Governor Martin O’Malley recently signed a new law that will reduce the sting of estate taxes over the next several years for Maryland residents. So how does the Maryland tax compare with the federal version? As defined by the IRS, “The Estate Tax is a tax on your right to transfer property at your death.” The federal government imposes a tax on taxable estates in excess of $5.34 million (the individual federal exemption amount, which increases for inflation annually). Maryland currently imposes an estate tax on taxable estates in excess of $1 million (the state exemption amount).
What does the new Maryland law accomplish?
Maryland’s new law gradually increases the state exemption to match the federal exemption. (See the new schedule below.) We are estimating that in 2019, when the state exemption will equal the federal exemption, the exemption amount will be just shy of $6 million.
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How much state estate tax will be owed?
The Maryland estate tax rate is based on a progressive/graduated scale that reaches a maximum of 16%. The federal estate tax rate is also based on a progressive/graduated scale, with a maximum of 40%. However, it is important to note that all property left to a surviving spouse is free of federal and state estate tax no matter how large the estate. This is called the marital deduction. These assets will be taxed when the surviving spouse passes.
Can anything be done to further reduce Maryland estate taxes?
Married couples can potentially reduce their tax burden by having an estate attorney draft their documents. In states where there’s a gap between the federal exemption amount and the state exemption amount, such as Maryland, there are some planning opportunities that will allow married couples to fully use both spouses’ state estate tax exemptions. One of the simplest methods is to change the way assets are transferred: Instead of assets passing directly to a surviving spouse, estate documents can be drafted to leave funds to certain trusts that can either avoid or delay the Maryland estate tax. This will maximize the family’s use of each spouse’s state exemption amount.
Is this ‘special’ estate planning worth the trouble?
Planning for the inevitable can potentially save hundreds of thousands of dollars. Imagine that a husband predeceases his wife in 2015. Together they have $4 million split evenly. By funding a bypass trust or credit shelter trust at the husband’s death — as opposed to passing assets to the surviving spouse — this couple could save $240,000 in Maryland estate taxes. If the husband was to leave his assets directly to his wife and she passed shortly thereafter, she would still have a $1.5 million exemption, though he would have never used his. The tax on $1.5 million is approximately $240,000. By funding a bypass trust with the maximum state exemption amount of $1.5 million (for 2015) they both would use their exemptions of $1.5 million. If the husband passed away after 2015 (where the state exemption amount is even higher), or if Maryland’s top estate tax rate is greater than 16% upon the surviving spouse’s death, the couple would save even more.
What is portability and does Maryland’s new law contain it?
Portability is an estate tax concept that allows spouses to use their full exemption amount even if there was no special planning performed prior to the first spouse’s death (i.e. no bypass trust created to capture the exemption amount at the first death). The exemption amount is rolled-over or transferred to the surviving spouse for use upon his/her death. Currently, portability is not applicable in Maryland, though it is at the federal level. That will change in 2019 when the state exemption amount is equal to the federal exemption.
How does this impact estate planning in the future?
The change in Maryland estate tax law could result in fewer married couples creating trusts that are geared towards taking full advantage of the exemption amount at the death of the first spouse. That said, who knows when we’re going to leave this physical world or when the next change in tax law will come? Wouldn’t you prefer to have peace of mind knowing that your estate documents were in good order?
I’ve been focused on estate tax planning, but that’s just a small part of comprehensive estate planning. We generally recommend that clients have Wills executed along with medical directives or living Wills, health care powers of attorney, and financial powers of attorney. If you have questions about your estate documents or if you don’t currently have documents in place, I encourage you to contact your financial advisor to discuss in detail.