Kevin Wong, CPA
05.03.21 | T&E Chat
“Wow! My uncle left me $100,000 in his will. Wait, what?! I only received $60,000. What happened to the difference? Did my cousins steal some of my inheritance?” This might be what you will hear from your beneficiaries once you’re in a better place.
The federal gift and estate tax exemption is as high as it has ever been, currently standing at $11.7 million for individuals and $23.4 million for married couples for 2021. As high as this may be, it may not be enough for some families and estate taxes may need to be paid by the estate. The exemption is expected to drop significantly in 2026, and there is a chance it may come sooner. A reduction to the exemption has been proposed. Even if your estate is not subject to the federal estate tax, there may be estate taxes levied by the state that you may have to contend with. It is important to consider how taxes will be apportioned if there is a chance your estate may be subject to estate taxes. A carefully worded apportionment clause in your estate plan can be beneficial to be consistent with your wishes.
Apportionment is primary governed by the applicable state law. Most states have some form of an “equitable apportionment” scheme, with slight differences from state to state. Under this approach, each beneficiary is required to pay his or her fair share of estate taxes generated with the assets he or she receives.
While the equity apportionment method may work for some people, it may not work for you. Your wishes may not be achieved if your estate relies on equitable apportionment. As shown in the example at the beginning of the article, if your intent was for your nephew or niece to receive the full $100,000, this result was not accomplished as he or she only received $60,000, and the remainder went to pay for estate taxes.
Another example is when applicable state law provides that estate taxes are apportioned to the residuary estate. Henry has two children. He has a son, Mason, to whom he will leave a real estate portfolio worth $10 million and a daughter, Ariel, who will inherit the residuary estate consisting of cash and stock of $10 million. Henry intended to leave each child with an equal amount. However, if state law provides that the residuary estate bears the estate taxes, the $10 million Henry left to Ariel would be less than $7 million once distributed to her. Mason would still have his $10 million in the real estate portfolio without paying estate taxes on his share. The effect of the estate taxes borne by the residuary estate would be inconsistent with Henry’s wishes.
Review your Estate Plan
While there is no right way to apportion estate taxes, it is still essential to understand how the taxes would be apportioned to be consistent with your wishes. If the applicable state law is inconsistent with those wishes, you may want to consider an apportionment clause added to your estate plan to ensure that your wealth is distributed as intended. Have a discussion with your trusted advisor about your estate plan and how estate taxes would impact your wishes.
Questions? I can be reached at 212.331.7441 | firstname.lastname@example.org or contact your Berdon advisor.
Kevin Wong is a Tax Manager in the Personal Wealth Services Group of Berdon LLP with nearly 10 years of professional experience. He works closely with high net worth individuals on matters involving their personal income tax, family businesses, and fiduciary, gift and estate taxes.