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NEW YORK A dramatic family legal battle over a $100 million estate does not often lead to life lessons for the masses.
But the California probate court decision in the case of the Tweten family, who got caught up in the one-year disappearance of the federal estate tax in 2010, offers some simple life lessons in estate planning.
If you're wealthy enough for your assets to trigger the estate tax, (which, absent new laws, means you have more than $1 million, or $2 million for a couple, as of January 1, 2013), you should know that the laws governing these taxes have been changing year after year.
So you need to make sure your will and trusts are worded to accommodate all the possibilities. You also need to revisit them regularly to avoid ending up with a very different result than what you think you're planning.
A YEAR WITHOUT ESTATE TAX
At the heart of the Tweten case were the oddities of 2010. In that year only, there was no estate tax. While that had been baked into the estate tax system for years, few financial planners or tax attorneys had expected that the U.S. Congress would let the gap year stand. But it did.
Magnolia Audio Video founder Leonard Tweten and his wife, Eileen, had amassed a fortune and set up a trust, as many of the wealthy do to minimize estate taxes. The trust included a common estate planning device, called a formula clause.
The formula clause typically divides the estate so that children get the amount of assets in the federal estate tax exclusion (currently $5 million per person), with the rest going to a marital trust for the surviving spouse. This allows the full amount of the exclusion to pass to the heirs tax-free.
Since assets that pass to a spouse are generally free of estate tax, this setup results in no estate taxes for the widow or widower at the time of the first spouse's death. And that was the plan for the Twetens, who were in their 80s and had been married for 58 years.
The problem is that because the formula clauses rely on the federal estate tax exclusion - a number that changes from year to year - the split can vary widely based on the tax policy in effect at the year of death.
The estate tax exclusion was $2 million in 2008, when the Twetens, who had sold their Magnolia chain to Best Buy Co Inc in 2000, drew up their latest trust agreement. But in 2010, the exclusion was unlimited, because there was no estate tax. So when Eileen died in April of that year, her whole estate, rather a few million dollars, would have gone to the kids, leaving Leonard out of the money.
This may sound complicated, but it was a big issue among estate attorneys, financial planners and wealthy families in 2010. It was only a matter of time until one of these high-stakes family squabbles made it to court.
In the Twetens' case, there was a last-ditch effort to change the estate plan. While Eileen was dying and in hospice care in the spring of 2010, there was "a flurry of activity by her attorneys and financial advisers to correct the drafting deficiency," according to the court. An amendment was executed 12 days before her death.
The couple's adult daughters, Nancy Crowe and Janet Houston, petitioned the court to invalidate that amendment on grounds of forgery and incapacity, while their father petitioned to allow the trust's modification.
The court threw out the amendment, noting that it had not been notarized as required by the trust but sided with Leonard.
"The intent of the parties was not reflected in the trust instrument for a death in 2010 but instead and as written completely thwarted their intent," the court stated.
MOVING AWAY FROM FORMULAS
With estate taxes in continual flux, those old formula clauses may send more families to court. After all, such provisions have a very different impact when the estate tax exclusion is $1 million, as it was in 2003, than it does at $5 million, as it is today.
The impact can be especially dramatic for a smaller estate, where a surviving spouse could be unintentionally disinherited and not have enough funds left to pay the bills during the remainder of his or her life.
"This issue is going to continue to pop up," says Clay Stevens, director of strategic planning at wealth management firm Aspiriant. "And it could (have) exactly the same consequence in a smaller estate."
Because of this, "good estate attorneys are now moving away from the formulaic approach," says Brent Brodeski, chief executive of Savant Capital Management. Instead, he says, they are using more flexible wording, and also revisiting those trust documents each year, particularly for large estates.
The Tweten case may be the first of its kind to get through the courts, but it does not offer any legal precedent. And the Twetens' daughters plan to appeal the decision, according to their lawyer, Adam Streisand, chairman of trust and estate litigation at Loeb & Loeb in Los Angeles.
"It's a ridiculous result," Streisand says. "The judge has no factual basis to say what Mrs. Tweten intended.
"People with money spend a lot of time and money trying to get it to the next generation tax-free. This was an estate-planning home run."
That, in fact, may be the big irony of this case: The original formula clause would have allowed $50 million (Eileen Tweten's half of the couple's fortune) to pass to the next generation with no estate tax due.
Remember the uproar over George Steinbrenner and other billionaires who died in 2010 and whose heirs escaped paying estate taxes? That's essentially what would have happened - however unintentionally - to the Twetens.
"From a tax perspective, the result they got before making the change was the right result," says Aspiriant's Stevens, who does high-net-worth estate planning but is not involved in the case.
With top estate tax rates set to rise to 55 percent in 2013, the potential tax hit to the Twetens' heirs could be gigantic when Leonard dies, assuming that he does not leave his money to charity.
(The writer is a Reuters columnist. The opinions expressed are her own.)
(Follow us @ReutersMoney or here; Editing by Beth Pinsker Gladstone, Linda Stern and Lisa Von Ahn)