FAQs—Massachusetts & Federal Estate Taxes

In December 2010, Congress temporarily increased the federal estate tax exemption to $5 million and, in January 2013, made permanent the $5 million federal estate tax exemption (indexed annually for inflation). Accordingly, the federal estate tax exemption (as well as gift and generation-skipping transfer tax exemption) for 2013 was $5.25 million and for 2014 is $5.34 million. According to some projections, the federal estate tax exemption will reach $6.58 million in 10 years and $8.95 million in 20 years. The 2014 federal estate tax rate is 40%.

Both the federal and Massachusetts estate taxes are calculated based on all of the property you owned or controlled or in which you had any incident of ownership at the time of your death (plus adjusted taxable gifts minus allowable deductions). This can include, for example, proceeds from life insurance, jointly held property and annuities. Both federal and Massachusetts estate taxes are due nine months from the date of death.

Assuming no lifetime taxable gifts, the federal estate tax applies only to the amount by which the taxable estate exceeds the federal exemption whereas the entire taxable estate is subject to Massachusetts estate taxes if the decedent’s gross estate exceeds $1 million.

Nothing in this Q&A should be considered legal advice as this is a complicated area of the law.

The Massachusetts estate tax exemption is $1 million and a Massachusetts estate tax return is required if the gross estate and the adjusted taxable gifts together exceed $1 million. In contrast, the federal estate tax exemption in 2014 is $5.34 million.

Moreover, the Massachusetts estate tax exemption is not indexed for inflation.

If there were no lifetime taxable gifts, the Massachusetts estate tax liability for a taxable estate (plus adjusted taxable gifts minus allowable deductions) of $1.05 million is $20,500, a taxable estate of $1.5 million is $64,400 and a taxable estate of $10.1 million is $1.082 million. 

Both the federal and Massachusetts estate taxes are calculated based on all of the property you owned or controlled or in which you had any incident of ownership at the time of your death (plus adjusted taxable gifts minus allowable deductions. This can include, for example, proceeds from life insurance, jointly held property and annuities. Both federal and Massachusetts estate taxes are due nine months from the date of death.

Assuming no lifetime taxable gifts, the federal estate tax applies only to the amount by which the taxable estate exceeds the federal exemption whereas the entire taxable estate is subject to Massachusetts estate taxes if the decedent’s gross estate exceeds $1 million.

As explained below, by using trusts drafted in a manner to minimize estate taxes (referred to as “credit shelter,” “bypass,” “A-B” or “A-B-C” trusts), a married couple is able to leave $2 million (twice the Massachusetts estate tax exemption) free of Massachusetts estate taxes to their children.

Nothing in this Q&A should be considered legal advice as this is a complicated area of the law.

In January 2013, Congress made permanent a new concept in estate planning for married couples called portability. Portability means that if the first-to-die spouse’s taxable estate is less than his or her remaining federal estate tax exemption, any unused federal exemption can be carried over and applied to the surviving spouse’s gifts during life and taxable estate at death if the personal representative of the first-to-die spouse elects portability on a timely-filed federal estate tax return. The end result is that in 2014 married couples can shelter from federal estate taxes up to $10.68 million.

Portability does not alter the unlimited marital deduction, which enables married individuals to give tax-free an unlimited amount to one’s spouse, during life or at death, if the spouse is a U.S. citizen. However, prior to portability, without proper planning, at the death of the surviving spouse, federal estate taxes would be owed to the extent his or her taxable estate exceeded the federal exemption. In other words, prior to portability, without proper planning, the first-to-die spouse’s federal exemption would be wasted.

Example 1 (assumes no lifetime taxable gifting): Mr. and Mrs. Elder have "I love you" wills whereby they leave everything to each other and they each have a taxable estate of $3 million (a total of $6 million). In 2014, Mr. Elder dies and his $5.34 million federal exemption (which went unused because his entire estate qualified for the marital deduction) goes to Mrs. Elder and his personal representative elected portability on a timely-filed federal estate tax return. With portability in 2014, she then is able to leave a total of $10.68 million free of federal estate taxes to their children. In contrast, prior to portability, Mr. Elder’s federal exemption was wasted and Mrs. Elder’s estate was subject to federal estate taxes to the extent that her taxable estate exceeded her federal exemption. However, if Mrs. Elder remarries and does not use Mr. Elder's unused federal exemption before her new husband dies, the unused federal exemption received from Mr. Elder will be forfeited as he will no longer be her “last deceased spouse.” Moreover, unlike Mrs. Elder’s federal exemption, Mr. Elder’s unused federal exemption is not indexed for inflation.

