4 Estate Tax Mistakes You Will Be Happy to Avoid
Estate taxes often get overlooked, so it’s no surprise to me when a client walks in the door not realizing their estate could be subject to hundreds of thousands (sometimes millions) of dollars in estate taxes. So what can you do to make sure your children’s inheritance doesn’t go to the government?
Here are the 4 most common estate tax mistakes you will be happy to avoid:
Not filing a QTIP election. If you are married and have two separate trusts or a joint trust that splits into separate trusts upon the death of the first spouse to die, then (assuming your trust is drafted properly) you have 9 months to file an estate tax return to elect whether to include that property as QTIP property vs. non-QTIP property - this means the difference between including the property in the estate of the surviving spouse for estate tax purposes or not including it in the surviving spouse’s estate. The interesting thing here is that you can do a partial QTIP election meaning you choose how much is includable in the surviving spouse’s estate vs. the deceased spouse’s estate. And you can also do different elections for state vs. federal - meaning what you elect as a QTIP on the federal return can be different from the state’s (Massachusetts) estate tax return. Why is this important? Because Massachusetts has only a $1 million estate tax exemption (and it’s not portable) so you either use it or you lose it. In other words, you either shield $1 million from estate taxes or you don’t.
Forgetting to include life insurance in the estate tax calculation. Many clients understand that for income tax purposes, life insurance proceeds are not taxable. The problem is that they are includable and taxable for estate tax purposes. Since Massachusetts’ threshold is only $1 million and the entire amount is taxable if the threshold is triggered, you need to consider if your estate plan covers what to do with life insurance proceeds if/when applicable. With inflating real estate prices, retirement accounts, and life insurance, many clients are in the estate tax range, but unaware of it because they forgot to include life insurance in calculating their estate value.
Not electing portability. Unlike the Massachusetts estate tax, the federal estate tax has something called portability. This means that when one spouse dies, you can port the deceased spouse’s federal exemption to the surviving spouse - effectively doubling that surviving spouse’s federal exemption amount. What people don’t realize is that this portability election is not automatic. So if you don’t file the estate tax return to show portability (even though no estate tax is actually due at that time), then you just gave up about $12 million (at the time of this writing) in estate tax exemptions. Now most people are thinking, “well I don’t need it because my estate isn’t worth that much anyway,” but that way of thinking is a mistake for two reasons. Number 1 is the estate tax exemption threshold is set to sunset in 2025 - meaning that estate tax threshold is going to be cut in half in a few years (as of the time of this writing). Number two is that you have no idea what your estate is going to be worth by the time the surviving spouse dies. Although it may seem far-fetched to many to have an estate worth more than $6 million, you should keep in mind that a person’s net worth tends to double every 10 years (assuming an average 7.2% real rate of return). So over 20 years, $2 million can turn into $8 million (2x2 = 4, 4x2 = 8, i.e., doubles every 10 years). In other words, if you're the same age as your spouse and your spouse dies at 75 and you live to be 95, then your children’s inheritance may have a chunk of it go to the government. In such scenarios, if you didn’t file the portability election then you may have just lost $800,000 in estate taxes because you didn’t file a form on time.
Not filing a disclaimer on the first spouse to die. This one is similar to # 1, but from a different approach. In Massachusetts, if you have a trust with a disclaimer credit shelter trust built in then you can disclaim or bypass up to $1 million from your estate but still get the benefit of it for yourself and your children. Why would you do that? Because (as stated in #1) if you don’t use your deceased spouse’s $1 million Massachusetts estate tax exemption then you lose it. And the disclaimer allows you to use up the $1 million exemption amount so it’s not included in the surviving spouse’s estate.
I know this is really fun stuff to talk about, so if you want to sit down and chat with me about it some more (or perhaps you want me to review your existing estate plan, then Give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help,
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
477 Main Street
Stoneham, MA 02180
