Retirement Watch Lighthouse Logo
Retirement Watch Lighthouse Logo

How the 2001 Tax Law Affects Your Will

Last update on: Jun 22 2020

Your will and estate plan need to be reviewed. If you’ve procrastinated about a plan, this is the time to get started. But even if you have been meticulous, the 2001 tax law requires at least a review and probably significant changes.

The common feature all estate plans will need for the next 10 years is flexibility. That will avoid extra fees and expenses, and it also will avoid problems with shifts in the tax law.

Beyond that here are the specific parts of your plan to examine closely in coming months.

Asset ownership. The 2001 law raises the exempt amount for each estate. In 2002 a married couple can transfer up to $2 million ($1 million each) tax free to the next generation. But they can only if each spouse has title to at least $1 million of assets. The exempt amount will rise to $3.5 million per individual ($7 million per couple) in 2009.

If your family owns more than $1 million in assets, be sure legal title is split among the spouses to take full advantage of both estate tax exemptions. If it isn’t, shift title of some assets from the “rich” spouse to the “poor” one.

Credit shelter trusts. The new tax law requires changes in virtually every will. The most critical changes will be for married couples who take advantage of the lifetime estate and gift tax credit through a tactic known as either a bypass, credit shelter, or A-B trust.

Each spouse’s will states that property equal to the estate tax exempt amount is put in a trust that pays income to the surviving spouse for life and also allows the spouse access to the principal during his or her lifetime for certain needs. After that spouse dies, the amount remaining in the trust goes to the children of the marriage. The rest of the estate is left directly to the surviving spouse. This trust allows the couple to get the maximum amount of property to the next generation free of taxes without depriving the surviving spouse.

This simple, standard provision is complicated in several ways by the new law.

As I mentioned, the exempt amount rises to $1 million in 2002, to $3.5 million by 2009, and to no limit in 2010. Many wills provide that a specific amount will be put in the trust, usually the exempt amount at the time the will was written. If that is so in your case, next year the amount will be too low, and even after a revision it will be too low in another two years. The will would have to be revised or amended every couple of years to reflect the new exempt amount.

An alternative is for the will to state that the highest amount eligible for the federal estate tax exemption be put in the trust. That avoids a revision every few years.

But it could create another problem, depending on the size of your estate.   Suppose your estate is $2 million and you die in 2004 when the exemption is $1.5 million. Then your spouse gets only $500,000 outright, and the rest goes to the trust.

Your spouse would have to live on less than you planned or ask the trustee for additional funds when income is not sufficient. In this case, the trust is overfunded.

A better solution might be a formula clause. Determine the maximum amount you want to put in the trust to ensure your spouse owns enough assets outright for a comfortable life style. Then use a formula in the will. It might say that the amount to be put in the trust will be $750,000 or the maximum federal exempt amount, whichever is lower. This approach won’t take advantage of the maximum federal estate tax exemption, but that is secondary to providing for your spouse.

Another option is to put the maximum exempt amount in the trust but make the trust more liberal. Your spouse could be co-trustee, giving him or her control over how it is invested, and therefore to some extent determining how much income it will earn. Or the trust can state that your spouse annually can take from the trust up to 5% of the value for any reason, with the trustee’s permission. This is in addition to being able to get additional amounts for needs such as support, health care, and education.

An alternative is for your spouse to be prepared to use a disclaimer while your will states that any inheritance your spouse disclaims will go to the bypass trust. Here’s how it works. Your will says that only $675,000 goes to the bypass trust (it even can say zero). You die in 2004 when the estate tax exempt amount is $1.5 million. Your spouse feels comfortable having the trust funded with the entire exempt amount. So he or she disclaims $825,000, which is added to the bypass trust. If your estate were smaller, your spouse could disclaim $500,000 or even zero. Or if it is 2010 and your spouse is confident his or her estate won’t be taxed, nothing might be disclaimed. That would be the ultimate in flexibility, but it does let your spouse to decide how much goes to the trust.

Hedging for changes. Your will might also need the ultimate in flexibility – a “but if” clause providing that certain provisions are to be ignored if the estate tax is not in effect the year you die. This clause could eliminate the bypass trust if there is no estate tax. It also might restructure charitable contributions.  For example, you might set up a charitable trust if there is an estate tax but leave a smaller amount outright to the charity and the rest outright to your children if the estate tax is repealed. This clause will be very important in a few years since the estate tax is scheduled to be eliminated in 2010 but restored in 2011.

State death tax alert. Your overall estate tax reduction might not be as much as you think. That’s because the federal credit for state death taxes paid is reduced immediately, and it is eliminated after 2004. Most states piggyback on to the federal estate tax. That means through the state death tax credit the federal government essentially transfers part of the federal estate tax to your state, without any additional money coming out of your estate.

But the loss of the credit might actually partially offset the reduction in the federal estate tax rate. You need to review how your state determines its death tax to see the net effect. Most states say their death tax is equal to the maximum federal tax credit allowed. There is no change in your total estate tax bill if you live in one of those states. But those states, including Florida and Texas, will lose billions if they don’t change their tax codes. So be aware of coming tax changes in those states.

A dozen states, including New York and Virginia, have a flat tax rate that is not tied to the federal estate tax. So your estate still will owe this tax and not get a credit against the federal tax for it. The result is that your total estate tax rate essentially is raised.

Also, your state’s exempt amount hasn’t been raised by the federal law. You might have an estate that is exempt from federal estate taxes but taxed by the state. The lesson is that most of us have to pay attention to state death taxes for the first time. They might become the most significant burden on the estate.
The new tax law also makes the QTIP trust more valuable and important than in prior years. I’ll review the uses of the QTIP trust in our next visit.



Log In

Forgot Password