By now everyone has heard that the federal estate tax exemption is up to $5,340,000 for 2014, and the law allows the portability of a spouse’s unused exemption. So if the value of your assets is less than $5,340,000 (or $10,680,000 for a married couple) you might be thinking that you are in the clear and don’t need to worry about estate tax. Well if you live in Massachusetts, you need to think again.
Massachusetts, like several other states, has its own estate tax that may cause an estate to be subject to tax even if the value of assets is well under the federal threshold. While the state’s estate tax makes reference to the federal calculation, there are important differences between the federal and state systems. These differences are the result of the fact that, for estate tax purposes, Massachusetts is living in the past and uses the federal laws as they existed as of December 31, 2000. The Massachusetts system is what is called a “sponge” or “pick up” tax because it is based on the state death tax credit that used to be allowed in prior years against the federal estate tax. Whatever the federal state death tax credit was calculated to be, Massachusetts collected that amount as its share of tax. When Congress began increasing the federal estate tax exemption and the state death credit began to disappear, Massachusetts realized that it stood to lose a lot of tax revenue and decided to freeze time.
So what does this mean? Well first of all, for Massachusetts purposes, it means that the estate tax exemption (or “threshold” for MA purposes) is a paltry $1,000,000. So a resident who has a gross estate of over $1 million will be subject to Massachusetts estate tax. For example, let’s consider “Mary”, an unmarried Massachusetts resident who owns a home worth $450,000, an IRA worth $750,000 and other financial assets worth $250,000. While not destitute, most people would not consider Mary to be especially affluent. With assets totaling $1,450,000, Mary does not need to be concerned with any federal estate tax; however, she will be subject to a Massachusetts estate tax of $61,200. This may come as a surprise to her because she has probably been focusing solely on the well-publicized increases in the federal exemption.
The second issue to consider is that Massachusetts does not adopt the federal portability of a pre-deceased spouses’ unused exemption. This federal provision comes in handy when a married couple’s combined assets are less than the federal exemption amount, and adequate estate planning has not been done. In this event, the portability ensures that the couple benefits from both spouse’s exemption amount. Since Massachusetts does not have this portability benefit, couples need to take steps to be certain that one of the spouse’s exemptions is not wasted, leading to unnecessary taxes. To illustrate, let’s pretend that Mary in the example above was married to John and that they owned all of their assets jointly with right of survivorship. If John died first, all of the assets would pass automatically to Mary. John’s estate would owe no Massachusetts tax because the marital deduction (available for property passing to a surviving spouse) would reduce John’s taxable estate to zero without utilizing any of his $1 million exemption. If Mary were to die shortly thereafter, her estate would still have a value of $1,450,000, and it would owe Massachusetts estate tax of $61,200. In this case, a little bit of planning could have preserved John’s exemption so that a total of $2 million of assets could have been sheltered from tax. Since Mary and John’s total assets are less than $2 million, the result would be no estate tax.
There are many other nuances of the Massachusetts estate tax system that aren’t mentioned here. The moral of the story, however, is that proper estate planning for Massachusetts residents (or residents of any state that has its own estate tax) should consider both federal and state estate tax rules. Otherwise, your estate may face a tax that you weren’t expecting (and less assets to be passed to your beneficiaries).
For more information please contact Tim Barry at firstname.lastname@example.org.
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