South Carolina Lawyer
SC Lawyer, September 2010, #5.
Construing Wills and Trusts During the Estate Tax Hiatus in 2010
South Carolina LawyerSeptember 2010Construing Wills and Trusts During the Estate Tax Hiatus in 2010By F. Ladson Boyle, S. Alan Medlin and Howard M. Zaritsky In 2001, Congress passed tax legislation that included a temporary repeal of the federal estate tax in 2010. Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. 107-16, 115 Stat. 38, amending IRC section 2001. Early on, many estate planners believed that the federal estate tax would be permanently repealed before 2010, but that legislation did not pass. In more recent years, the mood shifted and most believed that Congress would act and not permit a year in which there was no estate tax, but that legislation has not passed either.
The 2010 federal tax surprise-no estate or generation-skipping transfer (GST) tax-has many tax implications. Articles may be found in the tax literature that discuss the problems. See, for example, Congressional Inaction Yields One-Year Repeal of the Estate and GST Taxes: Hiatus Planning for Drafters and Fiduciaries, 22 Probate Practice Reporter 1 (January 2010), and The Impossible Has Happened: No Federal Estate Tax, No GST Tax, and Carryover Basis for 2010, 112 J. of Taxation 68 (February 2010).
In addition to the tax issues, nontax state law concerns arise because there is no federal estate tax in 2010. One particular issue has the potential to cause significant problems for estates of decedents who die while there is no federal estate tax. Many tax-sensitive wills and revocable trusts divide a decedent's estate between a surviving spouse or a trust for a surviving spouse (hereinafter collectively described as a devise to the surviving spouse) and a bypass or credit shelter trust or a gift to someone other than the surviving spouse (hereinafter collectively described as a devise to the bypass trust).
The controlling document's division between the surviving spouse and the bypass trust is often worded with formulas that use estate tax terms to describe the division. For example, such a formula simplistically might give the bypass trust "the maximum amount of property of the decedent's estate that may pass free of estate taxes." Alternatively, the formula might give the surviving spouse an amount equal to the maximum marital deduction-that is, 100 percent of the estate, but reduced by the most property that may pass free of estate taxes. When these formulas use terms that refer to federal estate taxes, the unified credit, the applicable credit amount, the applicable exclusion amount, the exemption equivalent or other such similar estate tax-derived terms that have no tax meaning in 2010, the state law question becomes: how is the property of the decedent's estate or revocable trust divided? To answer this question, it is first necessary to examine the variations in wording of the formulas that produced the same result when there was an estate tax, but potentially very different results when there is no estate tax.
Types of formulas
Formulas that divide a decedent's estate between a devise to a surviving spouse and the bypass trust to maximize estate tax savings usually can be divided into one of two categories: pecuniary formulas and fractional share formulas. A pecuniary formula may be used to define the marital devise to the surviving spouse or to define the non-marital, bypass trust devise. When a fractional share formula is used for the division between the surviving spouse and the bypass trust, it is usually a division of the residue of the decedent's estate or remainder of the property in the decedent's revocable trust.
A typical pre-residuary marital deduction formula might leave the surviving spouse an amount equal to the maximum marital deduction-that is, all of the decedent's estate, but reduced by the most that may pass free of estate taxes, after taking into account the unified credit or the applicable credit amount, as well as other possible adjustments such as prior taxable gifts. Alternatively, the devise to the surviving spouse might be described as the maximum marital deduction, less the applicable exclusion amount. Another alternative might be a devise to the spouse of the minimum amount of...