(6) My thoughts on MA estate tax planning

MA has an estate tax for wealth over $1 million.  Will it affect you?  Is this problem yours?

The problem...

You own more than $1 million of assets and live in Massachusetts. You know that Massachusetts has an estate tax on residents who pass away with more than $1 million.  With an extremely broad definition of what you 'own'.   Yes, retirement accounts, life insurance included.

Years ago I learned  from skilled tax accountants the approach to take. It's a 3 part way to lower estate taxes. And so today, 28 years later, we can talk about lowering  MA estate taxes on your family.

• Level 1:   Use Revocable Living Trust (for some people)
• Level 2:  Remove existing life insurance from estate taxes (if larger policy exists)
• Level 3:   Make Gifts (many different ways to do this)

Table shows MA Estate taxes

Estate size      MA Estate tax
$1 Million          Exempt
$1.2 Million       $45,200
$1.4 Million       $58,000
$1.6 Million       $70,800
$1.8 Million       $85,200
$2 Million         $99,600
$2.5 Million      $138,000
$3 Million        $182,000
$3.5 Million     $229,200
$4 Million        $280,400
$4.5 Million     $335,600
$5 Million        $391,600


Level 1 of Estate Tax Planning:  Use Revocable Living Trust

Are you: 

• ​Married? Have life partner?
• Own over $1 million?
• Live in a state with estate taxation, like Massachusetts?

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If you answer 'yes' to all these questions, each spouse or partner should consider signing a revocable trust. 

Each trust should contain an estate tax saving provision. This may be done by instructing the trustee who acts after your death to set aside a Separate Account at your death. It would be a maximum of $1 million of assets.

(This is one way of doing it, there are others. And based on Massachusetts law,)

The Separate Account is the 'exempt' amount. After your death, the trustee in charge of that account uses it for your spouse, partner, or children.

Let's call the Separate Account the Family Trust (FT). It has both tax and non-tax goals. The lesson today deals with the tax lowering goal.

The estate tax goal is to keep the Family Trust assets out of the surviving spouse (partner) estate at their later death.

So the estate of the survivor is smaller than would be if ALL the assets ended up in the surviving spouse's name. This has been part of estate planning for many, many years.

This approach can lower estate tax. Because the first $1 million is not taxed at either the first or second death. And $11.7 million (Federal, 2021) is similarly not estate taxed at either death either.

The subtrust design can frequently be in this form:

SUBTRUST AFTER I DIE

• Income.   All income to spouse. (Or discretion to distribute all or some.)
• Principal.   To spouse and descendants for their health, education, maintenance, and support. (Or variations on this wording,.)
• Death of beneficiary.   Subtrust ends with death of surviving spouse. Assets go to children, equally, or to their descendants. Maybe outright to child, maybe held in trust for a longer period you set.

  
Health, education, maintenance, and support.  This is broad. This language directs the trustee to distribute money to a beneficiary. How much? To let them continue to have the same style of living as the beneficiary enjoyed before the death.
 
Can the trustee be the same person as the beneficiary?  Yes, but you need to include precise language in the trust document.

Can the surviving spouse be both the trustee while also being a beneficiary?  Yes. This is common. It's what most people want and is frequently found in living trusts.
 
Want to improve your own estate planning for your family? Learn more at 7 Questions to Test the Strength of Your Estate Plan


Level 2 of Estate Tax Planning:  Remove existing life insurance from estate taxes

If you're:

• unmarried with assets over $1 million, or
• married with over $2 million (and already have Level 1 planning)

you face MA estate taxes. If so, you should ponder adding Level 2 to your estate planning.

Many people say that 'isn't life insurance free of taxes?'  Yes, free of INCOME tax. But not for estate tax purposes.

Yes, you heard me right. life insurance is not free from estate tax. Let me explain.

Life insurance is part of your estate because you can change the beneficiary right up to your death. It's that right to control its recipient after death that makes it part of your taxable estate.

By the way, if you make your spouse the beneficiary, the proceeds will not be estate taxed because of the marital deduction. A marital deduction eliminates estate tax on the first spouse to die.

