APRIL 22, 2002 VOLUME 9, NUMBER 43
Most Americans understand that there will be no federal estate tax (and, in most cases, no state estate tax) due on their deaths so long as they own less than a threshold amount—$1,000,000 in 2002. Many married couples realize that they can take fairly simple steps to ensure that each spouse can "use" the $1,000,000 exemption amount, and pass up to $2,000,000 total to heirs without taxation.
Earl and Koester owned a farm in Waseca County, Minnesota. They also had a home and some other assets; they were not millionaires, but they had substantial assets. Like many couples they had wills leaving everything to one another and directing that the survivor’s estate would be divided among their children after both died.
When Mildred Koester died in 1988 her share of their assets was valued at just over $200,000. Since her estate plan was to leave everything to her husband, Earl Koester received the entire estate.
When Earl Koester died eight years later the total value of his estate was just barely more than $1,000,000. In the year of his death the amount that could be passed to children without estate tax liability was only $600,000; since his estate was larger, it paid taxes of more than $150,000.
Mr. Koester’s heirs petitioned for return of the tax money. They argued that everyone knows that married couples can construct their estate plans to avoid the tax liability, and that the Koesters’ failure to take advantage of the usual tax planning devices was caused by their lack of education. In fact, argued the heirs, the Koesters’ poor educations prevented them from even hiring a competent attorney to prepare their estate plans.
The U.S. Constitution protects individuals from government action that unfairly targets one group over another. The Koesters’ heirs argued that the tax code discriminates against the uneducated, and that the Koesters’ estates should have been as if they had implemented the kind of estate plans that other couples know to execute. Failure to treat the Koesters as favorably as better-educated taxpayers denied them the equal protection of the laws.
The U.S. Tax Court disagreed. It refused to reduce the estate tax based on what the Koesters might have gotten around to doing if they had gotten better advice. Taxes are calculated, ruled the Court, based on how the decedent’s estate actually is constructed, and the courts are not permitted to rewrite the estate plan just to reduce the taxes. Estate of Koester v. Commissioner, March 28, 2002.
What might the Koesters have done if they had gotten better advice? Mrs. Koester could have left her estate in a trust for Mr. Koester’s benefit, giving him the right to receive all the income and access to the principal in some circumstances. This kind of trust, often called a "bypass" trust, causes the first spouse’s assets to escape taxation at both the first and second death. That simple plan would have saved their heirs over $150,000.