Lerch, Early & Brewer's Legal Update
Nothing about the estate tax revisions enacted in July 2006 by the Maryland Legislature does anything to dispel the old notion that “estate taxes remain largely a tax on ignorance.” If anything, the 2006 changes underscore the need for individuals to not only understand the law but to take appropriate steps to prevent their heirs from paying estate tax on their benefactors’ ignorance.
Background
To appreciate the planning opportunities made available by recent changes to the Maryland estate tax law it is helpful to briefly review the bidding so far. Maryland, like most states, previously followed the federal estate tax law and imposed estate taxes only on those estates of deceased individuals who were subject to the federal levy, generally those in excess of $1 million (the “exemption amount”). Property left to a spouse or charity avoided estate tax entirely. Special tax-saving trusts (“credit-shelter” or “bypass” trusts) could be employed to allow married couples to benefit from the $1 million exemption amount in both estates so that their children or heirs would ultimately receive $2 million of property tax-free of both state and federal estate taxes. Moreover, while the surviving spouse had access to the money in the bypass trust, whatever remained was not taxed in his or her estate at death, regardless of how much it had appreciated in excess of the exemption amount!
De-coupling Federal and State Exemptions
While changes to the federal law have increased the individual exemption amount to $2 million currently (with a planned increase to $3.5 million after 2007), many states, including Maryland, have not followed suit and have “de-coupled” their estate tax law from the federal exemption. Thus, despite the federal relief, Maryland continues to impose an estate tax on estates in excess of $1 million. Moreover, the Maryland Comptroller must take into consideration the value of non-Maryland property owned by a decedent in determining whether the exemption amount is met, even though the non- Maryland property is not directly subject to tax. What follows is a brief description of relief available under Maryland’s 2006 estate tax changes.
State-only QTIP Elections
One of the planning problems arising from the de-coupling of the Maryland and federal estate tax laws was that it exposed amounts in excess of $1 million left to traditional bypass trusts to a Maryland estate tax of up to 41% upon the death of the first spouse! Prior to the changes made in 2006, many wills and trusts containing traditional bypass trust funding instructions thus exposed the estate of the first spouse to Maryland estate tax to the extent it exceeded $1 million. At best, a surviving spouse essentially had to choose between paying Maryland estate tax on the million dollar difference between the federal exemption amount ($2 million) and Maryland exemption amount ($1 million), or avoiding Maryland estate taxes when the first spouse died by exposing the assets to even greater federal taxation upon the survivor’s death later.
The 2006 Maryland law now allows the use of a special election, (sometimes referred to as a “state-only QTIP election”), to be made by a surviving spouse to avoid both state and federal taxation of the amount by which the state and federal exemption amounts differ. However, in order to both take full advantage of the strategy resulting from the new law, married individuals will likely need to revise their existing wills or trusts to qualify for state-only QTIP elections. The necessary revisions are technical and require the assistance of competent counsel to assure the desired result.
Alternate Valuation
If the assets of an estate decreased in value six months after death, federal estate tax law traditionally allowed the use of a lower “alternate valuation” of the assets providing it would result in a decreased federal estate tax liability. However, after the Maryland and federal estate tax laws decoupled, the use of this technique to minimize Maryland estate tax liability where there was no federal estate tax liability (e.g., for estates between $1 million and $2 million) was not authorized. The 2006 Maryland law now allows an alternate valuation election to minimize Maryland estate tax liability. Because such an election may expose the estate assets to greater income taxation if later sold by the beneficiaries, taxpayers should check with their tax advisors before making the election.
16% Cap on Maryland Estate Tax
A major change in the way the Maryland estate tax is calculated, effective for decedents dying after December 31, 2005, is to limit the tax due to 16% of the amount by which the decedent’s taxable estate exceeds $1 million. Before the 2006 changes, estates having assets valued between $1 million and $1.3375 million were subject to a Maryland estate tax of up to 41% of the amount in excess of $1 million, while very large estates were taxed at less than 16%. The new law provides relief by limiting the tax to 16% of the amount in excess of $1 million.
While the Comptroller’s office will automatically adjust any returns that are subject to the new 16% cap, be advised that the tax-saving benefits of the earlier mentioned 2006 Maryland estate tax changes relating to “state-only QTIP” and alternate valuation elections require both insight and action on the part of the taxpayer.
For on-line information about Maryland estate taxes, visit the Maryland Comptroller’s official website, located at http://www.marylandtaxes.com/.
Richard N. Ruprecht is a principal in the firm’s estate Planning and Probate Group. He can be reached at (301) 657-0154, or via e-mail at rnruprecht@lerchearly.com.
