New Estate Tax Law Trouble for Conveyancers

From the December 09, 2002 Massachusetts Lawyers Weekly
by Leo J. Cushing and Andrew D. Rothstein

On July 25, Massachusetts enacted a new law entitled "An Act Enhancing State Revenues" (the "Massachusetts Act") creating a new estate tax for Massachusetts residents and residents of other states owning property in the commonwealth who die on or after Jan. 1, 2003.

The Massachusetts Act was intended to raise an additional $30-$40 million in estate tax revenues for the fiscal year ending June 30, 2004 to make up for the loss of revenue resulting from the elimination of the "State Death Tax Credit."

The Massachusetts estate tax due will no longer be determined by reference to the State Death Tax Credit shown on a federal estate tax return. Rather, a separate computation will be necessary, using the federal taxable estate, but with a filing requirement threshold substantially less than that required for federal purposes.

The Massachusetts threshold will begin at $700,000 instead of the federal exemption of $1 million. As a result, under the Massachusetts Act, a tax will be due and payable to Massachusetts where the decedent's taxable estate exceeds $700,000 even though no federal estate tax would be due unless the estate exceeded $1 million.

More importantly for conveyancers is how the Massachusetts Act interacts with the Massachusetts estate tax lien statute. The statute provides that for dates of death on or after Jan. 1, 1997, an affidavit of the executor, or the person in actual or constructive possession of the property under certain circumstances, recorded in the appropriate Registry of Deeds and stating that the gross estate of the decedent does not necessitate a federal estate tax filing releases the gross estate of the Massachusetts estate tax lien. G.L. c. 65C, Sects. 6(a) and 14.

Furthermore, Chapter 65C, Sect. 6 states that "[f]or dates on or after January 1, 1997, the certificate releasing the Massachusetts estate tax lien shall not be required." This forces the conveyancer to decide how to clear title when the estate exceeds the Massachusetts threshold but not the federal exemption.

Under the Massachusetts Act, an estate tax will now be due to Massachusetts (and some type of Massachusetts estate tax return will be required to be filed) even if no federal estate tax return is required to be filed.

For example, on a $1 million estate, a $33,200 estate tax would be payable to the commonwealth. When the federal exemption increases to $3.5 million in the year 2009, the liability to the commonwealth will be $229,200, thereby creating significant exposure to conveyancers under the lien statute.

Statutory Landscape

To understand the new Massachusetts estate tax system, a bit of history is needed, beginning with the 1997 Federal Tax Reform Act (TRA). Prior to 1998, the federal estate tax exemption was $600,000. In late 1997, Congress enacted the TRA, which implemented a new estate tax exemption to be phased in between 1998 and 2006, as follows:

Year

Exemption Amount

1998

$625,000

1999

$650,000

2000

$675,000

2001

$675,000

2002

$700,000

2003

$700,000

2004

$850,000

2005

$950,000

2006

$1 million

This phased-in increasing exemption had the effect of reducing both federal and Massachusetts estate taxes because, beginning in 1998, the Massachusetts estate tax liability, also known as the "sponge tax," was determined by reference to the federal State Death Tax Credit. As a result, if a federal estate tax return was not required to be filed, no Massachusetts estate tax was due.

Sponge Tax System

The sponge tax, or State Death Tax Credit, was determined by multiplying the federal "adjusted taxable estate" by marginal tax rates ranging from .8 percent to 16 percent. The so-called "adjusted taxable estate" was the federal taxable estate reduced by $60,000. IRC Sect. 2011(b)(3).

For example, if a decedent died in 2001 with a taxable estate of $1 million and a federal exemption of $675,000, the State Death Tax Credit, and therefore the sponge tax due to Massachusetts, would be $33,200.

Economic Growth Tax Revenue & Recovery Act Of 2001

On June 7, 2001, President Bush signed federal legislation changing the landscape of the federal estate tax system by first overriding the TRA phase-in of the exemption amount and replacing it with new phased-in exemption amounts as set forth in Table 1.

While this was good news for individuals, it was bad news for states relying on revenue from the State Death Tax Credit.

