The 2017 tax bill proposed by President Trump and passed by the House and Senate drastically increased the federal estate and gift tax exemption amount. Prior to the bill’s passage, an individual had a federal exemption amount of $5.4 million. The bill has now increased this exemption to $11.2 million beginning in 2018. For a married couple the potential exemption, through portability, is now $22.4 million. The exemption amount is now indexed with inflation through 2025, which means yearly increases in the exemption amount. In 2025, if there is no action by the federal government, the exemption amount will revert back to $5 million. Clearly, the bill’s increase in the federal exemption amount will shield a wider range of individuals and couples from a federal estate tax obligation and bill.
While the federal exemption amount has increased, there has been no similar increase concerning the Massachusetts estate tax. In fact, the threshold for filing a Massachusetts estate tax return is $1 million. The Massachusetts estate tax is equal to the credit for state death taxes computed using the Internal Revenue Code in effect on December 31, 2000. The tax is calculated using the federal estate tax return (Form 706) for 1999. The lines of importance from the Form 706 are the following: line 3 (taxable estate); line 4 (adjusted taxable gifts); and line 15 (credit for state death taxes). Adjusted taxable gifts are gifts made above the current $14,000 per year annual gift tax exclusion.
While there is a federal gift tax imposed on individuals, Massachusetts does not impose a gift tax upon its residents. Therefore, in determining if a decedent has a filing obligation upon their death, Massachusetts calculates the $1 million filing threshold by adding together the amount of the taxable estate (line 3 of Form 706) and the amount of lifetime adjusted taxable gifts (line 4 of Form 706). Once the Massachusetts filing threshold is met, the FULL VALUE of the estate (line 3) minus $60,000 is subject to Massachusetts estate tax. The tax rates range from 0.8% to 16%. Since the tax is imposed on the entire taxable estate, estate tax bills can be much larger than people expect.
Once again, the taxable estate in Massachusetts is determined by taxing the taxable estate (line 3 of Form 706) minus $60,000. Therefore, while the lifetime adjusted taxable gifts are utilized in determining whether a decedent has a filing obligation in Massachusetts, the amounts of these adjusted gifts are not subject to Massachusetts estate tax. This allows an individual to make significant lifetime gifts to reduce the amount of his estate subject to Massachusetts estate tax. In fact, an individual could make significant gifts right before death in contemplation of reducing the taxable Massachusetts estate. And while the donor may need to file a federal gift tax return, if lifetime or substantial gifts are made, there will be no federal gift or estate tax consequence if the donor’s gross estate is below the new $11.2 million exemption amount. Therefore, significant tax savings can be made over several years by making $14,000 annual gifts to individuals, or much larger gifts that would require a federal gift tax return filing and a reduction in the federal exemption amount.
You may ask, well what is the benefit of making these gifts if the decedent still has to file a Massachusetts estate tax return? Well, the amount of adjusted gifts are taken into account to determine whether the $1 million-dollar threshold is met to file, but these adjusted gifts are not subject to the Massachusetts estate tax. The Massachusetts estate tax, is a tax on the entire taxable estate (line 3 of Form 706) even if this amount is below $1 million. For example, let’s assume that a decedent died with $900,000 of assets and had made $110,000 of adjusted gifts. This decedent would have a filing obligation ($900,000 + $110,000 = $1,010,000). And $840,000 would be subject to estate tax. Now let’s look at another example. The same decedent now dies with $600,000 of assets and $410,000 in adjusted gifts. Now the Massachusetts estate tax would tax $540,000 of assets, which would lead to significant estate tax savings. Therefore, with the new increase in the federal estate and gift tax exemption, residents of Massachusetts should begin thinking about lifetime gift options or one-time gifts as a means of reducing their taxable Massachusetts estate.
There is one caveat that you should take into consideration. If you gift an asset away, the individual receiving the gift takes a carryover basis in the asset. If the asset passes to the same individual upon your death, the individual now receives a step up in basis. For example, let’s assume that Decedent purchased a stock at $5 a share. Decedent gifts this stock to Individual when the stock is worth $20 a share. Since the stock passed by way of gifting, Individual now has a basis in the stock of $5 and Individual will pay tax on the entire built in gain upon Individual selling that stock. If Decedent had held onto the stock until death and then Individual received the stock, Individual would receive the stock at its $20 value, and would only pay tax on any increase above this threshold. Therefore, an analysis should be made concerning the income tax consequences of gifting to determine whether a net tax benefit will be achieved by gifting an asset or holding on to the asset and subjecting it to the Massachusetts estate tax.
Lifetime gifting and gifting in general can be a simple and effective strategy to reduce the Massachusetts estate tax for estates that will be subject to filing a Massachusetts estate tax return and are below the current federal exemption amount. However, a net tax benefit analysis should be done to determine that true savings is being achieved. Attorneys at Lake Shore Legal have experience in advising individuals concerning the best way to structure their estates and assets to achieve the best tax savings upon their passing. Our attorneys will not only analyze your current estate value but will provide you with information concerning proper estate planning tools that should be utilized moving forward.