With the threshold for federal estate taxes now at $11.58 million (in 2020), you probably don’t have to worry about it or do any planning to avoid it. Very few Americans have federally taxable estates. But the threshold for Massachusetts residents is $1 million. So, if you live in Massachusetts and your estate is above $1 million—which isn’t hard if you own a house in many communities in this state—should you engage in estate tax planning?
How Much is the Massachusetts Estate Tax?
To start, you need to understand what the tax is and options for reducing your tax. The tax is determined on a graduated rate of up to 16%. The marginal rate for estates between $1.5 million and $2 million, for example, is 7.2%. A $2 million estate would have a tax of about $100,000. This would still leave your heirs with $1.9 million, but if you’re married, you can take steps to avoid this charge all together.
(For a more comprehensive description of the Massachusetts estate tax, you can download our complementary legal guide here.)
There are two principal ways to reduce or avoid Massachusetts estate tax (other than simply spending down your children’s inheritance): gifts and spousal credit shelter trusts.
You can reduce the size of your estate and thus the amount that is taxed by transferring funds to your heirs during life. You can make gifts of up to $15,000 a year per individual with no reporting requirements. If you make larger gifts, they need to be reported. These larger gifts still reduce the ultimate estate tax, but the calculation is a bit complicated.
If you are considering making gifts, you’ll need to consider two issues: First, make sure that you keep enough funds to meet your needs. Second, sometimes gifts have adverse capital gains tax consequences that far exceed any estate tax savings. So, it usually does not make sense from a tax planning point of view to transfer low-basis stock or real estate.
The principal method of reducing or eliminating the Massachusetts estate tax for married couples is for each to create a credit shelter trust for the survivor. This way, the survivor can benefit from the trust as needed, but it won’t be included in her taxable estate when she dies. This example should explains how this works:
Mr. and Mrs. Salmon own the following assets with the following values:
House in joint names – $700,000
Mr. Salmon’s retirement plan – $700,000
Mrs. Salmon’s retirement plan – $200,000
Savings and investments in joint names – $400,000
With no planning, there will be no tax when the first spouse passes away because there’s an unlimited marital deduction, meaning that no matter how much one spouse leaves another, there’s no tax when the first spouse passes away. However, assuming that the values stay about the same, the estate of the second spouse to die will have to pay a tax on about $2 million. (Remember, it’s the estate that pays the tax, not the Salmons while they’re alive.)
This can be avoided by the Salmons splitting the estate evenly between them and each executing wills and trusts that hold their half of the estate for the survivor. In splitting the estate, they would probably put the house in Mrs. Salmon’s name (or trust) and split their savings and investments, $100,000 on Mrs. Salmon’s side of the ledger and $300,000 on Mr. Salmon’s side.
This plan will save Mr. and Mrs. Salmon’s heirs approximately $100,000 in estate taxes, but is it worth the trouble?
Pros and Cons
In addition to the tax savings, this plan provides Mr. and Mrs. Salmon and their heirs the following benefits:
- Creditor protection in the surviving spouse’s trust.
- Protection from financial exploitation—seniors are prime targets of financial predators.
- Management tools if either Mr. or Mrs. Salmon becomes incapacitated.
- Preservation of half of estate for family if the surviving spouse gets remarried. Second, pros—tax savings, creditor protection, help with management, protection from gold diggers.
- Future appreciation of assets in the sheltered trust will not be in the surviving spouse’s estate, allowing more than $2 million to avoid estate taxation (but see the flip side of this below).
The disadvantages of carrying out this plan include the following:
- Legal fees, though they’re only incremental if the Salmons do the basic estate planning everyone should do.
- The cost and trouble of retitling the real estate and investment accounts and changing the beneficiaries of the retirement accounts.
- We don’t know what will happen to estate tax policies in the future.
- If the Salmons had a smaller estate or anticipated spending down their savings and retirement plans during their retirement, then the tax savings might be less.
- The surviving spouse will have file a separate tax return for the credit shelter trust.
- While the growth of investments in the credit shelter trust will not be in the surviving spouse’s name, they also will not benefit from a step-up in basis upon the surviving spouse’s death, perhaps trading estate tax savings for a higher tax on capital gains upon the sale of these assets (assuming both that there is appreciation and the assets are sold rather than simply kept in the family).
Every Massachusetts resident with an estate exceeding $1 million needs to balance the benefits and disadvantages of engaging in estate tax planning and decide how to proceed accordingly.