Often clients think of their estate plan as a set of documents dictating how their property will be distributed and who will take care of it. Many also realize that with the recent changes in the estate tax, far fewer people are affected by this tax than were before the Bush presidency. In fact, the difference in the applicable exclusion amount went from $675,000 in 2000 to the current $5.12 million. However, many estate plans that were drafted in the intervening time may be A-B Trusts.
Although there are reasons for having an A-B Trust besides estate tax planning, the most common use for them is to double the applicable exclusion amount for married couples. Trusts drafted several years ago may have been set up as A-B Trusts for legitimate, useful estate tax planning purposes. In the document, there is a paragraph that explains how to divide the property upon the first spouse’s death, often called the formula clause. Generally, especially in older trusts, that formula is tied to the estate tax.
The formula clause is one of the complex, hard to explain areas of estate planning. Fortunately, we now have a case to show just how important it is to review the formula in your trust. Enter the Tweten family! California mega-millionaires Leonard and Eileen Tweten created an estate plan to deal with their $100 million estate in 2008. They had, essentially, an A-B Trust tied to the applicable exclusion amount. When Eileen Tweten died in 2010, it just so happened that the exclusion amount was infinite, because the estate tax was repealed for that year only. This means that, rather than $2 million (the applicable exclusion amount when they created their plan) being segregated and, according to their plan being immediately distributed to the children, Eileen’s full $50 million share would be distributed.
At the heart of the family battle that raged in probate court was whether the Twetens intended to immediately pass $50 million to their children upon the first spouse’s death or whether they intended to pass a smaller amount ($2 million), which would allow the Surviving Spouse to keep $98 million until his death. The children argued that their parents’ plan hit the jackpot, saving the children potentially over $25 million in future estate tax. The court ultimately ruled in favor of the Surviving Spouse.
Although the Tweten family had a vast estate, their predicament illustrates the need to review your estate plan annually. The estate tax rules have been in a constant state of flux. Many married couples have A-B Trusts that are unnecessary because the applicable exclusion amount has been increasing so dramatically and individual family wealth has decreased so dramatically. Furthermore, even if your A-B Trust is still an appropriate plan, it may require an updating to the funding formula.
Consider the following example: Husband and Wife have an estate worth $4 million in an A-B trust that was written in the early 1990’s, when the applicable exclusion amount was $600,000. Similar to the Twetens, Surviving Spouse could wind up with $2 million (the surviving spouse’s half) of readily accessible assets rather than the planned $3.4 million ($4 million less $600,000). In circumstances where there is a lot of separate property, the results could be more dramatic! If your trust has not been reviewed in several years, you should take it to your attorney to verify that the type of trust, and the formula clause within it, is still appropriate for your situation.
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