The sad and tragic death of Philip Seymour Hoffman at age 46 last month is yet another reminder of the importance of estate planning. Most of us go along each day not thinking or worrying about what would happen to our loved ones if we suddenly died. Some, in an attempt to be conscientious, draft an estate plan but fail to keep such plan up to date. But most people die without ever doing any estate planning leaving state laws and the courts to decide who should get their estate. When these matters are neglected, surviving family members can be left with momentous legal, tax and financial problems resulting in uncertainty and expensive attorney fees to sort it all out.
Although Mr. Hoffman drafted his will in 2004, he failed to update it after having two children and even after some significant estate tax law changes. Such changes and ten years usually triggers a meeting with your estate planning attorney. For more on a checklist of events that should result in a meeting with your estate planning attorney please explore Estate Planning Triggers.
Mr. Hoffman’s 2004 will leaves everything to the mother of his children, Marianne O’Donnell. He was not married to her and this is where the problems start, at least from an estate tax perspective.
Federal and State Estate Taxes
It is estimated that Mr. Hoffman’s estate was around $35,000,000. Currently, $5,340,000 is exempt from federal taxes (the so-called unified credit) with amounts above that amount being subject to a federal estate tax rate of 40%. It would appear then that roughly $30,000,000 of his estate would be subject to estate tax at a 40% rate. This would generate a whopping $12,000,000 in federal estate taxes!
New York also has an estate tax with an exemption of $1,000,000. This New York estate tax has graduated tax rate that goes as high as 16%. It is estimated that roughly another $3,000,000 in will be paid in New York estate taxes.
Combined estate taxes: $15,000,000.
(Liquidity Side Bar: Be aware that estate taxes are due nine (9) months after the date of death so hopefully Mr. Hoffman’s estate has enough liquid assets to avoid a forced sale of assets to meet his tax obligations. Estate Planning Point: It is not known if Mr. Hoffman had life insurance but having life insurance to provide for liquidity is sometimes essential. In certain cases, the use of an irrevocable life insurance trust would allow for excluding the life insurance proceeds from being subject to estate tax.)
The point is that even though a meeting in 2004 may have explored marriage as a simple way to save estate taxes, Mr. Hoffman may, for whatever reason, not wanted to be married at that time. It also could have been that his wealth was not that great in 2004.
But here is the object lesson: Things change and so should one’s estate plan.
- A later meeting to review his estate plan would have explored the huge estate tax benefit to being married. No one is suggesting that people should get married only for tax reasons, however, under federal estate tax rules, inheritances to a surviving spouse are not subject to estate tax.
- Double Estate Taxation: Since they were not married, the amounts Ms. O’Donnell receives will be taxed twice. First, the amount she receives above the unified credit will be taxed at Mr. Hoffman’s death. When she dies the balance in her estate above her unified credit will be taxed a second time. Marriage eliminates this double estate tax.
- Marriage would have provided possible social security, retirement plan, income tax and other financial benefits.
- If Mr. Hoffman wanted to get married but did not want his wife to have absolute control of his assets, a qualified terminable interest trust (a QTIP trust) could have been used to obtain the estate tax savings while providing income and principal to her during her lifetime. The assets in this trust would pass to his children at her death. This would have been the best of both worlds: saving estate taxes but still providing for his wife and children.
- Sidebar: A QTIP trust is often used in second marriages where there are children from a prior marriage.
One Strategy To Eliminate Estate Tax At His Death
In a perfect world, Mr. Hoffman could have created a so-called marital deduction trust and a unified credit or by-pass trust by funding each trust based on a formula clause tied to the unified credit applicable in the year of his death. (Or he could have used the disclaimer trust discussed below to achieve this same result if he was married.) If he had implemented this estate planning strategy his 35,000,000 would have been split between these two trusts with $5,340,000 (the unified credit amount in 2014) going to the by-pass trust and the balance going to the marital trust. This would have resulted in not having to pay the $12,000,000 in federal estate tax at his death!
With this estate tax planning strategy there may have been some estate taxes due New York because they do not allow an amount equal to the federal unified credit. As mentioned above, they only provide for an exemption of $1,000,000 not $5,340,000. (Certain states like New York and Maryland decided to limit or reduce their estate tax exemption and those states are said to have “decoupled” from the federal estate tax system. Some states such as Pennsylvania do not have any exemption.) However, there are drafting techniques to minimize or defer any state inheritance taxes in decoupled states. The important point is that it may have been possible for Mr. Hoffman to cut or decrease most of the $15,000,000 in estate taxes that his family now faces.
