New Found Estate Planning Opportunities Following Ohio Estate Tax Repeal

Effective for estates of decedents dying January 1, 2013, Ohio has repealed its estate tax.  Long notorious for having the lowest estate tax exemption ($338,333) of the 17 states with estate taxes separate from the federal estate tax, this repeal provides an obvious and significant tax benefit.  From a more technical perspective, Ohio estate tax repeal also has many opportunities to better accomplish a client’s goals.  This posts outlines the need to carefully review formula provisions in existing trusts to be sure they accomplish the client’s goals.

Often in a “typical” planning situation, many revocable trusts allocate assets between a “Marital Trust” and a bypass, or credit shelter trust (“CST”) at the death of the first-to-die spouse, using language similar to the following:

“Trustee shall allocate to a separate trust known as the “Marital Trust,” the smallest fractional share of such trust assets includible in my gross estate for federal and Ohio (if I am domiciled in Ohio at death) estate tax purposes, which results in the least possible federal and if applicable, Ohio, estate tax payable by reason of my death.”

This leaves a CST to be funded with $338,333 and a marital trust qualifying for both a Federal and Ohio estate tax marital deduction.  Under the Ohio estate tax, this traditional plan results in no Ohio estate tax upon the death of a first-to-die spouse and is important even for “modest” estates that were below the federal estate tax exemption amount.  Often, if the Federal estate tax is a concern, the marital trust is a “QTIP” trust where a partial federal QTIP election can be made over the portion of the marital trust that, when combined with the CST, exceeds the Federal estate tax exemption but also allows for a QTIP election over the entire portion exceeding the Ohio exemption in order to qualify for the Ohio estate tax marital deduction (this is sometimes referred to as a “three trust” plan).  So, if an estate is valued at $1,500,000 and the federal exemption is $1,000,000, this “three trust” plan funds (i) a CST with $338,333; (ii) an Ohio QTIP with $1,161,667; of which, (iii) a Federal QTIP election is made over $500,000 preventing both Ohio and federal estate tax on the death of the first-to-die spouse.

Usually the CST includes the surviving spouse as the beneficiary (who is also often the trustee) as well as children or a broader class of descendants and possibly grants a limited or “special” power of appointment to the surviving spouse. Distributions of income and principal from the CST are often at the trustee’s discretion or subject to an ascertainable distribution standard for “health, education, maintenance and support,” with the idea that the assets of this trust will remain in trust to grow free of estate tax unless absolutely needed.   On the other hand, the marital trust, which often contains more value than the CST because of the low Ohio estate tax exemption, is a relatively inflexible trust so it can qualify for the federal and Ohio marital deductions.  For example, to qualify for the estate tax marital deduction, the spouse must be the only permitted beneficiary of the marital trust while living and all trust income must be distributed to the spouse at least annually.  These requirements, or restrictions, decrease the flexibility of the marital trust and can cause difficulty when planning for second marriages.  Furthermore, on larger estates these large QTIP trusts “leak” for GST tax planning purposes because the non-federal, or Ohio, QTIP portion still has to distribute income to the surviving spouse and also reduces the effectiveness of the marital trust for asset protection.

Repeal of the Ohio estate tax changes this.  It is now important for funding formulas to be reviewed for their effectiveness and to determine whether or not they are consistent with a client’s goals.  How was the formula drafted?  If tied in any way to the Ohio estate tax, how will it be interpreted when there is no longer an Ohio or tax?  In the absence of an Ohio estate tax, will all assets go to the CST?  Is this what the client intends?  Once it goes to the CST with multiple beneficiaries the trust is no longer exclusively for the surviving spouse.  Is this what the client intends?  Is this acceptable to the surviving spouse?  Perhaps not as the focus of many “modest” estates is to ensure that assets are for the surviving spouse and the CST/Marital trust planning was only done to save Ohio estate tax.  Some trusts even make express provision for a fourth trust (or a fifth trust if a “reverse” QTIP is carved out for federal GST tax planning).  These trusts are confusing to begin with; with no Ohio estate tax their interpretation may be difficult at best.

*this post is based on my upcoming article in the November/December issue of the Ohio Probate Law Journal titled “Ohio Estate Tax Repeal: The End or Just the Beginning?  Unlocking Opportunities After Repeal.”