As you may know, the threshold for taxing estates in Massachusetts is $1 million, much less than the current $11.4 million threshold for federal estate taxes. In addition, unlike the federal estate tax which only taxes the excess over the threshold, if an estate exceeds $1 million the entire amount above $40,000 is taxed. Fortunately, the rate is substantially less, ranging from 0.8% to 16%, whereas the federal rate is 40%. Here are the Massachusetts estate tax rates:
|Estate Size||Tax Rate|
|$40,001 - $90,000||0.8%|
|$90,001 - $140,000||1.6%|
|$140,001 - $240,000||2.4%|
|$240,001 - $440,000||3.2%|
|$440,001 - $640,000||4.0%|
|$640,001 - $840,000||4.8%|
|$840,001 - $1,040,000||5.6%|
|$1,040,001 - $1,540,000||6.4%|
|$1,540,001 - $2,040,000||7.2%|
|$2,040,001 - $2,540,000||8.0%|
|$2,540,000 - $3,040,000||8.8%|
|$3,040,001 - $3,540,000||9.6%|
|$3,540,001 - $4,040,000||10.4%|
|$4,040,001 - $5,040,000||11.2%|
|$5,040,001 - $6,040,000||12.0%|
|$6,040,001 - $7,040,000||12.8%|
|$7,040,001 - $8,040,000||13.6%|
|$8,040,001 - $9,040,000||14.4%|
|$9,040,001 - $10,040,000||15.2%|
The tax on a $1 million estate is about $36,500. That won't bankrupt the heirs, but the marginal tax on the difference between a $990,000 estate and a $1,010,000 estate can be significant, meaning that it behooves Massachusetts residents whose assets total just a bit above $1 million to get below that threshold before they dies if they can take such a step at that time.
Interestingly, while the tax rate between $1 million and $1.5 million is 6.4%, the effective tax rate can be as much as 25% since a $1.2 million estate will pay about $50,000 in taxes and a $990,000 estate will pay zero.
So, what about making larger gifts to get below the $1 million threshold? Here's where the interplay between Massachusetts and federal gift taxes gets interesting (at least for those of us who practice in this area; did anyone say anything about "nerds"?).
The Federal Gift Tax
While the federal system is set up to tax certain gifts, Massachusetts does not tax gifts at all . However, Massachusetts includes federally taxable gifts in determining whether the decedent's estate exceeds the $1 million threshold. Confused? Here's a longer explanation:
Many people have heard that gifts are limited to $15,000 per recipient per year. (Some people think it's $10,000 which was the amount for a long time.) But that's not true. The rule is that if you give anyone more than $15,000 in a year ($30,000 if you're married, including both spouses' gifts to the individual) then you are supposed to report the gift to the IRS. So, for instance, if you give your daughter $115,000 to help her with the downpayment on her house, you are supposed to report a taxable gift of $100,000. But you don't have to pay a gift tax. That only occurs once all of your taxable gifts added together exceed the federal estate tax threshold of $11.4 million (in 2019). The other effect of this taxable gift is that it comes back in in determining the federal tax on your estate. Instead of being able to give away $11.4 million tax free at death, the gift uses up some of your estate tax credit, meaning that after helping your daughter with her house purchase you will be able to give away only $11.3 million tax free at death. And if you're married, it reduces your combined credit from $22.8 million to $22.7 million.
Obviously, at these limits the federal estate and gift taxes only affect a small number of the richest Americans. The $15,000 mentioned above is an exemption to the normal gift tax reporting rule. You don't have to report gifts of up to $15,000 per recipient per year ($30,000 for a married couple). However, the reality is unless you have a very large estate, there will be no penalty even if you make gifts of more than $15,000 and don't report them to the IRS. That said, they could come into play on your Massachusetts estate tax return.
The Massachusetts Estate Tax Threshold
While your gifts of more than $15,000 a year are probably irrelevant for federal tax purposes, they get added back into your estate for purposes of determining whether your Massachusetts estate exceeds the $1 million threshold and will be taxed. So, for instance, if your estate totals $850,000 but a year prior to your death you gave each of your two children $115,000 during the same year, your estate will be deemed to total $1,050,000 for purposes of determining whether it's taxable -- the $850,000 you have at death plus the $200,000 you made in taxable gifts to your children. In other words, because your estate plus your taxable gifts exceed $1 million, your estate will be subject to a Massachusetts estate tax, but only the $850,000 actually in the estate will be taxed.
Here's another example of how this can work:
Jon Adams has $1.25 million. He gives $115,000 to each of his three children and then dies with an estate of $900,000. In preparing his estate tax return, the children must add back in their $300,000 in "taxable" gifts to determine whether he has a taxable estate. However, they need only pay taxes on the $900,000 remaining. So this saves some money in taxes, but not everything, reducing the tax from approximately $50,000 on a $1.2 million estate to approximately $28,000 on a $900,000 estate.
If instead of making these large gifts to his children all at once, Jon had given them $15,000 each over several years to reduce his estate below $1 million, the gifts would not be added back in and his estate would not be subject to tax (saving both taxes and legal fees to prepare the estate tax return).
While the Massachusetts estate tax rate is significantly lower than the federal rate, it can often be reduced or avoided entirely through judicious and timely gifting.