When Author Tom Clancy failed to define who would pay his substantial estate taxes, his family went to war in court. While this occurred in Virginia, it is not an uncommon situation, and lessons learned can be applied to Massachusetts estate planning.
Estate Planning Gone Awry
A Maryland judge recently sided with Alexandra Clancy, widow of suspense novelist Tom Clancy, determining that she is not responsible for payment of taxes on a sizeable and somewhat eccentric inheritance from her late husband. The estate includes such unique assets as a 12% share in the Baltimore Orioles baseball team, a property on Chesapeake Bay, and a 1943 Sherman tank. Ms. Clancy is one of five beneficiaries, the other four being Tom Clancy’s adult children from a previous marriage. After careful analysis of the specific wording in Mr. Clancy’s will, the judge agreed that the intention, though not clearly conveyed, was to exempt his widow from the burden of taxation on the inheritance, leaving his four children to pay almost $12M in taxes out of the approximate $28.5M they will receive. While most plans will not need to include provisions for baseball teams or antique artillery vehicles, this case highlights an all-too-common oversight in estate planning: death taxes.
Creating a Comprehensive Estate Plan Including Who Pays Estate Taxes in MA
Federal and state death taxes can consume more than half of an inheritance in larger taxable estates, such as the recent estate of Tom Clancy, yet designating the source of funds for paying death taxes is often overlooked in the estate-planning process. Practitioners should explain to clients how various options for allocating the tax burden affect the disposition of property and then have the clients make informed decisions. They should also prepare wills and trust agreements that draft tax clauses to carry out the clients’ wishes.
Federal Estate Taxes and Massachusetts Estate Tax Allocations Depend on the Following:
Who are your beneficiaries?
- A spouse who is or isn’t the parent of some or all of your children.
- Any charity or charities.
- A child who should be treated differently than the other children.
- A skip person.
The types of assets includable in your gross estate:
- Are there non-probate assets such as joint property?
- Do you have an interest in a family business?
The kinds of dispositions you make in or outside of the will:
- Are there specific bequests? Cash legacies?
- A trust that can be qualified for the marital deduction, such as a QTIP trust.
- Temporal or split interests:
- Annuity or installment payouts of retirement benefits
The amount of death taxes:
- How large is your estate?
- Are certain property interests excluded from your gross estate?
- Life insurance
What deductions, credits, and exemptions are available?
- Has your unified credit been used up?
- Have you made taxable gifts during your lifetime?
Allocating Federal Estate Taxes and Massachusetts Estate Taxes in an Estate Plan
The same information needed to structure the overall estate plan is needed to determine how death taxes should be allocated. Payment of death taxes shouldn’t be treated as an isolated topic during estate-planning conferences. Rather, you should cover it while discussing the distribution of your assets; the payment of death taxes directly affects the net amount you will pass to your beneficiaries. Your estate planner should educate you on the impact of the death-tax allocation by showing you how the law distributes taxes and how that will impact your bequests. Here is an example:
Client A lives in Massachusetts and during her lifetime gives away $5,000,000 in investments to her children. She wishes to give her home to her daughter (worth $2,000,000) and then have her remaining two children share equally in the remainder of her estate, cash stock, and bonds (worth $4,000,000). She also has an irrevocable life-insurance trust holding $2.5 million outside of her gross estate that divides equally between her three children. A provision is made for the allocation of death taxes to the remainder of her estate. Her expectation is that each child will receive $2,000,000 of assets after taxes.
Instead, the tax is allocated as follows:
- To the real estate: none
- To the residue (assets leftover after the payment of debts and the allocation of gifts): $2,534,480
- To the life insurance: none
Her first child receives the real estate ($2,000,000) and 1/3 of the life insurance ($833,333) tax-free for a total of $2,833,333. Her second and third children receive $2,833,333 each but each has to pay 1/2 of the taxes due of $2,534,480, or $1,267,240, so they receive a net $1,566,093—about 60% of what their sibling received.
Trusts Add Complexity to Estate Plans and Estate Taxes
Things become even more complicated when there are trusts involved, especially if—as in the Clancy case—the surviving spouse is not related to some or all of the surviving children. Through models, we can evaluate how the estate tax can be allocated so you can make an informed decision about how and why taxes are paid at your death.
Actions You Should Take to Protect Your Estate
How current is your estate plan? Do you potentially have some of the issues mentioned in this blog? If you answered yes to the second question, you may consider meeting with Matthew Erskine. For over 140 years, the lawyers at Erskine and Erskine have been generating estate plans, protecting assets, and developing successful family-business succession plans to ensure the smooth transition and control of assets between generations. Don’t leave your life’s work to chance. Contact Matthew Erskine.