As you probably heard, over the past twenty eight months, four sets of the estate tax and gift rules have been in effect, with the individual exemption bouncing from $2M (2008), to $3.5M (2009), to unlimited (2010), to $5M (effective January 1, 2011). Therefore, even if you do not want to make changes to the dispositive provisions of your wills or trusts, since the government has expanded the gift estate tax exemption to $5M, we urge all of our clients to schedule a review of your wills and trusts to make sure your existing documents still reflect your wishes.

The most worrisome clauses in the existing documents are known as “formula clauses.” These are provisions that allocate assets to a by-pass trust, limited to the estate tax exemption. In the past, attorneys drafted the documents to maximize the amount that a couple could pass on tax free to their children. Through 2009, the value of one exemption was lost if the assets passed directly to the surviving spouse. The trouble arises because this year’s $5M exemption creates different planning issues than the $1.5M level in 2005, and it was unexpected until this past December. So if a spouse dies this year with a $3M estate with an unchanged “formula clause,” the surviving spouse might get nothing outright because all the assets would fund their bypass trust.

Another profound change in the new estate rules is called the “portability” of the gift and estate tax unified credit. Portability allows each partner of the married couple use the rest of the other’s estate tax exemption. Although portability (as explained in more detail in a separate article) eases post-mortem planning and may appear to eliminate the need for trusts, especially for couples with assets below $10M, enough wrinkles remain in tax planning including the State of Illinois estate tax issues, that tax planning never ends.