Effective January 1, 2003, Massachusetts enacted an estate tax for decedents dying after December 31, 2002. The state estate tax impacts estates over $1 million. The state exemption, $1,000,000, is below the federal exemption of $5,000,000 (for 2011). This means that estates which are exempt from federal estate tax may still owe state estate taxes. See summary of exemptions below.
Background
The state estate tax revisions resulted from changes to the federal estate tax, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which phased out the state death tax credit (or Massachusetts’ share of the “sponge” tax). By the 1990’s, most states, including Massachusetts (for decedents dying after 1996), had adopted a state estate tax equal to the maximum credit available under IRC §2011. This was known as a “sponge tax” or “pickup tax”. Part of the reason was because studies indicated that any state estate tax beyond the amount of the federal credit resulted in a net revenue loss to the state, because the tax was one factor influencing retirees, along with their taxable income, to relocate to states without a state estate tax in excess of the federal credit (now known as the “applicable exclusion amount”. To offset the loss of revenue, Massachusetts now requires the payment of estate taxes even if there is no federal estate tax liability. It is estimated that the state estate tax added $30-$40 million in state estate tax revenue (for 2004).
In the case of a married couple, the estate tax due to the Commonwealth upon the death of the first spouse to die will be $99,600, based on traditional by-pass trust funding with the applicable federal exemption amount (currently $5,000,000). The state estate tax due increases as the federal estate tax exemption increases (and the gap between the state and federal exemptions widen). See chart below .
Four estate planning options are noted in this memorandum. First, if you are married, your revocable trusts can be amended to allocate the exemption differential (the difference between the state and federal estate tax exemptions) to a state QTIP trust for state estate tax purposes. This solution requires a more complicated Trust formula, but it is similar to the formula estate planners used prior to Massachusetts adoption of the “sponge” tax. A second option is to pay (and not defer) the Massachusetts estate tax upon the first spouse’s death. A third option is to provide liquidity through the use of life insurance (preferably owned by an Irrevocable Life Insurance Trust) to pay the estate tax. A fourth option might include, in the right situation, increasing your annual gifting.
The impact of EGTRRA law was not unique to Massachusetts. All states which had adopted a “sponge” tax, tying their revenues to the federal death tax credit, faced significant revenue losses. As of January 2003, 15 states, including Massachusetts, moved to “de-couple” their estate tax rules from the federal government to avoid this significant revenue loss.
Summary of Exemptions and Estimated Massachusetts Estate Tax
Massachusetts Federal Massachusetts Estate Tax on Federal
Year Exemption Exemption Exemption Amount
2003 $ 700,000 $1,000,000 $ 33,200
2004 $ 850,000 $1,500,000 $ 64,400
2005 $ 950,000 $1,500,000 $ 64,400
2006 $1,000,000 $2,000,000 $ 99,600
2007 $1,000,000 $2,000,000 $ 99,600
2008 $1,000,000 $2,000,000 $ 99,600
2009 $1,000,000 $3,500,000 $ 229,200
2010 $1,000,000 No estate tax