But even if you named your spouse as beneficiary of the life insurance, here's the problem

When you leave it to your spouse, the proceeds will be part of their wealth. To be part of their estate when they later die. So the proceeds do get estate taxed. Only later, as part of the surviving spouse's estate.

By the way, some people make this mistake. They think this:  because life insurance does not pass through probate then it's not part of an estate for taxation. Yet those are two different concepts. Probate is probate, taxation is taxation.

How to remove life insurance from estate taxation?

To remove life insurance proceeds from estate tax at your death and your spouse's death, you can do this:

• Transfer the life insurance policy to a separate trust. Now. As Level 2 of estate tax planning. 

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Because you don't own the policy at your death it isn't part of your taxable estate.

Yet that type of trust is not a revocable trust. It's an irrevocable trust.

Using an irrevocable trust in this way is not unusual. It's used so often that it even has its own term, the 'irrevocable life insurance trust.' Or ILIT for short.

There are two main requirements:
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• First, you must change both the owner and beneficiary of the policy to be your ILIT.

• Second, you must live 3 years after the transfer of the policy before you die. Take both these steps and you reduce the family's estate taxes.

Level 3 of Estate Tax Planning:   Gifting

Some people can't use Level 1 or Level 2 planning. They're not married (partner) and have no large life insurance to remove from their estate.

So, if that's you or if you already have Level 1 and Level 2 planning, and still face MA estate taxes, you can consider gifting.

After you make a gift, your estate is lower. It makes sense, doesn't it? There is less that remains in your estate because you gave some of it away during life.

And because the MA estate tax is based only on your estate at death, the estate tax is lower.

• Non MA real estate. You should know that real estate outside of MA is not taxable as part of your MA estate. This is important. So a gift of NH real estate, for example, will not lower your MA estate tax. And because NH estate tax doesn't exist, choosing NH real estate to gift does not lower your MA estate tax.

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Gifting comes in many forms

These include gifts of money, gifts of real estate, gifts of property like cars. Gifts can be outright in form or alternatively in trust form. 

Current gifts in trust form allow you to control the distribution of the asset after your death. While still lowering your estate by making lifetime gifts.

Gift trusts 

​You should not be the trustee. Until the trust ends, the trustee decides when to distribute money to the beneficiary (your loved one).  A gift trust can have more than one beneficiary. And there can be more than one trustee. You can name two people together to be trustees.

$15,000 gifts   Many people know that you can make a $15,000 gift to another person without paying a gift tax. They mistakenly think it's the most money you can make as a gift without paying a gift tax.

Yet, this is not true. You can give much more than that without paying a gift tax. The gift tax is a Federal tax, not a tax that MA has. 

The IRS rules say that you can give $15,000 before preparing and filing a gift tax return.

But you can ALSO give up to $11.7 million (2021) without paying a gift tax. Filing a gift tax return is not too difficult. It is called a 709 form.

Large gifts. You can lower your MA estate tax by making not only $15,000 gifts but also large ones. Much larger ones.

For example: You are single with $2.4 million dollars. You're somewhere between 70 - 90. 

If you make a $400,000 gift by check to an adult child, you will not pay any gift tax. Because it is under $11.7 million. You will have made a gift of $400,000 minus the $15,000 that is exempt from gift calculation. 

When you die with $400,000 less (due to the gift), the size of your MA estate is $2 million. And the MA estate tax is lower. Because the MA estate tax return calculates the estate tax on the size of your death estate. Not the amount you once owned.

Charitable gifting

Another way to lower your estate tax bill is to give or leave, at your death, money to charity. Your estate will be able to deduct any charitable distributions from your taxable estate and so lower the size of your taxable estate.

And the estate tax will be lower.

As I write this, I am listening to a podcast about food banks during the Covid 19 pandemic. Jobs were lost and families needed food for both adults and children.

All are embarrassed by their situation of waiting on line. A private foundation provides the money for the food. Mostly volunteers are on their feet for 9 hours. Trying to get the food in to the site, and out. Each day.

You can leave money, above the amount exempt from MA estate tax, to a charity or two. If you do not have obvious beneficiaries, or even if you do, you might want to search your gut for a charitable impulse.