When the Federal government raised the “death tax” threshold to more than $5 million, many people rejoiced and let the tax portion of their estate plan rest. According to the 2017 Market Insights Report by the Spectrem Group, there were over 9 million individuals with net worth between $1 million and $5 million. There are another 1.45 million whose net worth exceeds $5 million.
Hopefully those with net worth greater than $5.49 million (the amount that is exempt from federal estate or gift taxes) understand that their estate needs work to avoid or minimize the consequences of estate taxes on their heirs.
But here in my home state of Massachusetts the state limit is $1 million. Any amount over $1 million will be subject to Massachusetts death taxes. This turns out to be quite a surprise to many unsuspecting beneficiaries.
Just to clarify, your net worth at death includes any asset that you owned or had, what the taxing authorities call a life estate. If you own something, the answer is simple. Use the fair market value on date of death as the amount for the estate. You may be eligible to use what the IRS calls the alternate valuation date. The alternate valuation date is six months after date of death and can be helpful for assets whose value drops materially in the six months following the decedents passing.
The life estate, however, is a little trickier. For example, if you give your home to the children to possibly avoid health care entanglements, but have the right to live in the home rent-free, that is a life estate. As such, the home should be includable in the decedent’s estate. Most people miss this, only to later find out that it may not have been in their best long term interest to omit that asset from a death tax return.
The first issue is simply that the estate filing was not correct. That life estate asset should have been included.
The second issue may relate to future income taxes because of basis problems. Your tax cost (basis) for assets received by gift is the same as it was in the hands of the grantor. For a home bought many decades ago, that number may be quite low.
When you ultimately sell that home there could be significant capital gains taxes to pay.
If the home comes to you through the estate, you’ll receive a stepped up basis meaning that the fair market value on the decedent’s date of death becomes your new basis.
The intention here isn’t to deliver a lesson on death taxes and life estates, it is to wake up all of you to consequences that you may not have considered. Make sure that your estate is set up to minimize state death taxes.