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Attorneys move away from use of trust formula clauses as exclusion amounts change

One of the great functions of trusts in estate planning to is minimize estate taxes. For married couples, there is usually a concern that the surviving spouses have enough money to last until their death. One of the techniques married couples often use is to include a formula clause in their trust which specifies that their children get the amount of assets equivalent to the federal estate tax exclusion, while the rest will go to a marital trust for the surviving spouse.

This kind of arrangement allows the first spouse to die to make full use of the exclusion amount. One of the problems with this arrangement, though, is that the exclusion amount changes rather frequently. In 2008, the exclusion amount was $2 million; in 2010, the exclusion amount was unlimited; at present, the exclusion amount is just over $5 million. Next year it is set to decrease to $1 million unless Congress takes action.

In a recent California probate case, a father’s adult daughters challenged an amendment to a will that made use of a formula clause. The problem with the clause was that its practical effect-because of the shifting exclusion amounts-left the father disinherited. The daughters challenged amendment-made in a scramble 12 days prior to the wife’s death-on the grounds of forgery and incapacity. The judge in the case ultimately invalidated the amendment, but ruled that the wife’s intent was not reflected in the original document.

There was, interestingly, no legal precedent for the case. The daughters plan to appeal the ruling, arguing that the judge has no factual basis to deny that the wife intended the formula clause to allow her half of the couple’s wealth to pass to the next generation with no estate tax.

Because of situations like this, many estate planning attorneys are moving toward using more flexible wording and revising trust documents on a yearly basis, especially for large estates. Formula clauses can also have a potentially devastating affect on smaller estates, causing the surviving spouse to be disinherited and not have enough money to pay the bills.

In planning around these pitfalls, it is critical to work with an attorney who has understanding of changes in the law and foresight to plan around them.

Source: CNBC.com, “Dramatic estate tax battle delivers fresh lessons,” July 31, 2012