Well, there goes Congress! Just when we thought it was safe to prepare estate plans based on a stable estate-planning environment, Congress has changed the rules yet again! And, it is clear that what happens is even truer.
Estate taxes provide just one example. The Federal Estate Tax and the Maryland Estate Tax are intricately intertwined, and when the former is changed, the latter reacts. So, at the end of 2017, when Congress passed the Tax Cuts and Jobs Act (TCJA), those changes will, no doubt, have direct and significant impact on the Maryland Estate Tax.
The question is: What, if anything, will Maryland’s political leadership do to address the changes brought about under the TCJA?
WHAT DID CONGRESS DO? TAX CUTS AND JOBS ACT – ESTATE & GIFT TAXES
In brief, under the TJCA, taxable estates of less than $11.2 million will not be taxed, doubling the prior exemption for 2018 of $5.6 million. That tax was not insignificant because any portion of a taxable estate that exceeded $5.6 million would have been taxed at 40%. Before the TCJA, about 5500 estate tax returns were filed on which estate taxes were due; now, it is estimated that only 2000 federal estate tax returns will be filed that will require some payment of the federal estate tax. The Joint Commission on Taxes estimates that, over ten years, this reduction will cost the U.S. Treasury about $83 billion.
The federal estate tax was not the only tax impacted by this change. The federal gift tax, which is tied to the federal estate tax, will likewise reflect this increase in the exemption to $11.2 million. This is because Congress has taken the position that one may give away up to $11.2 million during life or upon death without paying any tax, but not both, so that only a total of $11.2 million may be given away during life or upon death.
For example, if one gave $5 million to a child during lifetime, that person could only pass $6.2 million upon death without incurring the federal estate tax. This is why gift tax returns are required when gifts are made that exceed the annual exclusion, which for 2018 stands at $15,000. If more than $15,000 is given by one person to another, a federal gift tax return should be filed reflecting the fair market value of that gift. Any amount over $15,000 will be included in any calculation of the estate tax upon the death of the donor.
Finally, so-called generation-skipping transfer (GST) taxes were affected. The GST tax is a separate tax that, in its simplest application, is assessed when a person transfers assets to a grandchild or great-grandchild, outright or in trust. Since the GST tax is assessed at 40%, it can be significant. Under the TCJA, the amount that can be transferred free of the GST tax was likewise increased to $11.2 million.
With regard to all three situations, as well as any other individual tax reductions under the TCJA, such tax reductions end on December 31, 2025. One can almost sense the tax-planning steps that will be taken by families to take full advantage of these tax reductions before that date, just like what happened in 2011 when the so-called “Bush tax cuts” were coming to an end.
IMPACT OF THE TCJA ON THE MARYLAND ESTATE TAX:
For us in Maryland, the real question will be how the Governor and the General Assembly will react to the changes enacted under the TCJA.
As a bit of history, up until 2001, the Maryland Estate Tax applied only to taxable estates of decedents when the Federal Estate Tax kicked in, which at that time was $675,000. Congress then passed the Bush tax cuts in June 2001 with the goal at that time to repeal the Federal Estate Tax after 10 years. The Bush tax cuts were extended by two years in 2010, deferring any decisions until 2012. That is why we had so much legislative activity by the Congress in 2012 to pass a new, “permanent” estate tax law, which was done at the last minute. Actually, the law was passed on January 1st of 2013, a date that many commentators refer to as December 32, 2012.
As a result of that new law, the federal estate tax was applied to estates of more than $5 million ($10 million for a married couple). Cost of living adjustments were also built in so that today (2018), each person could have protected up to $5.60 million ($11.2 million for a married couple) prior to the passage of the TCJA.
Going back to 2001, Maryland found itself in a dilemma. The Maryland Estate Tax applied only to estates that were subject to the Federal Estate Tax. If that tax was going to be phased out, what was Maryland to do? The General Assembly was not willing to give a good source of tax revenue. So, it “decoupled” itself from the Federal Estate Tax, and assessed a 16% tax on that portion of a decedent’s estate that exceeded $1 million. That law stayed in place until 2014.
In 2014, under pressure from a variety of sources, the General Assembly took it upon itself to reduce the Maryland Estate Tax in order to stay competitive with other states to attract businesses and keep people in Maryland when they retired. At this time, there are only 15 or so states that have an estate tax, and almost all of the states south of Maryland and in the Southwest have no estate tax at all. It’s one thing to fight the weather as a differentiator; it’s quite another thing to have to rationalize higher taxes too.
In 2014, Maryland took the steps to “recouple” with the Federal Estate Tax. This meant that the taxable estate of a decedent at the federal level would likewise be protected from the Maryland Estate Tax at the state level – at least eventually. In 2014, the amount protected from the Maryland Estate Tax remained at $1 million. Under the new law, that value of the taxable estate protected increased to $1.5 million. In 2016, the value increased to $2 million and in 2017, the value increased to $3 million. In 2018, the value is now $4 million, and in 2019, the value will increase to that amount that is then protected by the federal estate tax.
WHAT WILL MARYLAND DO?
And so, we have our next estate tax dilemma. Since the TCJA has doubled the estate tax protections for federal estate taxes, will Maryland likewise offer those protections in 2019 with the current law becomes fully implemented?
No immediate answer to this question need be given. During 2018, the original limit of $4 million remains in place. Then, in 2019, after the 2018 General Election and with a new group of legislators come to Annapolis, this issue can be tackled. In the meantime, Maryland will, no doubt, be looking at its neighbors to see how those states are reacting to this change in tax law. Since the goal of the 2014 estate tax law change was to keep Maryland competitive, by 2019, there should be some sense of what being competitive means in this new world.
Michael W. Davis is the Senior Partner of the law firm of Davis, Agnor, Rapaport & Skalny, LLC, located in Columbia, Maryland, focusing in the areas of estate and tax planning, probate, and fiduciary litigation. He has been active in both the Howard County and Maryland State Bar Associations.