New tax act demands scrutiny of wills

The Tax Relief Act, while easing and eventually, perhaps, eliminating estate taxes, requires a careful scrutiny of your wills and other estate planning documents.

One of the big challenges for estate planning documents in the wake of the new act involves the gradual increase in the exemption amount for estate taxes. While this is good news for those subject to estate tax, it could cause unintended consequences if their wills are not written properly.

Here's how the tax changes may actually foil your best-laid plans, and why you may need to have an attorney revise the language of your wills and related documents.

First, a quick review of the changing exemption amounts of the new tax act. The amount in estate value for each person that will be exempt from federal estate taxes (but not necessarily state estate taxes) jumps from $675,000 in 2001 to $1 million in 2002. In the coming years, that exemption amount increases to $1.5 million, $2 million and ultimately $3.5 million by 2009--certainly good news for valuable estates.

But here's where the language of your will becomes so critical. In most cases, a spouse simply leaves his or her entire estate to the other spouse because the surviving spouse inherits the assets estate-tax free. For families with modest estates not likely to be subject to the estate tax, this usually works fine. However, for larger estates, passing all your assets to your surviving spouse can, in essence, "waste" your exemption amount because it's not used at the time, and it can't be used later. When the surviving spouse dies, only his or her exemption amount can be used.

A common way around this is to have your will create at your death what's called a credit-shelter trust, or sometimes referred to as a marital deduction trust or Part B of an A/B trust. Typically, the language of the will directs that the trust be funded by an amount equivalent to the exemption amount. This makes maximum use of the exemption. The arrangement usually calls for trust income to go to the surviving spouse (if he or she needs it) and for trust assets to go to the children or other heirs upon the death of the surviving spouse.

For example, let's say you have an estate worth $3.5 million. If you died in 2001, $675,000 (the exemption amount) would go into the trust and the remaining $2,825,000 would go to your spouse. When your spouse dies, his or her personal exemption would shelter still more of the estate's assets from taxes.

In our example, this strategy might work fine for the moment, when the exemption amounts are still small. In 2002, $1 million would go into the trust and your surviving spouse would receive $2.5 million. But what happens in subsequent years if the language of the will is left unchanged? For example, if you die in 2009, the entire $3.5 million estate (we're assuming no growth in the estate) would go into the trust and your spouse would be left impoverished. You can see that your estate assets may not go entirely where you want them to assuming the exemption amounts increase as scheduled in the coming years.

This same problem may occur if your estate plan calls for using the generation-skipping exemption, which is used for passing assets directly on to grandchildren. That exemption amount, $1,060,000 in 2001, is also scheduled to rise to $3.5 million by 2009. In that case, you could overfund your grandchildren and leave children without enough money.

Alternative approaches to this dilemma include specifying a dollar limit for funding the trust, or perhaps a percentage cap, such as no more than 40 percent of the value of the estate. The key is to have an attorney familiar with the new act review your wills and trust documents to see whether the standard formula language should be redrafted.

Wm. Gerry Keene III, CFP, RFC, is a Certified Financial Planner practitioner with Keene Financial Group in Cape Girardeau. He is a registered representative offering securities through FFP Securities Inc., member NASD/SIPC, and a Registered Investment Advisory agent offering services through FFP Advisory Services Inc. (1-800-827-1929, 33KEENE 335-3363 or )