Citizens of all states may want to take note of recent legislation passed in Florida, highlighting the estate planning gap created by Federal inactivity. The underlying issues may impact estate and gift plans for many clients. Many wills (last will and testaments) for married couples contain formula clauses designed to distribute family estate assets in a way to help minimize or eliminate Federal estate taxes. Typical clauses provide that “my executor will identify the amount that can pass free of estate taxes under federal law in place at the time of my death and that amount will be distributed first to heirs other than the surviving spouse, the remainder is to be distributed to my surviving spouse.” Frequently, this technique involves the use of “family trusts” and “marital trusts” to receive estate assets. Commonly, we describe these as “A and B Trusts.” For example, if an estate owner had a $10 million estate and died in 2009, the first $3,500,000 (equivalent exemption amount) would be distributed to a family trust (B) and the remainder, $6,500,000, would be transferred to a marital trust (A) or to the spouse. The result would be zero estate taxes at the death of the first spouse and the removal of the estate tax equivalent amount ($3,500,000) from the survivor’s estate so it would avoid estate taxation at the death of the surviving spouse.

The Problem With Eliminating Federal Estate Taxes

When many of these “formula clause” wills were drafted, it was never taken into account the possibility that federal estate tax might be totally eliminated. And here we are, in 2010, without an estate tax. With a strict application of the terms of some of these wills, the effect is, that the whole probate estate will be distributed to the family trust and nothing would be available to distribute to the surviving spouse or marital trust.

Florida has recognized the uncertainty that may be created by Federal Estate Tax rules in 2010. To address this situation, legislation was designed to protect the surviving Florida spouse’s rights to an inheritance for deaths that occur during 2010. The new law allows a probate court to correct the potential inequity that may be created by a strict interpretation of a will whose distribution provisions rely on a Federal Estate Tax. The legislation allows an executor (or beneficiary) of the estate to petition the probate court to interpret the terms of a will and the Federal Unified Tax Credit, and address the estate distribution as if the death occurred in 2009. In most situations, the surviving spouse will not be left destitute. Most family trusts include a provision to provide income to the surviving spouse and to allow discretion to the trustee to provide for the surviving spouse’s health and welfare. In addition, many assets like life insurance, jointly held property, trust assets and other property types that provide for direct transfers to named beneficiaries are not subject to terms of the will. However, it remains possible that a surviving spouse can effectively be disinherited in 2010.

Whether clients live in Florida or any other state, the existence and use of formula clause wills may provide another opportunity to meet with and address the planning oversight that may exist.