest or a part of the residuary estate: each beneficiary pays his or her proportionate share.
Equitable apportionment is generally considered fairer than the other principal method of allocating estate tax liability, namely, the so-called "burden on the residue" approach.[16] Under the burden on the residue method, the first source for payment of estate taxes is the residuary probate estate. If those assets are sufficient to pay the taxes, then the recipients of non-residuary legacies and non-probate property (other than the types of property covered by the Internal Revenue Code provisions mentioned earlier) receive their shares free of any liability for estate taxes. If the non-residuary or non-probate gifts are sufficiently large, the residuary beneficiaries can potentially lose most or all of their inheritance to pay taxes on property they do not receive.[17]
An important caveat to the application of equitable apportionment under the new statute is that it, like its burden on the residue predecessor, is only a "default" rule. In other words, it applies unless the decedent provides otherwise - a decedent's intent is paramount and can override the statutory apportionment scheme.[18]
The decedent's power to specify a different method of apportionment has several important features and limitations. First, the statute provides that equitable apportionment may be overridden if the decedent "specifically" directs the manner of apportionment.[19] However, the act nowhere defines just how "specific" such a directive must be. This omission may well provide fertile soil for litigation. For example, most wills contain "boilerplate" clauses directing the executor to pay all "debts, expenses, and taxes." Is such generic language specific enough to override equitable apportionment and mandate that the executor pay the estate taxes from the probate estate in general, or the residuary estate in particular? The cases from other states interpreting similar language in wills are legion, and they are hopelessly muddled.[20]
This potential problem could have been avoided if the legislation had required decedents to refer specifically to the statute in order to override equitable apportionment. This would, of course, have required decedents to focus specifically on estate tax apportionment in order to override the default scheme, but that is as it should be.[21] This approach, however, would have created its own problems.[22] In the final analysis, although the lack of concrete guidance on just how specific language needs to be to override equitable apportionment is troublesome, it may well prove to be the least of several evils.
Another feature of the "override" provision is that it allows a decedent to negate equitable apportionment in not only a will, but also in any "written inter vivos or testamentary instrument disposing of or creating an interest in property."[23] This would include revocable living trusts, which are the cornerstone of many modern...
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