Under Sect. 532 of the Act, the federal credit for state death taxes was reduced incrementally beginning in 2002 by 25 percent in each year until fully repealed in 2005. At that time, the State Death Tax Credit is replaced by a deduction for death taxes (i.e., any estate, inheritance, legacy or succession taxes) actually paid to any state or the District of Columbia with respect to property included in the gross estate of the decedent, but this amount would no longer be based on a federal estate tax table.

Most states now impose a "pick-up" or "sponge tax." Since Massachusetts is a sponge tax state, new legislation was necessary to collect revenue by imposing a state estate tax, computed separately from the federal estate tax, to make up for the revenue lost by the elimination of the State Death Tax Credit.

Further complicating the matter is the fact that the phased-in exemptions under the 2001 Act, as well as the repeal of the State Death Tax Credit will "sunset" in the year 2011, unless further federal legislation extends the provisions of the 2001 Act.

This so-called "sunset" problem results from the fact that the Senate was unable to pass the 2001 Act legislation with the necessary 60 Senate votes to make the provisions of the 2001 Act permanent. The legislation was approved by the House by a vote of 240 to 154, and by the Senate with 58 votes in favor and 33 votes against.

Massachusetts (Estate Tax) Act

On July 25, 2002, the Massachusetts Act was passed effective for decedents dying on or after Jan. 1, 2003, and imposing a tax upon the transfer of the estate of each person who, at the time of death, was a resident of the commonwealth.

The amount of the tax will be equal to the amount of the credit for state death taxes that would have been payable by a decedent's estate as computed under IRC Sect. 2011, as in effect on Dec. 31, 2000 (hereinafter referred to as the "Credit") less the amount of death taxes paid to other states.

As to non-residents, the Massachusetts act provides that the tax is imposed upon the transfer of real property situated in commonwealth and upon tangible personal property having an actual situs in the commonwealth of every person who, at the time of his death, was not a resident of Massachusetts.

The amount of the tax is calculated in a similar manner as if the decedent died as a resident of the commonwealth, but only to the extent of the proportion of the decedent's property in the commonwealth bears to his total federal gross estate.

Additionally, the new tax will be imposed upon the value of any property subject to a power of appointment that is includible in the federal gross estate, notwithstanding that a tax has been paid thereon, pursuant to Section 14 of Chapter 65.

The term "federal gross estate" shall mean federal gross estate as defined under the Internal Revenue Code of the United States, as amended and in effect as of the date of death of the decedent.

The Massachusetts Act, by defining the tax due to be the "credit for state death taxes" computed under the Internal Revenue Code as in effect on Dec. 31, 2000, means that the lower exemptions of the TRA, and not the higher exemptions of the 2001 Act, must be used to determine the Massachusetts filing threshold. In effect, the Massachusetts Act de-couples the federal and Massachusetts estate tax systems.

The following table compares the filing thresholds:

Year

Mass. Exemption

Federal Exemption

2003

$700,000

$1 million

2004

$850,000

$1.5 million

2005

$950,000

$1.5 million

2006

$1 million

$2 million

2007

$1 million

$2 million

2008

$1 million

$2 million

2009

$1 million

$3.5 million

2010

$1 million

No Federal Estate Tax

2011

$1 million

$1 million

Massachusetts Lien Statute

The Massachusetts estate tax lien statute was amended for decedents dying on or after Jan. 1, 1997, in recognition of the increasing exemptions under the TRA. G.L. c. 65C, Sect. 14.

As currently enacted, emphasizing that it was not amended as part of the Massachusetts Act, the statute provides as follows:

(a) Unless the tax imposed by this Chapter is sooner paid in full, it shall be a lien for ten years from the date of death upon the Massachusetts gross estate of the decedent, except that such part of the Massachusetts gross estate, as is used for the payment of charges against the estate and expenses of its administration, allowed by the probate court having jurisdiction thereof, shall be divested of such lien. For dates of death on or after January 1, 1997, an affidavit of the executors subscribed to under the pains and penalties of perjury, recorded in the appropriate Registry of Deeds, and stating that the gross estate of the decedent does not necessitate a federal estate tax filing, shall release the gross estate of the lien imposed by this section. (Emphasis added).

Through a Technical Information Release, the Massachusetts Department of Revenue has indicated that it will not accept a Massachusetts estate tax return if the gross estate of the decedent did not necessitate a federal estate tax filing. TIR 98-14.

