Modifies certain formulas construed to refer to the federal estate and generation-skipping transfer tax on estates of decedents dying during 2010

This measure would amend section 2-1.13 of the Estates, Powers and Trusts Law ("EPTL"), which was added in 2010 in response to the repeal of the Federal estate tax for decedents dying in 2010 and the repeal of the generation-skipping transfer ("GST") tax in 2010. L. 2010, c. 349. In the view of our Advisory Committee, chapter 349 needs clarification in light of Federal election options.

According to the bill summary accompanying the 2010 enactment:

"Many wills, trusts and beneficiary forms prepared prior to 2010 were based on formula dispositions in the case of married testators. The aim was typically to leave as much as possible on the first spouse's death to a trust or to individuals other than the surviving spouse (typically issue of the decedent) without causing estate tax on the first spouse's death. This was commonly referred to as a "credit shelter bequest", since the amount involved ($3.5 million for decedent dying in 2009) would be sheltered from estate tax on the first death by a "unified credit" allowed under the Internal Revenue Code. The credit shelter bequest is not subject to estate tax at the surviving spouse's death. "The credit shelter bequest is usually phrased in terms of the maximum amount that can pass free of Federal estate tax on the first death, or in terms of like effect. The same results were obtained with formulas leaving a spouse outright or in a form qualifying for a marital deduction against the Federal estate tax, the minimum amount necessary to avoid imposition of an estate tax on the first spouse's death. With repeal of the estate tax, these formula clauses could be interpreted to leave the entire estate in a credit shelter disposition and nothing to the spouse or in a form qualifying for a marital deduction. This conclusion is reached since the entire estate and not just the part formerly sheltered by statutory credits can now pass under a credit shelter disposition without there being any estate tax.

The Federal generation-skipping transfer tax is also temporarily repealed for transfers in 2010. Many wills and testamentary instruments also left to grandchildren (or to trusts that would eventually pass to grandchildren) maximum amounts allowable without imposition of a Federal generation skipping transfer tax. With

repeal, this amount is now unlimited, and may pass to grandchildren to the detriment of the decedent's children."

Thus, in order to prevent unintended consequences of estate and GST tax repeal in the form of distorted formula dispositions, the EPTL was modified to construe certain formula bequests or other dispositions of property as if they were made pursuant to the provisions of the Internal Revenue Code of 1986, as amended, as those provisions were in effect on December 31, 2009.

The bill summary also indicated that (at the time the summary was prepared) there was still a possibility that Congress might reinstate an estate tax or a GST tax for 2010 retroactively. As a result, the EPTL was modified to contemplate a retroactive estate or GST tax by providing that the statutory rules of construction would not apply if the Federal estate tax "becomes applicable" before January 1, 2011.

As noted, our Advisory Committee believes that the 2010 legislation should be clarified. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "2010 Act:), retroactively reinstates the Federal estate tax, with a $5,000,000 estate tax exemption amount and 35% estate tax rate for 2010. The 2010 Act also includes an option to elect out of estate tax treatment and be subject to a carry-over basis regime. The GST tax is also retroactively reinstated, with a $5,000,000 exemption amount and 0% tax rate for 2010.

Pursuant to EPTL section 2-1.13(a)(4), the statutory rules of construction will not apply if the Federal estate tax or GST tax "becomes applicable" before January 1, 2011. Accordingly, if an estate is subject to estate tax under the 2010 Act, the statutory rules of construction will not apply, and formulaic provisions will be keyed to the $5,000,000 exemption amount However, the result is unclear if an election is made not to have the federal estate tax apply. In such a case, the estate tax would not "be applicable" to the particular estate at hand.

If the estate tax must be applicable to the case at hand in order for the statutory construction rules not to apply, there may be an anomalous result if carry-over basis treatment is elected: in the estate tax default treatment scenario, a $5,000,000 exemption would apply in the interpretation of formula clauses. However, if carry-over basis treatment is chosen and the statutory construction rules are applicable, formula clauses may be interpreted with a $3,500,000 exemption (because the EPTL refers to Federal law as of December 31, 2009). This election option could present a very difficult dilemma for a fiduciary, typically subject to duties of impartiality, if the fiduciary's election might determine a funding amount.

The modifications to the EPTL enacted in 2010 were drafted to anticipate a possible retroactive estate/GST tax; however, the issue of an election about whether to have the estate tax apply was not

addressed. Our Advisory Committee believes that a modification to the EPTL is necessary in order to effect consistency in the interpretation of formula clauses (whether an estate is subject to an estate tax or a modified carry-over basis regime), and to clarify that formula clauses will be interpreted with reference to a $5,000,000 federal estate and GST tax exemption amount.

We believe that the statute should be clarified regarding its beneficiary designations. EPTL 2-1.13(a)(1) and (2) both provide:

"If by reason of the death of a decedent property passes or is acquired under a beneficiary designation, in the case of a will or trust of a decedent...that contains a bequest or other disposition based upon the amount of property that can be sheltered from...tax..." (Italics added)

We believe the addition of the phrase "in the case of" leads to ambiguity as to whether the statute applies to beneficiary designations generally, or only those designations that are payable to an estate or trust. The ambiguity regarding the statute's application to beneficiary designations is compounded because the reference to "beneficiary designation" does not consistently appear in the statute with each reference to a "will or trust". Accordingly, we recommend that the phrase "in the case of" be deleted from the statute and that the reference to "beneficiary designation" appear consistently with each reference to a will or trust. These changes are necessary to clarify that the statute applies generally to beneficiary designations.

We recommend clarification of the statute regarding bequests and other dispositions that refer to the GST tax exemption. In light of the 2010 Act, we believe that language in EPTL section 2-1.13(a)(2) regarding direct skips to natural persons should be removed. As a result of the clarification provided by the 2010 Act regarding the GST tax regime, the EPTL provisions should reach all GST type transfers. The reference to direct skips to natural persons is therefore unnecessary and confusing and should be removed.

This measure also would extend the time for bringing a judicial proceeding. The EPTL currently allows a judicial proceeding to be brought within 12 months following the death of the testator or grantor. Since Federal law was not clarified until December 2010, it is urged that the time for bringing a proceeding be extended until the end of the later to expire of (1) 24 months after death and (2) six months from the date of enactment of this measure (i.e., the date on which the Governor signs it into law). Indeed, with a 12 month time-frame, the time to bring a proceeding may have already expired with regard to decedents who died early in 2010. We also recommend that the court have discretion to further extend the time for filing a proceeding (parallel to the discretion granted to the court pursuant to EPTL Section 2-1.11 "Renunciation of property interest").

Notably, other states, including Virginia, have introduced legislation to clarify the operation of state formulaic construction statutes, in light of the 2010 Act. The proposal introduced in Virginia on January 20, 2011 also seeks to effect consistency in the interpretation of formula clauses (whether an estate is subject to an estate tax or a modified carry-over basis regime), and to clarify that formula clauses will be interpreted with reference to a $5,000,000 federal estate and GST tax exemption amount. The Virginia bill also includes a provision that will extend the time for bringing a judicial proceeding, beyond the original time frame of within 12 months of death.

This measure would take effect immediately and apply to wills and trusts of decedents dying after December 31, 2009 and before January 1, 2011.

Legislative history

None. New proposal.