When evaluating which type of estate planning is best for you and your family (see Wills vs. Trusts here), including whether advanced estate planning may be indicated, it is important to understand what transfer taxes are (estate, gift, and GST taxes) and how they work.
Our Transfer Tax practice focuses on federal and Massachusetts specific laws.
Transfer taxation is an additional, parallel system of taxation to the all-too-familiar income taxation and applies under certain circumstances to lifetime transfers (gift taxes), transfers at death (estate taxes), and lifetime or death transfers that skip a generation (generation skipping taxes) like from a grandparent to a grandchild. Given the significant and sweeping changes under the newly adopted Tax Cuts and Jobs Act of 2017 (the “Act”) it is imperative to understand ‘where we’ve been’ and ‘where we’re going’ with respect to transfer taxes and the general estate planning landscape (see 2017 Year-End Tax Update for a more complete review of the Act).
It is important to note that like most tax reform acts of recent memory, tax reform under the Tax Cuts and Jobs Act, although dramatically altering the landscape, is not necessarily ‘permanent.’ Most of the provisions affecting individuals (including transfer tax provisions relating to gift, estate, and generation skipping taxes) will begin to sunset on December 31, 2025, reverting back to prior law beginning on January 1, 2026.
Overview of Federal Estate, Gift & Generation Skipping Taxes
Under the Act, the federal wealth transfer and creditor protection planning opportunities are incredibly advantageous. In determining whether an individual or an estate will pay any transfer taxes, it is first important to understand that everyone has an exemption amount – or ‘coupon’ as we are fond of calling it – for the amount of assets they may transfer during lifetime or at death before a tax is imposed. A tax will become due on a transfer only once the exemption amount is exhausted.
- The federal exemption amounts for the estate tax, gift tax, and generation skipping transfer tax remain unified and indexed annually for inflation after 2011. The Act doubles the exemption amount from $5,000,000 to $10,000,000 per person.
- The indexed amount for 2017 was $5,490,000 per person and the indexed amount for 2019 under the Act will be $11,400,000 per person. The Act effectively doubles the previously scheduled indexed amount for 2018 ($5,600,000 exemption per person) under prior law.
- For all married couples these amounts are effectively combined, allowing a total of $22,800,000 to pass to the next generation (or anyone else) free of federal transfer taxes in 2019. There is an unlimited marital deduction for transfers to a surviving spouse.
- The opportunity for spousal ‘portability’ with respect to a Deceased Spouse’s Unused Exemption Amount (“DSUEA”) continues in 2019. Portability simply means that the surviving spouse can use the deceased spouse’s unused exemption amount (except for GST taxes).
- These provisions ‘sunset’ after December 31, 2025. Beginning January 1, 2026, the exemptions revert back to $5,000,000 per person indexed for inflation after 2011. The Act directs regulations be implemented to protect additional exemption used during this period from ‘claw back’ post sunset.
Overview of Estate, Gift & Generation Skipping Tax Rates
Under the Act, the federal applicable tax rate for estates, gifts, and generation skipping transfers exceeding the exemption amounts remains 40%.
In conjunction with these exemption amounts, there is a federal annual exclusion amount that must be exceeded before a taxable gift is triggered. The annual exclusion amount for (non-charitable) gifting remains unchanged in its calculation under the Act and increases to $15,000 per person for 2018 and 2019. Married couples can continue to participate in ‘gift-splitting’ to effectively transfer $30,000 to any beneficiary. A donor may make gifts up to the annual exclusion amount to an unlimited number of recipient donees, provided the aggregate of gifts from a donor to a particular donee does not exceed $15,000 in a tax year.
- Gifts for qualified tuition payments or medical expenses are unlimited (not subject to annual exclusion limitations) if paid directly to the educational or medical institution, and gifts to a Section 529 Plan may be front-loaded for up to five years of annual gifts ($75,000 by an individual and $150,000 with gift splitting) before they are subject to federal gift tax.
Overview of Massachusetts Specific Law
Recognizing the significance of certain federal estate planning opportunities, it remains crucial to curb (mildly) our enthusiasm and keep in mind the following at a state level:
- Independent of federal tax law provisions, Massachusetts estate tax law continues to make available an exemption amount of only $1,000,000 per person ($2,000,000 for married couples with proper planning), and without an inflationary index.
- The applicable estate tax rate for Massachusetts estates is determined by calculating the size of the taxable estate using a sliding scale up to 16%.
- While there is no Massachusetts gift tax, the value of lifetime gifts is included when calculating the size of a decedent’s estate, and may ultimately impact the tax rate applied under the sliding scale.
- There is no spousal portability available with respect to DSUEA in Massachusetts – it’s “use it or lose it” with respect to the exemption amount.
- Legislation has been introduced in Massachusetts that could potentially increase the state level estate tax exemption from $1,000,000 per person to $2,000,000 per person indexed annually for inflation after 2005, allow for spousal portability to be the lesser of one-half of the federal exemption amount or the spouse’s unused state exemption limit, and exempt the value of a decedent’s personal residence from the calculation of the size of the decedent’s taxable estate.
- For those who have Massachusetts connections but are tax residents of states other than Massachusetts, there may be other state estate or inheritance taxes applicable which may present pitfalls as well as valuable planning opportunities.
This transfer tax information is provided for informational purposes only. It is not intended to be, and should not be relied upon or considered to be, professional advice on these issues as they relate to your individual and personal tax, financial, and estate planning situation. Every set of client facts, goals, and objectives is unique and therefore warrants tailored counseling and advice. If you have questions about any of this material, please contact our offices so we may discuss them with you and identify planning opportunities that impact your specific situation.