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Banking and Financial Services

The $1 Million Exemption Level Is Among the Lowest in the Country

By Barbara Trombley

Did you ever wonder why all of your Massachusetts neighbors move to Florida when they retire? And they make sure they spend six months and a day at their southern address?

Of course, the warm winter weather in sunny Florida is a draw. But another reason many people in Massachusetts change their state residence is to avoid the Massachusetts estate tax, which is levied on estates valued over $1 million. Given the value of real estate and 401(k) plans in Massachusetts, it is not that hard to pass this threshold for many middle-class people.

Surprisingly, the federal estate tax is $12.06 million per person in 2022. Also, it is portable between spouses. With the correct steps, a married couple can protect $24.12 million after the death of both spouses in 2022. Our state estate tax is shockingly different. Of the 18 states with an estate or inheritance tax, Massachusetts and Oregon have the lowest exemption level of $1 million.

Also, the Massachusetts estate tax has a regressive feature where, if you die with an estate valued at $1,000,001 or more, your heirs will pay a graduated tax starting at the first dollar over $40,000 (which is a small exclusion). The bill on a $1 million estate is about $40,000. The tax rate is a graduated one and rises from 0.8% to 16% depending on the size of the estate. The heirs of an estate worth $3 million could find themselves with a tax bill approaching $200,000.

Massachusetts is shockingly out of step with the nation and with the rest of New England. Maine, Connecticut, and Vermont all have exclusions of more than $5 million, and New Hampshire does not have an inheritance tax at all. Until our legislators raise the exemption to keep up with inflation and make the exemption a true one, residents will continue to flee the state or jump through hoops to help their heirs avoid the tax.

Barbara Trombley

Barbara Trombley

“The tax rate is a graduated one and rises from 0.8% to 16% depending on the size of the estate. The heirs of an estate worth $3 million could find themselves with a tax bill approaching $200,000.”

What is included in your estate? Bank accounts, real estate, retirement accounts, life-insurance proceeds, vehicles, etc. Upon the death of the first spouse, no tax is owed. It is upon the death of the last remaining spouse that the dollar amount of assets is counted and an estate tax will need to be filed if the total value exceeds $1 million. The return must be filed, and any tax must be paid nine months after the death. The state may grant an extension of time, but interest will accrue on any unpaid amounts past the due date.

What can be done to mitigate the tax if the laws don’t change? Perhaps you retitle the ownership of your house to a trust or to an adult child to remove it from your estate. Each spouse can also set up a trust to shelter $1 million upon their death. This keeps the funds out of their estate but available to the surviving spouse to use if set up correctly.

Cash and other assets can be gifted to reduce an estate, but be careful about capital gains or tax owed on retirement funds. Charitable contributions can also be made to reduce the size of the estate. Many retirees move to a tax-friendly state, like Florida, and become residents. Working with a qualified financial planner and an estate attorney is imperative to mitigate the estate tax.

 

Barbara Trombley is a financial advisor and CPA with Wilbraham-based Trombley, CPA; (413) 596-6992. Securities offered through LPL Financial. Member FINRA/SIPC. Advisory services offered through Trombley Associates, a registered investment advisor and separate entity from LPL Financial.

Accounting and Tax Planning

Death and Taxes

By Jim Moran, CPA

 

On April 28, the Biden administration released its FY 2022 revenue proposals. Along with raising the corporate tax rate to 28% and the top individual rate to 39.6%, widespread changes have been proposed to the capital gains tax rate and estate tax.

Under current federal law, upon death, property passes to a beneficiary at fair market value, with a few exceptions. This means the beneficiary’s basis generally becomes the value of the property at the decedent’s date of death, also referred to as ‘step-up in basis.’ For gifts made during a donor’s lifetime, the donee receives the donor’s basis in the property. This means the donee’s basis remains the same as the donor’s basis, generally original cost plus any improvements. No taxable gain or loss occurs upon the transfer of the property. Gain or loss is realized only when the property is eventually sold.

Under the Biden administration’s proposal, transfers of appreciated property upon death, or by gift, may result in the realization of capital gain to the donor or decedent at the time of the transfer. This means tax may be triggered at the date of the transfer regardless of whether the property is subsequently sold. This would be accomplished by eliminating the step-up in basis upon death of a decedent and requiring a tax be paid on a portion of the value of a gift made.

Fortunately, the Biden proposal would allow a $1 million per-person exclusion from recognition of unrealized capital gains on property either transferred by gift or held at death. The per-person exclusion would be indexed for inflation after 2022 and would be portable to the decedent’s surviving spouse under the same rules that apply to portability for estate- and gift-tax purposes (making the exclusion effectively $2 million per married couple). It is important to note, however, in the case of gifts, the donee’s basis in property received by gift during the donor’s life would be the donor’s basis in that property at the time of the gift to the extent that the unrealized gain on that property counted against the donor’s $1 million exclusion from recognition.

“Under the Biden administration’s proposal, transfers of appreciated property upon death, or by gift, may result in the realization of capital gain to the donor or decedent at the time of the transfer. This means tax may be triggered at the date of the transfer regardless of whether the property is subsequently sold.”

Tangible personal property (other than collectibles) would also be excluded from the triggering of gain. The exclusion under current law for certain small-business stock would remain, and the $250,000 per-person exclusion under current law for capital gain on a principal residence would apply to all residences currently allowed under IRC Section 121 and would be portable to the decedent’s surviving spouse, making the exclusion effectively $500,000 per couple.

The Biden proposal allows for some exempt transferees. Property transferred by a decedent to a charity would be exempt. Transfers by a decedent to a U.S. spouse would be at be the carryover basis of the decedent, and capital gain would not be recognized by the surviving spouse until the surviving spouse disposes of the asset or dies.

In addition to transfers upon death or gift to an individual, transfers of appreciated property into, or distributed in kind from, trusts (other than revocable grantor trusts) and partnerships may be treated as recognition events for the donor or donor’s estate. Valuation is another important concern in regard to a partial interest. The transfer of a partial interest would be at the ‘proportional share.’ Valuation discounts for minority interests will not apply.

Under Biden’s proposal, the donor would report any deemed recognition events on the donor’s gift-tax return. A decedent would report any capital gains on an estate-tax return or, potentially, a separate capital-gains return. A decedent would be able to offset capital gains against any unused capital-loss carry-forwards and up to $3,000 of ordinary income on their final individual income-tax returns. Any capital-gains taxes deemed realized at death would be deductible on the decedent’s federal estate-tax return if required.

The proposal would be effective for gains on property transferred by gift and on property owned at death by decedents dying after Dec. 31, 2021.

With a 50/50 partisan split in the U.S. Senate, it is currently unclear what the final proposal will end up being. Now is the time to start thinking about the how the proposed changes will affect you. Make an appointment with your tax or financial-planning professional to discuss what steps you should consider taking. You may need to be willing to act quickly should these proposals become reality.

 

Jim Moran, CPA, MST is a manager with Melanson CPAs, focusing on commercial services and tax planning, compliance, and preparation.

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