No matter the size of your assets, estate planning is essential--but it can easily become a complex issue.
When James Gandolfini, the actor who played Tony in the mega-hit TV show The Sopranos, died of a heart attack at 51 last month, he left an estate valued at roughly $70 million. Despite what’s been asserted, his estate plan was not a “disaster” on account of the fact that there will be a significant estate tax bill. It just highlights the complexity of our tax system. The way our system works, you can leave as much as you want to your spouse without incurring any estate tax. However, if you leave more than a certain amount(1) of assets to other beneficiaries- children, relatives, friends- that’s when estate tax kicks in.
Although only pieces of Gandolfini’s estate are public, including his will and the $7 million life insurance policy left to his son, it appears he was a generous and considerate man. He bequeathed two nieces half a million dollars apiece, his godson got $100,000, $200,000 went to a close friend and an equal amount was left to his assistant.
After these and other specific bequests are doled out (for instance, his clothing and personal effects go to his 13-year old son), you end up with something called the “residual” estate. Here’s where things get interesting.
Had he left his residual estate to his second wife Deborah, the entire amount would be exempt from estate tax. However, Gandolfini reportedly left Deborah and their daughter Liliana 20% of the “residual” estate, and his sisters, Leta and Johanna, received 30% apiece. Both their inheritance and Liliana’s are subject to the 40% estate tax.(2)
“That’s not a disaster,” says New York estate planning attorney Bruce Steiner. Assets left to a spouse or a charity escape estate tax; those that pass to other beneficiaries in excess of the exemption amount (see No.1 below), are taxed. Clearly, Gandolfini wanted to take care of his sisters. “You pay tax when you do that,” says Steiner with the firm Kelinberg, Kaplan, Wolff and Cohen.
The mistake made in drafting Gandolfini’s will is that the assets are allegedly given outright to his sisters. As a result, they are subject to being taxed twice: first at Gandolfini’s death and again when the sisters die. “All he had to do is leave each sister’s share in a trust. [Then] it would not be in the sister’s estate when she dies and wouldn’t be subject to estate tax again."
Each sister could have been named as trustee of her own trust with broad powers over withdrawals. In addition, she could determine who the trust would benefit and who would act as trustee if there were any assets remaining at her death. According to Steiner, “The unnecessary tax is not the tax in James’ estate, it’s the tax in the sister’s estate.” Furthermore, leaving property to his sisters via a trust would protect it from both creditors as well as, in the case of divorce, an ex-spouse.
Another issue concerns the assets Gandolfini left to his two children- Michael, from his first marriage, and Liliana, who is less than a year old. Under the terms of their respective trusts, each child will get complete control over the millions they’ve inherited as soon as they reach age 21.
“That’s unusual for such a large amount of money, says Steinberg. “He took it to the extreme. It’s better not to have the trust end at a certain age because you don’t know what the child will be like. What if she turns out to be the next Lindsey Lohan? Instead, make it fully discretionary and just pick good trustees.”
Not only do both kids come into possession of a boatload of money in their twenties, they also inherit Gandolfini’s house in Italy. Michael and Liliana will have full possession of it upon reaching age 25. In a significant omission, there are no instructions about what happens to the share given to a child if he or she dies before reaching age 25. In other words, does the remaining sibling become 100% owner of the home or does the deceased child’s share pass to someone else?
Steinberg points out that Deborah Gandolfini’s share of her husband’s residual estate is considerably smaller than it appears to be thanks to the instructions her husband left about how the estate taxes should be paid.
For the sake of illustration, let’s assume Gandolfini’s residual estate is worth $50 million. You’ll recall it is divided as follows: 20% to Deborah (second wife), 20% to daughter (Liliana), 30% to each sister (Leta and Johanna). Since assets left to a spouse escape estate tax, in this example, you would assume Deborah receives $10 million (20% x $50,000,000). The remaining $40 million goes to the daughter and two sisters and gets hit with combined state and federal estate taxes of roughly 50%, or $20 million.
Only that’s not what Gandolfini’s will says. Instead, Deborah has to chip in to help cover the tax bill for the other three beneficiaries. Let’s again use the assumptions made in the previous example. Thanks to the convoluted way estate taxes are calculated, instead of $10 million, Deborah’s “20%” share shrinks to $5,555,556, according to Steinberg. Daughter Lilian would receive the same amount. Leta and Johnanna, however, would each get $8,333,333. The total estate tax bill would increase to more than $22 million.
“It’s a little puzzling that she gets such a skimpy percentage when they’ve had a child together,” says Steinberg. “He wanted to be more generous to his sisters than his wife.” Note that Deborah also receives less than the value of the life insurance policy Gandolfini left to his son.
In addition, assuming he was well enough to get another policy, Gandolfini could have left everyone better off if he had covered at least part of the tax bill with a second life insurance policy specifically earmarked for this purpose.
In the end, however, Deborah might have an ace up her own sleeve. In many states, a surviving spouse is entitled to a minimum percentage of the decedent’s estate. In New York this so-called “elective share” is one-third. According to Steinberg, “Unless she waived it in a pre-nup(3), she can demand her one-third [of the residual estate] free of estate tax.”
Of course, Deborah may be very satisfied and well taken care-of via other assets that we know nothing about. All property that is held jointly is automatically hers. This might include the primary residence, bank and investment accounts, cars, boats, second homes, etc.
Still, you gotta wonder: What would Carmela do?
- The current amount that is exempt from estate tax is $5,250,000.
- According to attorney Bruce Steiner, when combined with NY state inheritance tax, the total estate tax rate is roughly 50%.
- A pre-nup, or prenuptial agreement is a contract a bride and groom enter into prior to getting married. It lays out how property is to be divided in the event of divorce.
Ms. Buckner is a Retirement and Financial Planning Specialist and an instructor in Franklin Templeton Investments' global Academy. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content.
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