High net-worth individuals and families should be mindful of possible tax implications when it comes to planning their estates. As an Estates & Trusts firm that also has a robust Tax Law practice, SederLaw is prepared to guide you and your family and develop strategies for reducing estate tax liability. We can also advise personal representatives (executors) as to their responsibilities for filing the final income tax return of the decedent (the individual who died). That’s the level of comprehensive legal service you can expect from our dedicated team.
What to Know About the Federal and Massachusetts Estate Taxes
Both the federal government and Massachusetts levy taxes on high-value estates. Unless you anticipate that your estate will be worth a significant amount of money, you probably will not have to worry about this. Still, it’s worth knowing how both estate taxes work.
Federal. The federal estate tax ranges from 18% to 40% and is applicable to estate assets over $12.06 million. That figure is as of 2022 and is subject to future changes and sunset provisions in the tax laws. The federal tax is assessed on the current market value of assets, not their original values. Because of what’s known as the unlimited marital deduction, assets that are inherited by the decedent’s surviving spouse are generally not subject to the tax.
Most people do not end up paying the federal estate tax due to the $12.06 million exemption. It should also be noted that the exemption is per person, meaning a married couple can double it to $24.12 million.
Massachusetts. The estate tax threshold in Massachusetts is $1 million, much lower than the federal amount. If you are a personal representative (executor) for an estate valued at over $1 million, you will therefore need to complete an estate tax return. Federal estate tax exemptions do not affect the Massachusetts exemption of $1 million.
Adjustments, credits, and deductions. As with personal income tax returns, estate taxes are often subject to variations. First, it must be determined what the “gross estate” is, which generally consists of the following estate assets:
- Cash and securities
- Real estate
- Business interests
- Other assets
Added to the gross estate, for purposes of determining whether the tax exemption has been exceeded, are the values of taxable gifts. But deductions and credits are also allowed. For instance, Massachusetts grants a credit for estate or inheritance taxes paid to other states. A knowledgeable attorney can explain how the state and federal estate taxes are computed and make sure eligible credits and deductions are applied.
Ways to Minimize Estate Tax Liabilities
If you are in the process of planning your estate, an Estates & Trusts attorney can discuss various ways to reduce estate tax liability. A few of the most common strategies are:
Tax-Free Annual Gifting. The annual gift tax exclusion is $15,000 for individuals and $30,000 for married couples. By making annual gifts up to these amounts, you can provide beneficiaries with an early portion of their inheritances while also reducing the value of your taxable estate.
Charitable Trust. A charitable trust allows an individual to combine annual gifting with charitable donations, thereby reducing both estate and income tax liability. One of the most popular types of these instruments is the charitable remainder trust. An individual can transfer property into this trust and designate individuals who receive income for a certain amount of time. The remainder is given to a charitable organization, such as a nonprofit.
Qualified Personal Residence Trust (QPRT). There’s a good chance your home is one of your largest assets. If so, the QPRT may be for you. Title to the home is transferred into the trust to the benefit of family members, while you can continue dwelling at the residence for a specific amount of time. The property itself and its appreciated value will pass to your beneficiaries after death, without additional estate tax repercussions. But if you die before the specified time period ends, the full value of the residence will be included in the estate’s taxable assets.
Grantor Retained Annuity Trust (GRAT)/Grantor Retained Unitrust (GRUT). Both of these trusts are used for certain income-producing assets, like stocks and closely-held businesses. These are moved into the trust for a set number of years, during which time the trust pays you income. That income takes the form of either a fixed dollar amount that is not annually adjusted (GRAT) or a percentage of the trust assets’ value which may vary annually (GRUT). At the end of the set time period, trust assets and appreciated value are transferred to beneficiaries, decreasing the taxable value of the estate. If you die before that time period ends, either all or a portion of the assets will be taxable.
Irrevocable Life Insurance Trust (ILIT). Although life insurance proceeds pass outside of an estate, a policy’s cash value is taxable to the estate. Beneficiaries can therefore lose out on a significant portion of life insurance proceeds. An ILIT can fix this. It assumes ownership of the life insurance policy and thereby exempts the proceeds from the taxable estate. The ILIT acts as both the owner and beneficiary of the policy. Proceeds can therefore be used to pay estate taxes, debts, and final expenses. They can also provide income to a surviving spouse or children.
Generation-Skipping Trusts (GSTs). With a GST, it is possible to skip a generation in your estate, your surviving spouse and children, and pass estate assets directly to grandchildren, great-grandchildren, and other descendants. A carefully designed GST can use the current exclusion amount and allocate future appreciation of trust assets directly to beneficiaries.
Filing the Decedent’s Final Income Tax
In addition to any estate tax filings, the personal representative must pay the decedent’s final income tax. Both the Massachusetts and federal returns must be filed by the April 15 deadline, along with any tax-related elections. The estate itself, as a separate legal entity, may have to file income tax returns for certain estate earnings. Note that this estate income tax is not the same as the estate tax described above.
Contact Our Worcester Estate Tax Planning Attorney
Taking care of all estate tax obligations is essential, whether you are the individual creating your own estate or the personal representative who must probate one. Don’t let complex Massachusetts and federal estate and tax laws overwhelm you. Contact SederLaw to connect with our Estates & Trusts team.