It is important to note that Massachusetts does not have a similar portability provision. In other words, for purposes of the Massachusetts estate tax, if a married couple relies solely on portability for their estate plan, the couple will waste the Massachusetts exemption of the first-to-die spouse.

Consequently, for Massachusetts residents, portability should not take the place of traditional tax planning using trusts drafted in a manner to minimize Massachusetts estate taxes (referred to as “credit shelter,” “bypass,” “A-B” or “A-B-C” trusts). In addition to the non-tax reasons (avoiding probate; privacy; creditor protection; protection for the surviving spouse and children in the event the surviving spouse remarries; control and management of assets for spendthrifts, minors and those disabled; and avoiding ancillary probate for real estate owned in another state), the most obvious reason for utilizing credit shelter trusts is that portability applies to federal estate taxes and not Massachusetts estate taxes. Otherwise, as shown by Examples 2 and 3 below, the Massachusetts exemption will be wasted and a married couple will be subject to the Massachusetts estate tax to the extent that the surviving spouse's taxable estate exceeds $1 million.

Example 2 (assumes no lifetime taxable gifting): A widow or widower dies with a Massachusetts taxable estate of $2 million. The end result here is a Massachusetts estate tax liability of $99,600.

Example 3 (assumes no lifetime taxable gifting): Assume the same facts as in Example 2 except that the married couple had done traditional tax planning using credit shelter trusts to minimize Massachusetts estate taxes. The end result in this example is that there is no Massachusetts estate tax liability.

Nothing in this Q&A should be considered legal advice as this is a complicated area of the law.

Trusts drafted in a manner to minimize estate taxes (referred to as “credit shelter,” “bypass,” “A-B” or “A-B-C” trusts) are still relevant for purposes of minimizing Massachusetts estate taxes as Massachusetts has not enacted a portability provision similar to the federal provision. The federal provision allows any unused federal exemption of the first-to-die spouse to be carried over and applied to the surviving spouse’s gifts during life and taxable estate at death if the personal representative of the first-to-die spouse elects portability on a timely-filed federal estate tax return. Consequently, as shown by Examples 4 and 5 below, if a married couple has “I love you” wills whereby they leave everything to each other, the Massachusetts exemption of the first-to-die spouse will be wasted.

Example 4 (assumes no lifetime taxable gifting): A married couple has “I love you” wills whereby they leave everything to each other and they each have a Massachusetts taxable estate of $1 million. The estate of the first-to-die spouse would not be subject to Massachusetts estate taxes as a result of the unlimited marital deduction. However, upon the death of the surviving spouse, his or her taxable estate would be $2 million, which would trigger a Massachusetts estate tax of $99,600. The end result here is that the cost of not utilizing credit shelter trusts to minimize Massachusetts estate taxes is $99,600.

Example 5 (assumes no lifetime taxable gifting): Assume the same facts as in Example 4 above except that the couple has done traditional tax planning using credit shelter trusts to minimize Massachusetts estate taxes. At the death of the first-to-die spouse, his or her credit shelter trust will be funded with the Massachusetts exemption amount, thereby utilizing the Massachusetts exemption of the first-to-die spouse. On the death of the surviving spouse, the surviving spouse’s taxable estate is $1 million, which is equal to his or her Massachusetts exemption. The end result in this example is that by utilizing credit shelter trusts to minimize estate taxes, the couple completely avoids any and all Massachusetts estate tax liability.

In summary, for the most part, as shown by Examples 4 and 5 above, it makes sense for married couples with assets in excess of $1 million to consider traditional tax planning using credit shelter trusts to minimize Massachusetts estate taxes.

