Dead federal estate tax rises from the ashes

With the federal estate tax law having lapsed — and no sign that Congress is planning to address the issue anytime soon — a growing number of states are taking matters into their own hands.

Lawmakers and estate attorneys in the District of Columbia and at least 13 states, including Florida, Georgia, New York and Virginia, are drafting or have introduced legislation aimed at clarifying estate tax law in the absence of a federal statute. Specifically, they hope to avoid a wave of lawsuits that will likely arise from ambiguities in wills and trusts filed this year, attorneys said.

“We believe this will save a lot of time and expenses by having a law in place instead of having the courts step in,” said Nikola R. Djuric, a partner at Sutherland Asbill & Brennan LLP, who helped draft a bill in Georgia.

The law that authorized the federal estate tax, which imposed duties of up to 45% on estates valued at $3.5 million or more, expired Jan. 1. Although the federal estate tax will be reinstated next year, with a $1 million exemption at a rate of 55%, observers said that they are waiting to see whether Congress will pass retroactive legislation that would address the 2010 tax year.

In the meantime, a number of states are tackling the issue, but taking different approaches. That could result in huge headaches for financial advisers, certified public accountants and estate-planning attorneys.

“We are going to get radically different results, depending on what state the client is in,” said Gail Cohen, head of global wealth management at Fiduciary Trust International. “It’s very important that advisers follow the various states’ approaches and have flexibility in the documents.”

Raymond Radigan, managing director of U.S. Trust Bank of America Private Wealth Management, agrees that the varying state approaches will make advisers’ jobs tougher. “This is a mess any way you look at this,” he said. “We are trying to work with clients and figure out where we are right now.”

On Jan. 12, Virginia became the first state to introduce legislation aimed at dealing with the estate tax. The bill would require all estates and trusts to be treated as though they were governed by 2009 federal tax law.

The proposal addresses the use of specific formula clauses, which the majority of wills and trusts use, said Howard Zaritsky, the estate-planning attorney who drafted the bill. Virginia’s main concern, he said, is that without a clear law in place, these formulas require interpretation by the courts and could open the door to litigious family battles.

For example, one of the most common formulas used in wills says that a deceased person’s children can receive the largest amount possible ($3.5 million) without triggering federal estate taxes and that the remainder of the estate goes to the deceased person’s spouse. But technically, without a federal estate tax law, it could be interpreted that the entire sum would go to the children and the spouse would receive nothing, Mr. Zaritsky said.

Another common clause says that a deceased’s children can receive “an amount equal to the decedent’s applicable exclusion amount,” which means $3.5 million under the federal law, he said. The rest would go to the spouse. But again, without a governing estate tax law, that could be construed to mean that the children would receive nothing because there is no “applicable exclusion amount,” Mr. Zaritsky said.

“Our goal in the [Virginia] legislation is to provide some closure and a clear answer to what the deceased meant [in writing a will],” he said.

The Virginia bill is expected to pass by the end of this month and would be retroactive to Jan. 1, Mr. Zaritsky said. If Congress does pass a law addressing the estate tax issue for 2010, the federal statute will take precedence.

The District of Columbia, Indiana, Maryland, Minnesota, Missouri, South Dakota and Tennessee are considering legislation that uses the Virginia bill’s language and applies it to their own states’ needs, attorneys said. In all these states, bills are expected to be introduced within the next few weeks, and no opposition is expected, attorneys said.

Georgia’s bill, which is expected to be introduced in the state Legislature next week, is slightly different than Virginia’s proposal in that it includes language addressing what happens if the beneficiary of a deceased person dies in 2010.

“The Virginia statute applies to people who die this year,” Mr. Djuric said. “But in a case where someone died years ago and the beneficiary of that trust dies this year, there could be similar complications.”

At least four states — Florida, New York, Ohio and Wisconsin — are addressing other estate tax issues.

Florida’s bill would give beneficiaries a process to introduce outside evidence if they thought that attorneys were not interpreting the will as the decedent intended, according to Bruce Stone, a partner with estate planning firm Goldman Felcoski & Stone, who wrote the Florida draft bill. Under current law, one can bring in outside evidence only with trusts, not wills.

Ohio has a draft of a bill that includes the Virginia language regarding formulas but also specifies that families can bring in outside evidence to court to contest a will, said J. Donald Cairns, a partner with Spieth Bell McCurdy & Newell LPA, who helped write the proposal.

“The Virginia law doesn’t lean toward maximum estate tax avoidance; it just leans toward preserving the status quo,” said Mark Shiller, a partner at Godfrey & Kahn, who is working on the draft of a Wisconsin bill. “I am not sure you can ever slice it thin enough, but I think I can slice it thinner than Virginia has.”

A bill was introduced in New York that would set the 2010 state estate tax exemption at $1 million.

“I cannot imagine a reason for this not to pass,” said Catherine G Schmidt, a partner with Patterson Belknap Webb & Tyler LLP.

All the state bills would be retroactive to Jan. 1, and they would be void if Congress took action.

Some observers think that the states are jumping the gun by working on legislation before Congress has done anything.

“Let’s wait to see what Congress does before we ask for anything,” said Jonathan Blattmachr, a retired estate tax attorney. But the attorneys pressing for this legislation don’t think they can rely on Congress.

“As time goes on, there is less certainty about Congress acting,” said Bill Berens, a partner and head of the trusts-and-estates practice at Dorsey & Whitney LLP. “Meanwhile, we have people dying every day, many of whom have estate plans that are ambiguous.”

E-mail Jessica Toonkel Marquez at [email protected].