I don't understand the reason for the complexity of the tax allocation clause in the sample will on the web site. Most tax allocation clauses I have seen seem quite short. Why not say for purposes of tax allocation simply that all taxes shall be paid as the executor deems appropriate?
First let us explain in simple terms what a tax allocation clause is so regular folk can also follow along. This is important because a tax allocation clause could be a key provision in a will and far too few people understand it. If you have an estate that is taxable, who pays the tax? Let's give a few simple examples. Let's say you bequeath a half million dollar painting to your favorite art teacher and then leave your remaining $10,000,000 estate to your best friend. Assume that you have used up your applicable exclusion so that everything is taxable at a 50% rate to keep the math simple. There is a tax due of $5,250,000 (50% x $10,000,000 plus $500,000). Who pays the tax, if the will were silent or indicated that state law would govern? It is possible that under state law, or if a generic tax allocation clause was used stating that everyone should pay their share, your art teacher receiving the painting would owe one-quarter million dollars in tax yet have received no cash from you. How generous of a gift would the painting really turn out to be? It could be a financial disaster! If your best friend is getting $10,000,000 in cash and securities, it will be infinitely easier for him or her to simply pay the entire tax, including the $250,000 on the painting. In most cases when people bequeath a painting or similar personal property, they are looking to give the particular piece of property free and clear to the designated beneficiary, not to create a tax nightmare for them. This situation becomes progressively more complex and the answers more difficult to assume if the estate and assets become more complex. What if you give a home to one of your children who does not have the financial wherewithal to buy a home, not an uncommon estate move? If you saddle that child with a huge tax cost they can ill afford to pay, your help may turn out to be of little additional benefit. Let's make it even more complex. What happens when some of the assets involved are outside of the control of the executor? Say you have a joint bank account with your favorite cousin of $1,000,000. Who pays the tax on that $1,000,000? To leave things up to the executor could be a horrific nightmare. What if the executor is your eldest child and you have left your youngest child your house because he needs the additional assistance? If it is up to the executor to allocate taxes, they could allocate all taxes against the house bequest thus wiping out their sibling. Therefore, executor's discretion simply won't work. As a general matter, but there are lots of important exceptions, you will want the beneficiary who gets property to pay their fair share of the tax. Exceptions include personal property bequests noted above. Other exceptions include marital trust property. If your husband dies and sets up a marital (QTIP) trust for his surviving wife on her later death all the assets in the marital trust are taxed in her estate. Since the husband controls in his will where those assets go, might it not be fair that the marital trust pay tax at the marginal rates considering that the estate tax is progressive? State law will often govern this unless the will is expressly stated to the contrary. Thus, a comprehensive tax allocation clause that provides where the tax should be paid from under different circumstances can have an important benefit of minimizing intra-beneficiary problems. This situation can even be more problematic. Suppose you have a $2,000,000 estate. Assume the rate is 50%, and you have used up your application exclusion amount to keep the math simple. $1,000,000 goes to your only son, and the second million goes to your college alma mater, a qualified charity. There is a tax due of one-half million dollars on the amount going to your son. The $1,000,000 to be distributed to your college alma mater qualifies for an estate tax charitable deduction and does not generate any tax. Who pays the one-half million? If it comes out of your son's half, he now gets a one-half million and the college receives a full million, double what your own son gets. If it is allocated ratably, the $250,000 in tax that will come out of the college bequest reduces the estate tax charitable contribution deduction (the charity is now not getting a million but a million less $250,000 paid for tax). The result is that your charitable contribution deduction is now only $750,000 so that you now actually have a greater tax. You end up with a situation of a tax on a tax and a complex calculation. Thus, simplistic tax allocation clauses not only don't always work but they can be expensive as well as ruin relationships as illustrated above. As to your key question as to why so many tax allocation clauses and wills you have seen are so simple, the answer is probably one of two things. Either the situation is really simple so that a simple clause of just saying that the tax should be paid out of the residuary or an administrative expense might suffice. The other reason might be that simply no one really paid attention to the planning, the consequences, and so on. As you can see from the above discussion, this can have very substantial adverse tax as well as personal consequences. As an aside, when you are evaluating living trusts which are hawked is the greatest thing since sliced bread, be sure that whoever is selling them understands the consequences of a tax allocation as between the living trust, your will, and the relationship between them. Caution: You can see from the above that this is a complex question. Be sure to seek the counsel of a qualified estate planning attorney before attempting the "simple" solution.
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