If you live in the Bay State and are responsible for the estate of someone who has passed, chances are you may need to file an estate tax return. Many people in the U.S. aren’t concerned about estate taxes because the federal tax exemption is high. However, there are a dozen states that impose their own estate taxes and Massachusetts is one of them – with the lowest estate tax threshold of $1 million.

When working with clients, the focus of our tax planning is often directed at reducing or eliminating these taxes – which is why it’s critical to work with an experienced tax attorney who can walk you through the process and ultimately save you money. This blog post will answer many of the questions that often arise when deciphering Massachusetts estate taxes.

How much is the Massachusetts estate tax?

The Massachusetts estate tax ranges from .8% to 16% of the net value of the estate based upon a graduated scale. In reality however, only estates well in excess of $10 million achieve the 16% rate. For estates less than $10 million, the true effective rate ranges between 5% and 10% of the net value of the estate. Below are some basic calculations of Massachusetts estate tax assuming no applicable lifetime gifts were made

How is the Massachusetts estate tax calculated?

The Massachusetts estate tax is determined by calculating the value of the decedent’s adjusted taxable estate and applying that adjusted value to a graduated tax scale. (There is also a comparison federal estate tax calculation required, but is more detailed than is necessary for this discussion). The adjusted taxable estate for purposes of Massachusetts estate taxes is calculated as follows:

Gross Estate plus Lifetime Gifts minus Standard Exemption ($60,000) minus Liabilities and Expenses = Adjusted Taxable Estate

Thus, if a decedent has gross assets of $1.5 Million with liabilities and expenses of $100,000.00, the net taxable value of the estate would be calculated as follows:

$1,500,000 minus $60,000 minus $100,000 = $1,340,000

Is the Massachusetts Estate Tax exemption really an exemption or is it a threshold?

The term “exemption” can be a bit misleading because it suggests that only the value of the estate in excess of $1 million is taxed. This is not the case. If the taxable estate exceeds $1 million (even if only by a small amount) then the value of the entire net estate is subject to an estate tax calculation on the graduated scale. Thus, $1 million is actually a “threshold,” not an exemption. In its simplest terms – if the gross estate plus all lifetime gifts does not exceed $1 million, then the estate is not taxable. If the gross estate (with or without lifetime gifts) exceeds $1 million, then the net estate is fully taxable. (See below for further explanation).

So, a net estate of $1,000,001 will pay tax on the entire value of the estate while an estate of 1,000,000 is exempt from tax?

Yes. Although this statement is technically true, it would be more accurate to say that an estate of $1,000,001 causes the necessity of an estate tax calculation, whereas an estate of $1,000,000 does not. And, although the estate tax calculation is measured from the first dollar, the actual tax is less dramatic as compared to the entire value of the estate.

For example, the estate tax on a $2 million estate would be $103,920. This is approximately 10.4% of the portion over $1 million, but is only 5.2% of the entire value of the estate. This is still a significant tax, but does not approach the highest rate of 16%. And, because of the companion federal estate tax calculation, the actual Massachusetts estate tax is 41% of every dollar over $1 Million until the taxable estate reaches $1,040,000 after which the calculation changes. So in the case of a $1,000,001.00 estate, the actual tax would only be 41 cents.

Since there is no gift tax in Massachusetts, can a person give away assets before death to avoid paying estate taxes?

One might assume that they could simply give away their assets in order to bring them below the $1 million threshold and avoid estate taxes altogether. However, lifetime gifts are added back to a decedent’s adjusted estate for determining the Massachusetts taxable threshold.

If a person who dies has only $500,000 in their estate, but also made $1 million of lifetime gifts, they would have a $1.5 million pre-adjusted taxable estate for Massachusetts estate tax purposes. The gross estate would not escape an estate tax calculation. Therefore, giving away the $1 million would not eliminate tax altogether, but will reduce the estate taxes from approximately $68,000 to approximately $10,000 – a significant savings. But why is this so?

Lifetime gifts are added to the gross estate solely for the purpose of determining whether the estate exceeds the $1 million taxable threshold, but the gift itself is not actually taxed as part of the net estate. While the threshold amount in the above scenario is $1.5 million, the net adjusted value applied to the graduated scale is only $440,000.

Nevertheless, it should be noted that while a gifting strategy may reduce, or even eliminate estate taxes, it may also inadvertently increase capital gains tax in excess of the estate tax savings. Assets gifted prior to death will result in the donee inheriting the donor’s basis in the asset, whereas a transfer on death will result in the donee receiving a “stepped up” basis to market value. For example, if the gifted asset was a $1 million home which the donor had purchased for $200,000, the donee would be potentially subject to capital gains tax on the $800,000 at the time of sale.

In the above scenario, a $70,000 savings in estate tax would result in the donee potentially incurring $160,000 in federal capital gains tax. This is not a desirable outcome from a tax perspective. One must also factor in federal gift tax consequences of such a gift. Unless, the donor elects to pay the federal gift tax, the $1 million gift will reduce the donor’s lifetime federal exemption by $1 million. With that said, a comprehensive tax analysis should be performed before making a substantial gift.

How can I avoid paying Massachusetts estate taxes?

Although an estate may exceed the Massachusetts threshold amount, it does not necessarily mean that an estate tax will be due. For example, Massachusetts has an unlimited marital deduction. A spouse may leave unlimited assets to their spouse without paying an estate tax on the first to die. Thus, if left to a spouse, even an estate of several million dollars would not pay a Massachusetts estate tax.

However, Massachusetts does not allow spouses to pass on their unused exemption amount to each other in the manner allowed by federal law (referred to as “portability”). Leaving assets outright to a surviving spouse is not always the best strategy because all of the devised assets will be taxable in the surviving spouse’s estate when they die. There are a number of planning strategies to preserve this exemption and to reduce or eliminate Massachusetts estate taxes.

As Tax Day quickly approaches (April 18th), it’s important to connect with an experienced tax attorney who can help you employ these strategies in your estate plan. Please contact Edward Puglielli, Director of Ligris Tax Services, for additional information.

Posted In: Articles