Formula Clause Fallout
Most estate plans written before this year that contain a formula funding clause are now doing something their authors never intended. The One Big Beautiful Bill Act (OBBBA), signed in July 2025, set the federal estate, gift and generation-skipping transfer (GST) tax exemption permanently at $15 million per individual and $30 million for a married couple, effective Jan. 1, 2026. We’re in the first year those numbers actually govern, and the year-end review season now underway is the last comfortable window to catch what they broke.
Three provisions need a fresh read. The marital and bypass funding formula, which in many documents will now sweep an entire estate into the wrong trust. The GST allocation language is moving far more than any drafter contemplated. The bypass trust itself now costs more in forfeited income tax basis than it ever saved in estate tax for a larger number of families. We tend to find all three after the client has died, when nobody is left to explain the intent.
Formula Trouble
A document drafted in 2004 tells the trustee to fund the family trust, also called a bypass or credit shelter trust, with the largest amount that can pass free of federal estate tax, then pour the balance into a marital trust for the surviving spouse. When the client signed it, that formula moved $1.5 million. Today, it moves $15 million.
Take a couple with a $12 million estate. The family trust now takes everything, and the marital trust takes nothing. If the family trust is fully discretionary for the surviving spouse and the children, the result is awkward but workable. If the remainder beneficiaries are children from a first marriage and the survivor is a second spouse, the decedent has disinherited the individual they intended to protect with the document.
GST Allocation
The GST tax exemption tracks the basic exclusion amount, so it sits at $15 million, too, and it still isn’t portable between spouses. If the first spouse to die doesn’t use it, it’s gone. Formulas that carve out an amount equal to the settlor’s remaining GST exemption for a dynasty trust are pushing far more into that structure than anyone planned.
Older documents also lean on the reverse qualified terminable interest property (QTIP) election, which treats the first spouse to die as the transferor for GST purposes, allowing the first spouse’s exemption to be applied to a marital trust. That election works alongside inclusion ratio language, the fraction measuring how much of a trust is exposed to GST tax. Both were calibrated to the old exemption figures. Confirm they still deliver a zero inclusion ratio when the drafter wanted one, because this language won’t survive a glance at the end of the marital formula review.
Basis Costs
The harder conversation involves families who now sit comfortably under the threshold. Many credit shelter trusts we administer exist for one reason, the federal estate tax, and that reason has evaporated. What’s left is an irrevocable trust holding appreciated assets that won’t receive a second step-up in basis at the survivor’s death, taxed at compressed trust rates and costing real money to administer each year.
Real estate is where this stings. A Southern California rental property funded into a bypass trust at a first death in 2006, with a basis of $600,000, may be worth $5 million today. The heirs inherit the $600,000. The federal estate tax that the structure was built to avoid would have been zero, but the capital gains exposure it created isn’t.
Remedies exist, and none of them are passive. These include:
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Decanting, when state law and the trust’s terms allow a trustee to pour assets out of an outdated trust into a new one with better terms.
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Non-judicial settlement agreements, in which the interested parties resolve matters by consent without going to court.
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Modification through a trust protector, in which a third party is granted powers in the document that can include amending its terms.
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In the right circumstances, granting a general power of appointment so that the assets return to the survivor’s taxable estate and qualify for a step-up.
Each trades against creditor protection, remainder beneficiary interests and state law. Make the choice deliberately rather than inheriting it.
Phantom Provisions
Documents drafted between 2018 and 2025 frequently anticipated a reversion that never arrived. Springing provisions, contingent gifts and trustee instructions keyed to the exemption dropping below a stated number. Much of that language is inert today. Some of it is worse than inert, because it will sit in the instrument waiting for a successor trustee to misread it in 2045. Clean it out while someone still remembers why it’s there.
The gifting side deserves the same look. Families who accelerated spousal lifetime access trusts and outright transfers in 2024 and 2025 to beat a deadline that dissolved won’t get those assets back. But the plan surrounding those gifts may rest on assumptions nobody would choose today, including donor cash flow and irrevocable life insurance trusts that are still paying premiums on policies bought to fund a tax the family will never owe.
Draft Ahead
Permanent means the statute carries no expiration date. The number itself is another matter. Congress last called an exemption permanent in 2013, and that version lasted five years (American Taxpayer Relief Act of 2012, Public Law 112-240, which set the exemption at $5 million indexed and was superseded by the Tax Cuts and Jobs Act of 2017).
So, the drafting instinct worth carrying forward is flexibility over precision. Disclaimer-based funding. QTIP trusts with a Clayton election, which lets the executor decide after death how much property lands in the marital share. Broad powers of appointment. Real discretion in the hands of a trustee who can read the environment at the time it matters.
Watch the states next. Federal permanence pushes the action to state thresholds, and jurisdictions that decoupled from the federal exemption are where the next round of formula problems will surface. A clause producing no federal tax can still produce a state bill at the first death, and clients who have relocated or who hold property across state lines are exposed already.
There have been five resets since 2001. Draft for the sixth.
