With the federal estate tax threshold now at $11.7 million, very few people need to do federal estate tax planning any more. (The threshold was at $1.5 million as recently as 2005.) President Biden has proposed ratcheting back this limit to $3.5 million, but together through “portability” married couples would still be able to shelter $7 million from estate taxation. (The threshold will automatically drop to about $6 million in 2026 even with no new legislation since the Trump-Ryan increase had a 10-year sunset.)
Portability permits a surviving spouse to inherit the unused estate and gift tax credit of a deceased spouse. 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
Massachusetts, like many other states, has its own estate tax, tying Oregon with the lowest threshold at $1 million. It does not have portability. As a result, married couples having estates in excess of $1 million should consider doing estate tax planning.
Credit Shelter Planning
Let’s take the example of Fred and Ethel to understand why. They have $2 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 $2 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, half of the estate 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 begin subject to an estate tax. If Fred’s half of the estate is protected in this way and Ethel’s estate is under $1 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.
Even Further Estate Tax Reduction
Let’s also consider the case of Mark and Alison who have a combined estate of $3 million. If they do no estate tax planning, when the second one dies, his or her estate will have a tax bill of approximately $180,000. If they set up the same plan as Ethel and Fred, and the surviving spouse still has $2 million in her name (having sheltered $1 million), her estate will still be subject to a $100,000 tax, more or less, saving approximately $80,000.
However, many years may transpire between Mark and Alison’s deaths. If during that time, Alison invests the assets in Mark’s trust, allowing them to grow, and spends the funds in her own name, depleting them to some extent, she will be able to change the distribution of assets. If when she passes on, she has $1.5 million and Mark’s trust also has $1.5 million, the Massachusetts estate tax will drop to approximately $65,000, saving about $115,000 in estate taxes. Again, Mark and Alison 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.