In terms of taxes, the income tax is something we all understand and deal with on a regular basis, whether it’s seeing withholding come out of our paychecks, making estimated tax payments, or filing our income tax returns every April. However, the estate tax is something many people never encounter during their lifetime. It is a one-time tax that is paid after your death. Unless you are involved in the settlement of an estate that is subject to estate tax, you may be altogether unfamiliar with this type of tax.
For those of you who are lucky enough to have not yet encountered the estate tax, here are five things to know about this little-known tax:
- What is the Estate Tax? The estate tax is a tax imposed on the value of the assets a deceased person owns on the date of death. Your “estate” for estate tax purposes includes any asset you own or have an interest in at the time of your death – your home, other real estate, bank accounts, investments, annuities, retirement accounts, tangible personal property, and life insurance are all examples of assets that are subject to estate tax at death. Estate tax returns must be filed and any estate tax owed must be paid within nine months of the date of death.
- Federal and State Estate Tax May be Payable. Like the income tax, there is both a federal and state estate tax. Unlike the income tax, your estate will not necessarily owe both federal and state estate tax. Under current law, the federal estate tax is payable only if the value of your estate exceeds $5.45 million (and this figure is adjusted for inflation). If you have a federally taxable estate, your estate will pay a flat rate of 40 percent on the value over $5.45 million. The Massachusetts estate tax is payable if the value of your estate exceeds $1 million and is a graduated tax with rates ranging from 0.8 percent to 16 percent. There are many estates that owe a Massachusetts estate tax but no federal estate tax, because the value of the estate is more than $1 million but less than $5.45 million. The estate of a Massachusetts resident with a taxable estate of $1.5 million will pay Massachusetts estate tax of about $65,000, but no federal estate tax. The estate of a Massachusetts resident with a taxable estate of $8 million will pay Massachusetts estate tax of about $775,000, and federal estate tax of about $700,000.
- Deductions are Available. As with the income tax, there are deductions available to reduce the value of your taxable estate. The marital deduction allows an estate to deduct all amounts passing to the deceased’s spouse at death, or into certain types of trusts for the spouse’s benefit. The charitable deduction allows all amounts passing to a qualified charity to be deducted from the value of an estate for estate tax purposes. Deductions are also available for the cost of the deceased’s funeral, estate settlement costs (i.e. legal, accounting and executor’s fees), and debts owed by the deceased at the time of death. For most married couples, the marital deduction means that no estate tax will be payable at the death of the first spouse to die if all assets are left to the surviving spouse or in trust for the surviving spouse’s benefit.
- What is the Gift Tax? In addition to the federal estate tax there is also a federal gift tax that may be imposed on gifts given during your lifetime. There is no Massachusetts gift tax. The federal gift and estate taxes are related, in that the $5.45 million exemption is a combined federal estate and gift tax exemption. What this means is that you are permitted to give up to $5.45 million of assets away, either during your lifetime by gift or at your death by inheritance. If you give a “taxable” gift during your lifetime, it will reduce your federal estate and gift tax exemption amount. If you give away more than $5.45 million, you will pay gift or estate tax on any additional amounts given away either during lifetime or at death. The first $14,000 given to any individual in a calendar year is not subject to gift tax, and therefore only gifts above $14,000 in any year are considered taxable gifts that will reduce the gift and estate tax exemption. This $14,000 “annual exclusion amount” is also adjusted periodically for inflation. Like the estate tax, gifts to your spouse or to charity are not considered taxable gifts.
- Can the Estate Tax be Avoided? If your estate is large enough to be subject to estate tax at your death, speak to your estate planning attorney about how you can plan to reduce or eliminate the estate tax that will be payable. Your attorney may recommend that you implement an annual gifting plan or create one or more of the variety of trusts that can be used to reduce your taxable estate. Trusts that are commonly used for this purpose by married couples will allow your surviving spouse to benefit from the trust assets following your death, while sheltering those assets from estate tax at your spouse’s death. With estate tax planning, a large potential estate tax bill can often be reduced significantly if not eliminated.
The estate tax is a tax that does not impact everyone. Only two out of 1,000 people will owe any federal estate tax at death. However, here in eastern Massachusetts, if you own a home and have some life insurance and a 401k, as many people do, it is very likely that estate tax will be payable at your death. Take the time to consult with an estate planning attorney to understand how this tax may impact your estate and what you can do to reduce the tax. In the case of estate tax planning, the time and effort you put into planning during your lifetime will result in dramatic savings for your heirs.
Attorney Maria Baler is an estate planning and elder law attorney and a partner with the Dedham law firm of Samuel, Sayward & Baler LLC. She is also a director of the Massachusetts Chapter of the National Academy of Elder Law Attorneys (MassNAELA). For more information, visit www.ssbllc.com or call (781) 461-1020. This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney.