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2023 TRANSFER TAXES: A VERY BRIEF AND BASIC PRIMER

FEDERAL SUMMARY:

  • 2023 federal estate, gift, and generation skipping exemption = $10million for every taxpayer, indexed for inflation
  • 2023 federal estate, gift, and generation skipping exemption as indexed = $12.92 million (Up from $12.06million in 2022)
  • 2026: The above exemptions “sunset” and revert to $5 million indexed for inflation.
  • 2023 federal annual gift exclusion = $17,000 per year, per donee. (Up from $16,000 in 2022)
  • 2023 federal unlimited gift exclusion for qualified tuition payments and qualified medical expense payments paid directly to provider
  • Estate taxes paid to Massachusetts are a deduction on the federal estate tax return

FEDERAL EXPLANATION:

The federal government taxes gratuitous transfers of wealth. If the transfer is made during lifetime, the “gift tax” is applied. If the transfer is made at death, the “estate tax” is applied.

But not all lifetime transfers are subject to the gift tax. Some lifetime gifts are not considered “taxable gifts” at all under federal law. A federal gift! Small outright gifts to an individual during any year are exempt from the gift tax under the “annual exclusion” rule if the amount of the gift falls under the “gift taxannual exclusion amount”. This annual exclusion amount is indexed for inflation. Gifts to certain (but not all) trusts can qualify for the annual exclusion, too. Additionally, certain payments made directly to an education institution for a person’s qualified education expense or to a medical provider for a qualified medical expense are also not taxable gifts. If “qualified”, there is no annual limit to those education and medical expense gifts.

The federal government only wants to impose the gift and estate tax on wealthy people, as that term is defined by federal law. To exempt most people from the gift and estate taxes there are “exemptions” applied to shelter transfers from these transfer taxes.

Over your lifetime, you can make taxable gifts in a total amount equal to the gift tax exemption amount and not reach into your pocket and pay a gift tax (although you do have to report the taxable gift to the federal government – IRS Form 709). The gift tax exemption is $10 million, indexed for inflation. In 2023 the lifetime gift tax exemption is indexed to $12.92 million. The exemption is scheduled to “sunset” and revert to $5 million in 2026, also indexed for inflation.

The estate tax lifetime exemption is also $10 million, indexed for inflation. And the 2023 estate tax exemption is also $12.92 million. This also is subject to the same sunset.
The two exemptions – gift and estate – are inter-related. The relationship is complex, but here is a very simple way of looking at it: For every $1 of gift tax exemption you use to shelter a taxable gift from the gift tax, the estate tax exemption available at your death decreases by $1. If you make $2 million of lifetime gifts, then at your death in 2023 your available estate tax exemption would be $10.92 million ($12.92 million estate tax exemption – $2 million use of gift exemption).

But wait. There’s more! The federal government seeks to impose the gift and estate tax at each generation. So, the “generation skipping transfer tax” is a third transfer tax. This tax is imposed when a gratuitous transfer is made at life (gift) or at death (inheritance) which “skips” a generation: grandparent to grandchild (or a trust for grandchildren). For example, if you gifted $2 million to a grandchild, this transfer would be subject to the gift tax (40% rate) as well as the generation skipping transfer tax (40% rate). Very punitive. So punitive, in fact, that the federal government provides another exemption, the generation skipping transfer (“GST”) tax exemption. This, too, is $10 million indexed for inflation. And the 2023 GST tax exemption is also $12.92 million. In this example, assuming available exemptions, the $2 million gift to the grandchild can be sheltered from the transfer taxes by applying $2 million of gift tax exemption and $2 million of generation skipping transfer tax exemption on a timely filed gift tax return.

Since the GST tax only applies to certain lifetime or death transfers depending upon the generation assignment of the person (or trust) who receives the transfer, it is possible to use up your entire gift tax exemption (such as by making a $12.92million lifetime gift to a trust for children) and then die with your entire GST tax exemption available to shelter from the GST tax up to $12.92million of transfers at death to a trust for grandchildren. The estate tax would apply (since the estate tax exemption was reduced dollar for dollar by the lifetime gift), but the GST tax would be defeated by application of the GST tax exemption.

Finally, the concept of “portability” applies to the federal estate tax exemption. If at the death of the first spouse the deceased spouse’s estate does not use up its exemption to shield the estate from the federal estate tax, the remaining spouse can add the unused exemption to its own exemption (by electing to do so on an estate tax return). So, in 2023, if “spouse one” dies and only uses $7.92 million of its available $12.92 million exemption, “spouse two” (in certain circumstances) can port the unused exemption for its own use, and now have a total of $17.92million of exemption ($5 million unused exemption + $12.92million of its own exemption) to use during lifetime or at death.

MASSACHUSETTS SUMMARY (INCORPORATING NEW LAW ENACTED IN OCTOBER 2023):

  • Massachusetts has a “filing threshold” that is calculated based upon prior federal adjusted taxable gifts and wealth owned at death.
  • 2023 Massachusetts estate tax filing threshold = $2 million. It is not indexed for inflation.
  • Once the threshold is met, a Massachusetts estate tax return must be filed (Form M-706).
  • The estate tax rate is a graduated rate that effectively starts at 7.2% at amounts in excess of $2 million and caps out at 16%.
  • Massachusetts does not have a gift tax or a generation-skipping tax.

MASSACHUSETTS EXPLANATION:

The Massachusetts’s estate tax applies to both residents and non-residents. Residents are taxed on real property situated in Massachusetts, and personal property wherever located. A resident is not taxed on non-Massachusetts real property and tangible personal property. A non-resident is subject to the Massachusetts estate tax only as to property that has a “situs” in Massachusetts, such as Massachusetts real estate owned individually.

In October 2023 Massachusetts enacted the first significant change to its estate tax since 2006:

  • The new law applies to the estates of decedents dying on or after January 1, 2023.
  • The filing threshold of $1 million was doubled to $2 million, and a credit will be applied on the Massachusetts estate tax return which should result in the Massachusetts estate tax being applied only to wealth above the $2 million mark. The $2 million is not indexed for inflation.
  • The effective tax rate on assets above the $2 million mark begins at 7.2% and caps out at 16%.
  • Massachusetts will continue to base its estate tax on what is known as the federal “credit for state death taxes” as the credit was in existence on December 31, 2000. To calculate this credit, a federal estate tax return (Form 706) with a revision date of July 1999 must be completed and attached to the Massachusetts return (Form M-706).
  • Real and tangible property located outside of Massachusetts will not be subject to the Massachusetts estate tax (adopting the approach taken by Massachusetts courts).
  • A surviving spouse continues to be unable to use any unused Massachusetts exemption in the first spouse to die’s estate. (No portability.)
  • A Massachusetts estate tax has to be filed if the value of decedent’s wealth at death plus the value of past adjusted taxable gifts exceeds the $2 million filing threshold. Once that threshold is met, a return must be filed. For example, if a Massachusetts resident dies owning a $900,000 securities account and a Massachusetts home valued at $800,000 and had made prior lifetime federally taxable gifts of $400,000 then the $2 million filing threshold has been exceeded ($900,000 + $800,000 + $400,000) and return must be filed.
  • There continues to be an automatic Massachusetts estate tax lien which attaches to Massachusetts real estate. The lien is released by signing and recording an “Affidavit of No Estate Tax Due” if a Form M-706 is not required to be filed, or by recording a “Certificate Releasing Massachusetts Estate Lien” issued by the Department of Revenue if a Form M-706 is filed.