The one-year suspension of the federal estate tax may be a bit of good news for the bereaved - but it also could upend some careful estate planning.
That's because a will or trust could unintentionally disinherit a spouse or child because the language in the document refers to the federal estate tax that, for now, doesn't exist.
Some in Congress promised to fix the problem by restoring the estate tax early this year. But several states, including Maryland, aren't waiting for federal action. They are looking to adopt legislation that would presume a deceased person's wishes are tied to the federal estate tax rules in place last year.
"It's a helpful thing," says Lutherville estate planning lawyer Jason Frank. "It should be a short-term patch for a short-term problem."
Those most likely to benefit from this state action are high-net-worth individuals - and Maryland has plenty of those - whose documents haven't been updated lately to reflect the lapse of the estate tax. If they die this year, old language in their documents could mean their assets are distributed in ways they didn't want.
For instance, a will might direct the amount of money that can pass free of the federal estate tax into a trust for the benefit of children from a first marriage, and any amount above that to the second spouse. But what happens if there is no federal estate tax? Well, the kids could end up with everything while the spouse is left empty-handed.
It was never expected to get to this.
How it happened
The Bush administration's 2001 tax law gradually raised the amount of money one could exempt from the estate tax, hitting $3.5 million in 2009. The law also called for the estate tax to disappear in 2010, returning next year under old rules allowing estates to shelter $1 million from the tax.
But most estate planning lawyers expected Congress would never let the tax lapse and assumed the 2009 rules would be extended or made permanent. Then health care reform consumed the U.S. Senate late last year, and that chamber didn't get around to voting to extend the tax, as the House did.
Now, it's uncertain when or if Congress will address the issue, with members divided on how much money people should be able to exempt from estate taxes.
Clint Stretch, a tax policy expert at Deloitte, predicts the estate tax will be tackled this summer as part of a large bill to address the many Bush tax cuts set to expire at year-end. But Stephen C. Hartnett, associate director of education with the American Academy of Estate Planning Attorneys, expects Congress won't touch the estate tax in an election year.
The uncertainty has prompted states to take action on their own.
Virginia lawmakers introduced legislation earlier this month. Under the bill, if an older will or trust uses terms such as "estate tax exemption" or other reference to the federal estate tax, the presumption would be that the document is referring to the 2009 federal estate limits - unless clearly stated otherwise. A personal representative or a beneficiary, however, can ask for a hearing to determine what the deceased really intended.
And when Congress restores the estate tax, the Virginia law would no longer apply.
The Maryland State Bar Association is working with state legislators to draft similar legislation here.
In a sense, state legislators would be rewriting people's estate documents by assuming a person meant to distribute assets based on 2009 rules. But what if you drafted documents counting on the federal estate tax's disappearing this year and Maryland passes this legislation?
It's possible that you may need to contact your lawyer to update your documents if your intentions aren't clear, says Richard Wright, chair of the state bar association's estate and trust law section. But Wright, who is working on the state legislation, says the majority of Marylanders who drafted documents did so assuming the federal estate tax would stick around and the proposed legislation would help them.
Not everyone likes the legislation. Maryland attorney Michael Hodes says he's concerned that legislators will rush into this without giving Congress time to fix the problem first.
"When you do a blanket patch, it may give us results that we might be unhappy with," Hodes warns.
The bottom line: Don't wait for federal or state legislators to act. Take this time to review your documents. And if there's any fear that your assets won't go to your heirs as intended, call your lawyer.