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Have you considered adding a tax apportionment clause to your estate plan?

June 29, 2021

Even though the federal gift and estate tax exemption is currently at a historic high ($11.7 million for 2021), there are many families that still have to contend with how to manage and plan for significant federal estate tax liabilities. Additionally, the exemption is scheduled to drop significantly in 2026, and there have been discussions about reducing it sooner. Even if you aren’t subject to federal estate tax, there may be taxes levied on your estate by your state. If your estate could be subject to estate tax, it’s important to consider how the tax will be apportioned – that is, who will bear the burden of the tax. Including a carefully worded apportionment clause in your estate plan may be beneficial.

Apportionment options

Without an apportionment clause, the allocation of estate taxes will primarily be governed by applicable state law (although federal law covers certain situations). Most states have some form of an “equitable apportionment” scheme. Essentially, this approach requires each beneficiary to pay the estate tax generated by the assets he or she receives. Some states provide for equitable apportionment among all beneficiaries while others limit it to assets that pass through a will or to the residuary estate.

There’s no one right way to apportion estate taxes, but it’s important to understand how taxes would be apportioned under applicable law. If that wouldn’t be consistent with your wishes, consider an apportionment clause and any other changes you may need to make to your estate plan to ensure that your wealth is distributed in the manner you intend.

Suppose, for example, that your will leaves real estate valued at $10 million to your son, with your residuary estate, consisting of $10 million in stock and other liquid assets, passing to your daughter. Your intent is to treat your children equally, but your will doesn’t include an apportionment clause, and applicable law provides for estate taxes to be paid out of the residuary estate. In this situation, the entire estate tax burden — including taxes attributable to the real estate — would be borne by your daughter.

One way to avoid this result is to apportion the taxes to both your son and daughter, noting that this approach could cause problems for your son, who may lack the funds to pay the tax without selling the property. To avoid this situation while treating your children equally, you might apportion the taxes to your residuary estate but provide life insurance to cover your daughter’s tax liability.

Speak with your advisor

It is important to speak with your legal and tax advisors to ensure that your estate plan will achieve the desired outcome. Without including an apportionment clause, heirs may be burdened with paying the tax attributable to assets they don’t receive. For more information, contact your Anchin Relationship Partner or a member of Anchin Private Client at [email protected].

Life Sciences