In addition to the assets that one owns on their death, its important to remember that this filing threshold includes “the adjusted taxable gifts made by the decedent after December 31, 1976.” See Massachusetts Estate Tax Instructions Form M-706 at page 2.
Thus, while the property gifted by the decedent during lifetime is not subject to the estate tax, the value of the gifted property may increase the property subject to the state tax at death. Nonetheless, in many cases lifetime gifting may reduce the estate tax paid to Massachusetts at death, subject to one giant caveat in regards to income taxes, explained below.
Examples illustrate this. In this case, we have a single individual with no out of state property with a taxable estate of $1.8 Million.
Example 1: The individual passes away owning all property at death, having made $0 gifts during lifetime. Since the assets of the estate ($1.8 Million) exceed the filing threshold of $1 Million, the estate must file a return and the Massachusetts Estate Tax is $85,200.
Example 2: The individual passes away after having gifted $700,000 of assets during lifetime leaving them with $1.1M of assets on death. Since the combined assets of the estate ($1.1 Million) and the adjusted lifetime gifts ($700,000) exceed the filing threshold of $1 Million, the estate must file a return and the Massachusetts Estate Tax is $38,800. The lifetime gifting in this case reduced the Massachusetts Estate Tax by $46,400.
Example 3. The individual passes away after having gifted $900,000 of assets during lifetime leaving them with $900,000 of assets on death. Since the combined assets of the estate ($900,000) and the adjusted lifetime gifts ($900,000) amount to $1.8 Million, they exceed the filing threshold of $1 Million and the estate must file a return. The Massachusetts Estate Tax is $27,600. The lifetime gifting in this case reduced the Massachusetts Estate Tax by $57,600.
Note that in these examples it is only “taxable gifts” that determine whether the estate is over the filing threshold. Therefore gifts made using the annual exclusion or payments directly to the provider of educational or medical services for a third party do not impact the filing threshold. (And before you dismiss these as trivial amounts, consider how much property a grandparent could remove from their estate by paying for college expenses for their grandchildren).
Lastly, the caveat: income taxes. Arguably one of the most powerful provisions of the entire US Tax Code is section 1014, commonly referred to the step-up in basis provision. When you inherit property from someone at their death you do not inherit their tax basis in the property, rather your basis is determined by looking at the property’s fair market value at their date of death (with some exceptions). Whereas if you transfer property by lifetime gift, the recipient receives your tax basis in the property and will receive no adjustment to basis on your death. While reducing estate taxes is a worthy cause, no estate tax planning can be done without careful consideration of the recipient’s income tax costs when they later sell the property or through loss of depreciable basis in the property. A recent analysis we did for a client showed that lifetime gifting could provide estate tax savings of $50,000, but that it would generate $300,000 of additional income tax costs to beneficiaries, and thus the lifetime gifting plan was not implemented.
Everyone’s situation is different and we encourage you to contact us today to look at whether you can reduce your estate’s exposure to the Massachusetts Estate Tax in an income tax sensitive manner.