As a result, the executor is unable to obtain a form M-792, the usual document recorded to release the Massachusetts estate tax lien.

Further, a conveyancer must confront the very real situation of certifying marketable title to property acquired from a decedent in a case where the decedent's gross estate exceeds the new Massachusetts exemption amount of $700,000, but the gross estate did not necessitate a federal estate tax filing.

One interpretation would be to simply follow the unambiguous language of the statute and continue to file an affidavit, which would not be fraudulent, and would serve to release the Massachusetts estate tax lien.

Very few practitioners, however, would subscribe to this practice, where although no federal estate tax would be due, a Massachusetts estate tax may be due. Conveyancers are well advised to obtain an M-792 to be recorded at the registry to protect themselves from liability in the situation where the estate exceeds the lower Massachusetts threshold of $700,000.

Tax Impact

Single Persons

The following table illustrates the Massachusetts estate tax due for single individuals dying between Jan. 1, 2003 and 2009, when the estate equals the federal exemption and no federal estate tax return is even required to be filed.

Year of Death

Federal Estate Tax

Massachusetts Estate Tax

2003

$0

$33,200

2004, 2005

$0

$64,400

2006-2008

$0

$99,600

2009

$0

$229,200

Married Couples

Another major problem with the Massachusetts Act is that it will be impossible to eliminate federal estate taxes upon the death of the first spouse to die using traditional by-pass and marital trust funding formulas, since the by-pass trust is funded by reference to the federal exemption amount and not the new Massachusetts exemption amount.

Consider the case of a couple worth $2 million, who each implement revocable trusts designed to eliminate federal estate taxes upon the first death and minimize, if not eliminate, estate taxes upon the death of the surviving spouse. In this case, the assets would be split between the two spouses so that, if the husband died first, his gross estate would be $1 million and all of the assets would flow to the by-pass trust.

If death occurs in 2002, no federal estate tax will be due and therefore no Massachusetts sponge tax will be due and payable. If, however, death occurs on or after Jan. 1, 2003, the funding of the by-pass with the federal exemption amount of $1 million will result in a Massachusetts estate tax due of $33,200.

Upon the death of the surviving spouse, again no federal estate tax will be due and payable, but assuming death occurs in 2003, an additional $33,200 will be due and payable to Massachusetts.

Under the new Massachusetts Act, a zero federal, taxable estate will suddenly cost the family $66,400 in Massachusetts estate taxes. If the trusts are revised to limit the by-pass trust to the new Massachusetts exemption amount, both federal and Massachusetts estate taxes would be eliminated on the first spouse's death, but, in this case, both a federal and Massachusetts estate tax will be due upon the death of the surviving spouse.

The total estate tax due upon the death of the surviving spouse will be $124,000, with $72,400 due in federal estate taxes and $51,600 payable to Massachusetts.

It is the authors' opinion that, as the estate planning bar works its way through the various drafting options, none of which are particularly attractive, a decision will be made to simply pay the Massachusetts estate tax upon the first death. This, of course, presents a huge problem for conveyancers.

Conclusion

The good news is that the commonwealth and the DOR have until Dec. 31 to prescribe procedures, and the bad news is that the state and the DOR have only until Dec. 31 to prescribe appropriate procedures, such as accepting returns where the gross estate is not sufficient for a federal filing but where a Massachusetts estate tax is due, and then issuing a Form M-792 in connection therewith.

Perhaps we all should move to a much warmer and hospitable climate, such as Florida. The Southwest Airlines commercial comes to mind as we grapple with this: "You are now free to move about the country."

Year

Estate Transfer Exempt Amount
(Applicable Exclusion Amount)
and GST Exemption

Lifetime Gift Exempt Amount

Highest and Gift Tax Rates

2002

$1 million

$1 million

50%*

2003

$1 million

$1 million

49%

2004

$1.5 million

$1 million

48%

2005

$1.5 million

$1 million

47%

2006

$2 million

$1 million

46%

2007

$2 million

$1 million

45%

2008

$2 million

$1 million

45%

2009

$3.5 million

$1 million

45%

2010

Tax repealed

$1 million

35% (gift tax)

2011

$1 million

$1 million

55%

*Reflecting repeal of the 5% surtax.

Leo J. Cushing and Andrew D. Rothstein practice at Cushing & Dolan in Boston.