A Burden Left Behind Estate Taxes Are Going Down — But They’re Not Going Away Anytime Soon

There’s a saying that the only sure things in life are death and taxes. For many families grappling with a recent death, estate taxes can seem like an unfortunate combination of the two.
Estate taxes are taxes on the assets left by an individual who has died. The intent of the tax is to collect from the estates of some of the wealthiest Americans, which is why the law kicks in only when a certain asset level is reached. Those who inherit these assets — in most cases, family members — must pay them up front.
President Bush pushed estate tax repeal during his 2000 campaign, and he indeed addressed it in the sweeping tax legislation signed into law last year. But by most accounts, it wasn’t as radical a change as supporters had hoped, and it certainly wasn’t a death blow to estate tax law.

Simply put, the gradual reduction and elimination of the estate tax is only set in stone through 2010. The following year, unless Congress extends the act, the estate tax will be reinstituted at pre-2001 levels.

And because the new federal tax laws are slowly phasing out an estate tax credit that allowed states to collect some of the federal estate tax bill, Massachusetts lawmakers might soon be tempted to return to the days of a separate estate tax within the Commonwealth.

“Over the next couple of years, Massachusetts and other states are going to compare notes and figure out what they’re going to do,” said Arthur Price, a Springfield attorney who specializes in estate planning. “They’re all going to do something similar because you don’t want people leaving the state to go somewhere that’s more tax-favorable.”

In other words, attorneys say, no one should be looking for legislative relief as a substitute for careful estate planning.

A Shifting Tide

The federal estate tax has been around in some form since 1916. In the past, because of an asset threshold, it taxed only wealthy estates without much controversy.
But in the past decade, with property values increasing and investments in 401(k) and other programs rising, more and more individuals who wouldn’t consider themselves ‘wealthy’ were accumulating assets greater than the threshold, which was $675,000 in 2000 and is currently $1 million — and rising.

On the campaign trail, Bush made elimination of the estate tax a centerpiece of his tax platform. He got some movement on the issue in his 2000 tax legislation, but certainly not as much as estate tax opponents would have liked.

To be sure, federal lawmakers have provided some short-term relief from the estate tax. From 2002 through 2009, the top estate tax rate will fall from 50{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to 45{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}, and the amount exempted before the tax kicks in will rise from $1 million this year to $3.5 million in 2009. In 2010, the tax will be repealed completely — but beyond that one year, it’s anyone guess as to whether Congress might re-institute the tax, at what rates, and with what exclusion levels.

Estates in Massachusetts are allowed to pass tax-free to the surviving spouse, a rule known as the marital deduction. This means that most estate tax issues kick in after the death of the second spouse. And, even for those not at the top of the rate scale, those estate taxes are steep, starting at 37{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}. There are a few ways to avoid them, however.

For example, in an AB trust, an individual leaves property in trust for his or her children but gives the surviving spouse the right to use it for life, which cuts the spouse’s estate in half for tax purposes. A QTIP trust allows couples to postpone estate taxes until after the second spouse dies. Meanwhile, charitable trusts involve making a gift to a tax-exempt charity, and life insurance trusts remove the value of life insurance proceeds from the estate.

Then there are tax-free gifts. Individuals may give up to $10,000 per calendar year, per recipient, without paying what is known as gift tax. These ‘gifts’ can range from charitable donations to payment of another person’s tuition or medical bills. These gifts, obviously, reduce the size of an estate and the eventual estate tax bill.

However, one-time gifts that surpass that $10,000 figure — or cumulative gifts that total more than $1 million over a lifetime — are subject to gift taxes, and regulations for those have not changed significantly under the new federal guidelines. However, the top gift tax rate will gradually drop from 50{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} by 2010.

Changing State Laws?

In Massachusetts, estate tax law has not changed to any real degree. The Commonwealth has no independent estate tax per se, but instead imposes what is known as a ‘sponge tax,’ in that it soaks up some of the money which would otherwise be due the federal government through a federal credit for estate taxes.

However, from 2002 through 2004, the federal government is reducing the amount allowed in this credit by 25{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} increments, and it will eliminate the credit altogether in 2005. Unless Massachusetts changes its law, the state will receive no revenue from estate taxes after that time.

“Massachusetts will undoubtedly change its law at some point to go back in some way to an independent system for estate tax, regardless of what the federal government does. That’s not definite, but it’s what people are anticipating,” Price said.

That makes sense, added E. Paul Amata, a Springfield attorney with Robinson Donovan Madden & Barry. “Are states going to walk away from that revenue?” he asked. “Massachusetts brought in $280 million from that tax two years ago. That’s real money. As a result of this new rule, the issue is whether states are going to enact new legislation to get their money.”

The bottom line is, estate taxes aren’t going away anytime soon, so they must be a critical consideration for many individuals when planning for the security of their children and other family members.

After all, tragedy can strike at any time. By making the decisions now on where to place assets, attorneys say, the burden placed on the family after death may be thankfully lessened.