Marital Deduction Is A Powerful Deferral Technique
It is important to understand that the marital deduction is subject to tax at the surviving spouse’s later death. The $30,000,000 or so that would have been placed in the marital trust would be included in Ms. O’Donnell’s estate at her death. But if she survives for a long time, then the power of deferral and the time value of money will allow the assets in the marital deduction trust to grow very large, leaving a lot more money available to her and for her family’s benefit.
When Ms. O’Donnell dies, she would have her own $5,340,000 unified credit or exemption, as adjusted for inflation, that will be used to reduce her estate taxes.
If I have lost anyone here, the point is that deferral of taxes on the marital share will result in leaving more assets available to the surviving spouse during her lifetime and to the children and grandchildren at her death.
Mr. Hoffman’s will provided that Ms. O’Donnell could disclaim a portion or all of her bequest. Whatever amounts she disclaimed would go into a trust. This estate planning tool is used to give a spouse maximum flexibility to either take her inheritance or disclaim it for the benefit of her children based upon the circumstances of the family and tax laws at the time of death. It is similar in effect to the marital deduction and by-pass trust with the formula clause discussed above, except that it provides more control to the surviving spouse or in this case Ms. O’Donnell. In Mr. Hoffman’s situation, two problems exist under his 2004 estate plan:
- First, as discussed, since Ms. O’Donnell is not married, then anything she keeps above the federal estate tax exemption is subject to federal estate tax. As we saw above, this results in a huge estate tax bill.
- Second, the disclaimer trust that Mr. Hoffman drafted in 2004 only provides for one of his children.
- It is somewhat surprising that the language in the document did not include a provision for children born after the will or trust was drafted. A simple well drafted sentence or two would have solved this problem.
- Once again, had Mr. Hoffman met with his estate attorney to review his estate plan periodically this problem would have been prevented and corrected very inexpensively.
- Since he failed to update his legal documents to include his later born children in his estate plan, now a guardian ad litem may need to be appointed for each of the unnamed children by petitioning the court. This may require attorneys for both children (or perhaps one attorney) and obvious additional legal costs.
- Anxiety, uncertainty and expense will occur with petitioning the court to have a determination made as to whether the other children should share equally in this disclaimer trust. States have different rules and case law on this issue. It is possible that a New York court may find that the after-born children who were not named in the will or trust (called pretermitted children) are not entitled to share in the estate.
- This is a far more expensive and uncertain situation than simply meeting with an estate planning attorney to periodically revise and update one’s estate plan and the related documentation.
- Keeping these matters private, especially for a celebrity, should be a priority.
- The whole idea of estate planning is to leave your family with a workable and streamlined estate plan with minimal involvement from the courts.
It should also be pointed out that will substitutes can distort any estate plan. If Mr. Hoffman had set up custodial accounts or payable-on-death (POD) accounts in the name of his one son and failed to revisit and re-balance his assets, he may have unwittingly given his son a disproportionately larger share of his estate. This would also be the case with any retirement plan and life insurance beneficiary designations. This is yet another reason to have a periodic estate planning review to make sure the prior estate plan has not been compromised by unwitting or unknowing actions such as changing the title of assets, form of ownership, change in beneficiary designations, and the like.
It is unfair to make any value judgments about what was done or not done in regards to Mr. Hoffman’s estate plan. There are, however, some very critical object lessons for the rest of us:
Estate Planning Lessons For Spouses and Unmarried Women With Children
It is so important to learn and know about estate planning matters. Usually women have a different perspective on these matters. They should not rely on their husband or significant other to make these critical decisions that can impact them for the rest of their lives. They need to consider that if their loved one dies everything falls on them. The gravity of this reality is something that is hard to comprehend and appreciate but prudence and due care should be brought to these important considerations.
In my practice, many times it is the wife who is initiating and in some cases forcing the estate planning discussion. It is clear from this discussion that women should not rely on their husband or significant other to take care of these essential and critical matters. The important point here is to get involved in the process and make sure your estate plan is something that will actually work in practice and is something you can live with after your loved one’s death.
Implementing an Estate Plan That Meets Your Specific Family Needs and the Essential Periodic Review
The estate planning process is extremely personal with some really hard choices to be made. It is important to understand that sometimes these are matters of the heart and taxes and financial issues may be secondary considerations. This article is not suggesting what Mr. Hoffman’s particular estate plan should have been. But the important point here is that sound, comprehensive and effective estate planning must address the entire and specific financial, family and tax considerations of each particular client. Good estate planning should explore all the possibilities and pitfalls while determining which estate planning techniques will work best for the family’s current situation.
Bottom Line: In light of all that has been discussed here, by all means have your estate plan done by an attorney with the expertise and skill to implement your wishes. Remember to have your estate plan periodically reviewed to avoid problems for your family when you are no longer here.
For those interested in learning more about estate planning the following articles may be worth exploring:
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