Governor Maura Healey has signed the tax cut bill agreed upon the Massachusetts House and Senate that increases the threshold for estate taxation from $1 million to $2 million effective for anyone dying on January 1st of this year or later.
The Sponge Tax
This brings Massachusetts more in line with other states. Eighteen states currently have estate or inheritances taxes. Up until now, Massachusetts was tied with Oregon as having the lowest threshold at $1 million. The thresholds for other states range from $1,648,611 in Rhode Island to $9.1 million in Connecticut. (All the New England states except for New Hampshire have an estate tax.)
The Massachusetts estate tax has seemed out-of-synch with other states as they have eliminated their estate taxes or raised their estate tax threshold and as rising housing prices have increased the value of many otherwise moderate estates above the $1 million threshold.
The Massachusetts estate tax is based on the federal estate tax system that was in effect in 2000. At that time, the federal estate tax allowed a credit for state estate taxes paid. Massachusetts, like many other states, simply charged the amount of that credit simply it didn’t cost estates any more to pay it. This was known as a “sponge” tax.
But then, Congress got rid of the credit and mostly eliminated federal estate taxes. The threshold in 2023 is $12.92 million, so very few estates pay a federal estate tax. Massachusetts has simply grandfathered in the tax that was in place 23 years ago.
How the New Law Works
The new bill increases the threshold in two ways. First, it gives estates a $99,600 credit, which is the amount of the tax on a $2 million estate. Second, it says that there will be no tax if the estate is under $2 million.
You may well ask why the legislature needed to take both of these steps. I believe that the reason is our unique structure with regard to gifts. If someone makes a gift of more than $17,000 to an individual in any one year they must file a gift tax return. On the federal level, such gifts simply erode the $12.92 threshold, which affects very few people. So, for instance, if you gave someone $117,000 one year, you could (only) give away $12.82 million tax free at death.
In Massachusetts, this worked differently. You would not be taxed on your gift, but the $100,000 taxable gift would be added back into your estate to determine whether it exceeded the estate tax threshold. As a result, sometimes estates that were less than $1 million were subject to the Massachusetts estate tax. The way I read the law, this is no longer the case. It appears that someone could make a deathbed gift to reduce their estate below $2 million and avoid the estate tax all together. One wonders whether that is really the legislature’s intent.
Another question you might ask is how this works if its dated back to January 1st of this year. That won’t be much of a problem since estate tax returns are due nine months after the date of death. So, only the estates of those dying in January of this year are likely to have filed an estate tax return already. Those that have can amend their returns and receive a rebate.
Finally, while the estate tax reform eliminates the tax on estates between $1 million and $2 million, it also reduces the tax on larger estates by approximately $100,000. This makes the tax somewhat less progressive in that it reduces the amount of redistribution of wealth by that amount. The legislature could have eliminated the tax on under $2 million without reducing the amount of the tax on larger estates.
What Does This Mean for You?
If your estate is under $2 million and unlikely to exceed that level, you don’t need to worry about the Massachusetts estate tax. If you’re estate is over the new threshold and you are married, basic estate tax planning using credit shelter or QTIP trusts.
But if you already have such a plan in place and your estate is under $2 million, should you eliminate the trusts? Perhaps, since having two separate trusts can complicate things a bit. But don’t rush to repeal the trusts. They still work under the new threshold and your estate may grow to exceed $2 million over time.
Trusts also provide non-tax benefits, including probate avoidance, asset management in the event of incapacity, protection from financial scams and creditor and divorce protection. So, consult with your estate planning attorney before repealing or modifying your estate plan.