Law Office of John S. Palmer Attorney at Law

Apportioning Estate Taxes

Posted Tuesday, July 28, 2015 by John S. Palmer

When preparing an estate plan, it is wise to address whether estate taxes should be paid equitably (with each beneficiary’s share of the estate reduced on a pro rata basis) or allocated to specific assets or class of assets, such as the residuary estate.

There are various reasons to direct that estate taxes to be paid with certain assets, such as to avoid being forced to sell a valuable investment in order to generate the cash needed to cover that asset’s share of the tax due, or to ensure the tax is borne by particular beneficiaries.

Allocation of estate tax is permitted by Washington’s Estate Tax Apportionment Act, which states that to “the extent that a provision of a decedent’s will provides for the apportionment of an estate tax, the tax must be apportioned accordingly.” It also provides that any portion of an estate tax not apportioned by the decedent’s will “must be apportioned in accordance with any provision of a revocable trust of which the decedent was the settlor which provides for the apportionment of an estate tax.”

Absent such provisions, estate tax is to be apportioned on a pro rata basis among each beneficiary of the estate or trust. In order to ensure that estate taxes are paid on time, the act allows the fiduciary responsible for paying the tax to require each beneficiary to advance the necessary funds and defer distribution of estate property until he or she is satisfied that adequate provision for the payment of estate taxes has been made.

A recent case shows how tricky these allocation rules can be. In In re the Jensen 1980 Trust Agreement (published May 19, 2015), Leon Jensen died with assets worth just under $3 million in his trust and $1.8 million in pay-on-death financial accounts. The trustee of the trust was Leon’s daughter Jo, who was to receive 25% of the trust upon Leon’s death and $1.7 million of the POD funds. Jo paid $1.5 million in state and federal estate taxes solely with trust assets, claiming that it was required by Leon’s will and trust documents. The other trust beneficiaries noted that this interpretation benefitted Jo as the primary beneficiary of the POD accounts and argued that the apportionment language in Leon’s will and trust did not shield the POD accounts from bearing their share of the estate tax.

The trial court ruled against Jo and ordered her to reimburse $582,000 to the trust. Jo and her daughter (a smaller POD beneficiary ordered to repay $10,500) appealed.

The Court of Appeals affirmed the trial court, stating: “In order to avoid statutory apportionment under RCW 83.110A.030, an instrument (the will or the trust) must clearly apportion estate taxes and express the specific intent to require certain assets to carry the tax burden.”

Jo argued that Leon’s trust gave her the discretion to pay all estate taxes with trust assets. The Court of Appeals disagreed, stating that “the Trust does not express a specific intent for the Trust to pay all estate taxes attributable to Trust and non-Trust property.”

The court also noted that Leon’s will contained an apportionment clause that “specifically directs estate taxes attributable to Trust property be paid by the Trust and estate taxes attributable to non-Trust property be paid by the residual probate estate.” However, Leon died without any residual probate estate because all of his assets were nonprobate property, defined by statute as interests “that pass on the person’s death under a written instrument or arrangement other than the person’s will.”

In this case, all of Leon’s assets passed to beneficiaries designated in his trust and written POD beneficiary designations. As a result, the Court of Appeals found that the language in his will did not control and “estate taxes attributable to the POD accounts must be statutorily apportioned…among the non-Trust beneficiaries.”

This case probably would not have been litigated if the same individuals inherited Leon’s trust and POD accounts in equal shares; the case illustrates that the apportionment issue may need to be more carefully considered when setting up an estate plan that involves certain nonprobate assets such as POD accounts, particularly if the beneficiaries differ from those inheriting other assets.

If you have any questions or would like to schedule an appointment, please call us at (425) 455-5513, toll free at (877) 455-5513, or info@palmerlegal.com.