Nothing in this Q&A should be considered legal advice as this is a complicated area of the law.

As explained below, trusts drafted in a manner to minimize estate taxes (referred to as “credit shelter,” “bypass,” “A-B” or “A-B-C” trusts) are still relevant for purposes of minimizing federal estate taxes if the married couple’s assets are close to or exceed their combined federal estate tax exemption ($10.68 million in 2014).

Prior to portability, if a married couple wanted to maximize their protection from federal estate taxes, they typically used credit shelter trusts. This type of planning essentially boils down to the concept of “use it or lose it” because prior to portability, your federal exemption died with you and thus if you left everything to your spouse, he or she would have all the assets (what he or she inherited from you and his or her own assets), but only one federal exemption. Prior to portability, as shown by Examples 6 and 7 below, in order to avoid wasting the federal exemption of the first-to-die spouse, the first-to-die spouse would leave property to his or her credit shelter trust in lieu of his or her surviving spouse.

Example 6 (assumes no lifetime taxable gifting): Mr. and Mrs. Elder have “I love you” wills whereby they leave everything to each other and they each have a taxable estate of $4 million (a total of $8 million). Mr. Elder dies in 2014 with a $5.34 million federal exemption but without portability after which Mrs. Elder has a taxable estate of $8 million, but only her own federal exemption of $5.34 million (because without portability Mr. Elder’s federal exemption died with him). Mrs. Elder dies in 2014 (six months after Mr. Elder). The end result here is that her estate is subject to federal estate taxes on $2.63 million (her $8 million minus her federal exemption of $5.34 million).

Example 7 (assumes no lifetime taxable gifting): Assume the same facts as in Example 6 above except that Mr. Elder leaves his assets to his credit shelter trust in lieu of his spouse. His credit shelter trust is separate from Mrs. Elder and restricts her access. The trust typically would be structured to provide access to the income and principal for the surviving spouse’s health, education, maintenance, or support. As a result of using his credit shelter trust, Mrs. Elder’s estate is subject only to federal estate taxes on her taxable estate of $4 million, which in 2014 is sheltered by her $5.34 million federal exemption. The end result in this example is that Mr. and Mrs. Elder completely avoid any and all federal estate tax liability (even in the absence of portability) by using credit shelter trusts.

However, once portability of the federal estate tax exemption is available, the picture rapidly changes.

Example 8 (assumes no lifetime taxable gifting): Assume the same facts as in Example 6 above except that portability is available and the personal representative of Mr. Elder’s estate elects portability on a timely-filed federal estate tax return.  As a result of portability, in 2014, Mrs. Elder has a taxable estate of $8 million and her total federal exemption is $10.68 million (as she has both her federal exemption and her spouse’s unused federal exemption of $5.34 million). The end result here is that her estate is not subject to federal estate taxes notwithstanding the fact that there was no credit shelter trust to minimize estate taxes. However, if Mrs. Elder remarries and does not use Mr. Elder’s unused federal exemption before her new husband dies, the unused federal exemption received from Mr. Elder will be forfeited as he will no longer be her “last deceased spouse” and her estate is subject to federal estate taxes on $2.63 million (her $8 million minus her federal exemption of $5.34 million). Moreover, unlike Mrs. Elder’s federal exemption, Mr. Elder’s unused federal exemption is not indexed for inflation.

One downside of portability is that there is no sheltering of the appreciation of assets occurring between the deaths of the spouses.

It is important to note that the federal exemption of the first-to-die spouse does not increase in the future although the values of the assets of the surviving spouse are likely to appreciate. In contrast, assets allocated to a credit shelter trust will be exempt from federal estate taxes in both estates even if the value of these assets appreciates significantly.

Consequently, as shown by Examples 9 and 10 below, if a married couple’s assets are close to or exceed their combined federal exemption ($10.68 million in 2014), credit shelter trusts are relevant in minimizing estate taxes and sheltering future growth from federal estate taxation. Moreover, married couples with assets close to or exceeding their combined federal exemption should equalize the assets of both spouses in order to ensure that each has significant assets at their death.

