The question of when and how often estate planning documents should be reviewed is a very common and important one to ask your estate planning attorney. As discussed in the October 2010 Newsletter (“Reviewing Your Existing Estate Planning Documents”), any significant change in your family or financial situation should trigger an immediate review of your existing estate planning documents. However, due to substantial changes in Federal and state estate tax laws on a nearly annual basis, certain estate plans can fail to accomplish the creator’s goals and trigger dramatic battles among family members.
The estate plan of Leonard and Eileen Tweten provides an example of such a battle and emphasizes this important lesson in estate planning.
Formula Clause
In most cases, when an individual is married with children, he or she prefers to leave all assets to the surviving spouse, whether outright by Will or in Trust. If the spouse predeceases or upon the spouse’s death, the balance will typically be left for the descendants.
In certain cases, commonly those that involve larger estates or second marriages, a portion of the individual’s estate may be left to his or her descendants at the first death. This is usually accomplished using a “formula clause” in which (1) the amount of the estate tax exemption in the given year of death is allocated to the Family Trust for the benefit of the descendants and (2) the amount exceeding the estate tax exemption is allocated to the Marital Trust or left to the surviving spouse outright (the “Marital Share”). Since transfers from one spouse to another are exempt from transfer taxes, no estate tax liability is incurred at the first death using this arrangement.
This formula clause was utilized in Leonard and Eileen Tweten’s joint trust (an instrument commonly used in community property states such as California). However, the anomaly that was the 2010 estate tax gap threw a significant wrench into the Twetens’ estate plan.
Significant Law Change Between Planning and Death
Leonard Tweten, founder of Magnolia Audio Video, and his wife, Eileen, had a sizable estate valued at approximately $100 million dollars. The Twetens’ joint trust called for the greatest amount possible that may pass without incurring any estate tax to pass to their descendants and the balance to remain in trust for the surviving spouse. In 2008, when the joint trust was established, this would have meant that upon Eileen’s death, $2 million (the Federal estate tax exemption in 2008) would have passed to the descendants and the balance of Eileen’s share would have remained in trust for Leonard’s benefit, thus incurring zero estate tax liability while passing the exempt portion on to the next generation.
However, in 2010, when Eileen died, there was no estate tax. For an Illinois estate plan which left both the Family Trust and the Marital Share to the surviving spouse, this law change would have had little or no effect. Since Eileen’s estate plan left the tax exempt portion to the children, this one-year lapse in the estate tax would leave her entire share of the joint trust to the children and none of it for Leonard, effectively disinheriting him.
Following her death, Eileen’s true intent became the subject of painful litigation between her elderly husband and two of their three children.
Need for Review
In addition to significant changes in your family and financial situations, changes in the law should trigger a review of your estate planning documents. With a significant estate like that of Leonard and Eileen Tweten, it is surprising that their advisers did not recognize this deficiency in planning prior to Eileen’s entry into hospice care.
Twelve days prior to her death, an amendment was executed by Leonard and Eileen, which stated that all of the trust assets would remain in the joint trust upon the death of the first grantor rather than passing to descendants. After her death, Eileen and Leonard’s daughters petitioned the court to have the amendment invalidated upon claims of forgery and incapacity. The court invalidated the amendment because it was not notarized, but determined that the documents, as written, did not reflect the wishes of the grantor, which was “to fund a marital trust on the first death of a settlor, for the use and benefit of the surviving settlor.”
Of course, the damaging family dispute and the costly and time consuming litigation could have been avoided with a review of the Twetens’ estate planning documents and a timely amendment to the terms of the trust before Eileen or Leonard’s health failed. Had the Twetens executed the same amendment to the joint trust while Eileen was in good health, it would have been far less likely that her daughters would have petitioned the court to have it invalidated.
Anticipating Bumps in the Road
Knowing which events should trigger a review is an important part of having an estate plan that reflects your wishes. Although a review of existing documents may require some time and cost, failing to review your documents can have significant consequences.
January 1, 2013, may bring about significant changes in the Federal estate tax laws. If Congress does not reach an agreement on the future of the estate tax, the Federal exemption is scheduled to decrease to $1 million with a top tax rate of 55%. The Federal exemption is currently $5.12 million with a top tax rate of 35%. The Illinois estate tax exemption is currently $3.5 million, but will also decrease if the Federal exemption drops below $3.5 million.
With this significant and foreseeable change ahead, it is crucial for those with existing estate planning documents and their advisers to review the terms of those documents and confirm that they are drafted in accordance with their wishes. Please feel free to contact me if you have a question regarding your existing estate planning documents.