Increased Federal Exclusion & Tax Saving Opportunities for Massachusetts Residents

The IRS has published new guidelines relating to estate and gift tax changes for 2019. Starting this year, estates of decedents who die during 2019 have a basic estate tax exemption amount of $11,400,000 (increased from $11,180,000 in 2018). This means that the estate of a person dying in 2019 with more than $11.4 million in assets may pay a federal estate tax (on assets which do not pass to charity or to a surviving spouse). Over both deaths of a married couple, $22,800,00 may pass estate tax-free to the next generation.

This basic exemption amount is also a lifetime exemption from the gift tax applicable to taxable gifts—which, generally, are gifts exceeding the annual exclusion (see below) and certain other statutory exceptions. Taxable gifts made during life reduce the basic exemption amount available to one’s estate by the reported value of the gift.

As to non-taxable gifts, the federal annual exclusion limit remains at $15,000 per recipient, per year. Annual exclusion gifts, in many cases, are not reportable on a gift tax return. Annual gifts up to $30,000 made jointly by spouses can be made to each child or other recipient. Spouses who elect to split gifts on a tax return can also make unequal separate annual gifts to a child or other recipient that together equal $30,000.

In contrast to the increased federal estate tax exemption, Massachusetts maintains its $1 million filing threshold for estate tax purposes. The Commonwealth does not tax lifetime gifts, but will include those gifts when determining whether the filing threshold has been met. This rule confuses many, so here is an example of how it works: In an estate where no lifetime gifts were made, if you have $3 million in assets and die in Massachusetts, your estate would exceed the $1 million filing threshold, and when your estate files its tax return, the entire $3 million would be shown as subject to estate tax—subject, of course, to the usual deductions available against the tax.

Instead, let’s say that before you die, you make a federally reportable gift of $2.5 million in assets to your kids (or others), and you die with $500,000 ($3 million – $2.5 million). When determining whether the $1 million filing threshold has been met, your estate must calculate the value of the assets owned at death ($500,000), plus the lifetime gifts ($2.5 million), which, in this case, total $3 million—and would cause a requirement that your estate file a return. But, because Massachusetts doesn’t impose a gift tax, your estate pays no tax on the $2.5 million gifted before death, leaving only $500,000 subject to the estate tax. In sum, the lifetime gifts remove $2.5 million from the reach of Massachusetts tax authorities. However, while the tax can be greatly reduced with this strategy, it cannot be reduced to zero.

Something else to keep in mind is that that annual exclusion gifts don’t get added back when determining whether the $1 million filing threshold is met. For instance, assume that, every year, you gift $15,000 to each of your three kids, as well as $15,000 to each of their spouses (totaling $90,000/year). If you stick with this plan for 10 years, you’ll have reduced your assets by $900,000 ($90,000 x 10 years), and at your death, because these gifts were covered by the annual exclusion and are thus not taxable gifts, they don’t get added back when determining whether the $1 million filing threshold is met. (Of course, before making any gifts, you must take into account your own current and future needs.)

Working with your advisors to develop and implement a gifting plan is a great way to make meaningful financial contributions to your loved ones while you are living, and may reduce any Massachusetts estate tax on your death. Varying structures, including trusts, can be incorporated within the plan to allow oversight of the funds, while getting the tax benefit of removing the assets from your estate.