Example 9 (assumes no lifetime taxable gifting): Assume the same facts as in Example 8 above except that Mrs. Elder dies in 2024 (ten years after Mr. Elder) and their assets have doubled between their deaths. As a result, Mrs. Elder has a taxable estate of $16 million and her total federal exemption is $11.92 million as she has her own federal exemption of $6.58 million (the projected federal estate tax exemption is $6.58 million in 2024) plus Mr. Elder's unused federal exemption of $5.34 million (as he died in 2014). As the federal estate tax rate is 40%, the end result here is that the federal estate tax liability of Mrs. Elder’s estate is $1.632 million—40% of $4.08 million (her taxable estate of $16 million minus her total federal exemption of $11.92 million).

Example 10 (assumes no lifetime taxable gifting): Assume the same facts as in Example 9 above except that Mr. and Mrs. Elder have done traditional tax planning to minimize federal estate taxes. As a result, at the time of her death, Mr. Elder’s credit shelter trust has $8 million, Mrs. Elder has a taxable estate of $8 million, and her total federal exemption is $7.92 million (her projected federal exemption is $6.58 million in 2024 plus his unused federal exemption of $1.34 million as he died in 2014 with a taxable estate of $4 million and a federal exemption of $5.34 million). As the federal estate tax rate is 40%, the tax liability of the estate of Mrs. Elder is $32,000—40% of $80,000 (her taxable estate of $8 million minus her total federal exemption of $7.92 million). The end result in this example is that Mr. and Mrs. Elder avoid any and all federal estate taxes not only on Mr. Elder’s assets, but also on the growth of his assets after he passed away.

The potential for tax savings is somewhat exaggerated by Example 10 as a result of the fact that the assets in the credit shelter trust do not receive the step-up in tax basis that they would have  received in the estate of the surviving spouse. Nevertheless, those assets, upon sale or disposition, would trigger a federal capital gain tax of 20% on the appreciation that occurred between the spouses’ deaths whereas inclusion in the surviving spouse’s estate would trigger a tax rate of 40%. Thus, if a married couple’s assets are close to or exceed their combined federal exemption ($10.68 million in 2014), it makes sense for them to consider traditional tax planning using credit shelter trusts to minimize estate taxes rather than relying on portability.

In addition, if a married couple’s estate plan keeps assets in trust for the lifetime of their children (generation-skipping trusts), using a credit shelter trust at the first spouse’s death and applying the first spouse’s GST exemption will ensure that the GST exemption is maximized as the GST exemption is not portable to a surviving spouse.

Nothing in this Q&A should be considered legal advice as this is a complicated area of the law.

There are several non-tax reasons for utilizing credit shelter trusts such as avoiding probate; creditor protection; protection for the surviving spouse and children in the event the surviving spouse remarries; control and management of assets for spendthrifts, minors and those disabled; and avoiding ancillary probate for real estate owned in another state. Moreover, living trusts are private (not public) documents and notice of the trust assets and accountings need to be given only to the interested parties.

Example 11: Mr. and Mrs. Elder have “I love you” wills whereby they leave everything to each other and they each have a taxable estate of $2 million (a total of $4 million). Mr. Elder dies and Mrs. Elder remarries. She and her new husband have a verbal agreement that at their deaths their respective assets will go to their respective children by prior marriages. Mrs. Elder’s estate plan leaves her $4 million to her children. However, after her death, Mrs. Elder’s new husband waives her Will and claims a forced share (also referred to as “elective share” and “statutory share”). Under Massachusetts law, assuming there is no valid and enforceable prenuptial or separation agreement and one of Mrs. Elder’s lineal descendants survived her, the new husband’s forced share is 1/3 of Mr. and Mrs. Elder’s $4 million (the first $25,000 outright and a life estate in the remainder). In contrast, if Mr. and Mrs. Elder had credit shelter trusts to minimize estate taxes, the new husband’s forced share is 1/3 of her $2 million (again, the first $25,000 outright and a life estate in the remainder).

Nothing in this Q&A should be considered legal advice as this is a complicated area of the law.

 

 

 

 

 

 

 

 

 

 

 

 


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