With the federal estate tax threshold now at $14 million, very few people need to do federal estate tax planning any more. (The threshold was at $1.5 million as recently as 2005.)
“Portability” permits a surviving spouse to inherit the unused estate and gift tax credit of a deceased spouse, so even with no tax planning, married couples can protect $28 million from federal taxation. To take advantage of this, however, the surviving spouse must file a federal estate tax return for the deceased spouse’s estate.
The Massachusetts Estate Tax
But Massachusetts does not have portability and its estate tax threshold is $2 million. As a result, married couples having estates in excess of $2 million should consider doing credit shelter estate tax planning.
Credit Shelter Planning
To explain how this works, let’s take the example of Fred and Ethel to understand why. They have $3 million in combined assets, including their home, retirement savings, investments and life insurance. When Fred passes away (before Ethel) there will be no estate tax because assets passing to a spouse are never taxed. However, when Ethel goes to the great beyond still holding $3 million in her name, her estate will be subject to a tax of approximately $100,000.
Ethel and Fred could decide not to worry about this, since it’s their kids who will pay the tax, not them, and they may well spend down their estate on travel, living expenses and, ultimately, long-term care. But they can protect against the tax without incurring great cost or inconvenience by executing an estate plan that provides that at the death of the first spouse, at least $1 million will pass into a “credit shelter” trust for the benefit of the surviving spouse.
This is called a “credit shelter” trust because it protects the first $1 million of the first spouse to pass away from every being subject to an estate tax. If Fred’s half of the estate is protected in this way and Ethel’s estate is under $2 million, the estate tax will be eliminated. The trust provides other benefits as well, including creditor protection if Ethel were ever sued, protection from a future spouse or his children, and if within a will (a “testamentary” trust) MassHealth protection if Ethel ever needed long-term care (though it’s unlikely that she would ever qualify if she still has $2 million in assets).
Even Further Estate Tax Reduction
In the above example, we have assumed that Fred and Ethel’s investments stay static. However, what happens if many years pass between Fred and Ethel’s deaths. If during that time, Ethel invests the assets in Fred’s trust, allowing them to grow, she may well protect more than $1 million from taxation. If when she passes on, she still has $2 million and Fred’s trust has grown to $1.5 million, the Massachusetts estate tax will still be zero.
Fred and Ethel may or may not think this matters—after all, the Commonwealth can use the funds—but they should discuss the option with their estate and financial advisors.
Related Articles: