Potential death taxes need to be addressed in any Maryland estate or trust administration after the death of the testator/settlor. If any of the various potential taxes apply, the personal representative of the probate estate and/or the successor trustee of a revocable trust must deal with the issue promptly. The failure to assure that any tax due is, in fact, paid can lead to nasty surprises, including the possibility that a tax lien will cloud the title of estate and trust assets.
A Maryland estate may be subject to three separate death taxes regardless of whether the transfer of property takes place in the probate court or outside the probate court. These three potential death taxes are the Maryland inheritance tax, the Maryland estate tax, and the federal estate tax.
Determining Maryland Inheritance Taxes
Maryland is one of a few states with an inheritance tax. The tax focuses on the privilege of receiving property from a decedent. The Maryland inheritance tax rate is 10% of the value of the gift. It is currently only imposed on collateral heirs like a niece, nephew or friend. Certain heirs, like parents, grandparents, children, stepchildren, children’s spouses, brothers or sisters, are not currently taxed, although they have been taxed in the past.
“The list of those subject to the Maryland inheritance tax and those not is not intuitive. Originally the distinction was between lineal heirs and a surviving spouse who were exempt, on the one hand, and all others who were subject to the tax. Over time, the Legislature added to the list of those exempt from the tax to include more family members. Stepchildren and siblings of the decedent were added to the list of those exempt. But why are siblings exempt but not nieces and nephews? The distinction is arbitrary,” says, a principal of the Maryland estates and trusts law firm of Franke Beckett LLC.
Because the inheritance tax is seen as a tax for the privilege of receiving property, the tax due from and paid by the recipient, unless otherwise directed by the governing document. Thus, if the governing document directs a specific bequest of $10,000 to a niece, and the document pays the inheritance tax in the same manner as defined by law, the niece receives $9,000, the net value of the gift and inheritance tax. This result can be changed. A governing document may direct that the residuary estate to pay the inheritance tax. In such a situation, the niece would receive the full $10,000 and the estate or trust would pay an additional $1,1111 in inheritance tax. The tax rate increases from 10% to 11.1111% because the payment of tax by the estate or trust is deemed to also be a gift to the recipient and additional inheritance tax is due on the additional gift.
Calculating The Maryland Estate Tax
Maryland also has a state estate tax. This tax operates under rules similar to the federal estate tax. The tax casts a wide net in order to define what property is includable in the taxable estate. For example, a term life insurance property that had no little surrender value to the decedent during her lifetime is includible in the decedent’s estate at the value of the death benefit (although the death benefit may or may not be subject to the inheritance tax). Like with the federal estate tax, the inclusion of the death benefit of a life insurance policy for Maryland estate tax purposes can be mitigated with an irrevocable life insurance trust.
The threshold for the Maryland estate tax is currently $5 million. Unlike the federal estate tax, the credit amount is not indexed for inflation. Under current law, the threshold will only be adjusted by future legislation. Since 2019, the Maryland estate tax allows any unused credit amount to be transferred to a surviving spouse. This is called “portability.” This means that if a timely Maryland estate tax return (MET1) is filed, the surviving spouse may carry forward the unused portion of the $5 million shield until the surviving spouse’s death, whereupon it is used on the surviving spouse’s estate. This permits a couple to double up their estate tax threshold and shield $10 million from the Maryland estate tax.
“Portability is an important right which can only be preserved by the filing of a timely Maryland estate tax return. It is a take it or lose it situation. Because of the unlimited marital deduction under both Maryland and federal estate tax rules, it may not be obvious that you should file a tax return when there is no current tax due. If the combined estate is, or may become, over $5 Million at the second death, not filing the return exposes the estate to a Maryland estate tax at the surviving spouse’s death,” says Anne Franke, a CPA who assists in estate administration, including preparing estate and trust tax returns, for the Annapolis estates and trusts law firm of Franke Beckett LLC.
The tax rate for the Maryland estate tax is graduated. It starts at 8% and tops out at 16%. The tax rate is ultimately dependent on the size of the estate. Furthermore, the state of Maryland does not track lifetime gifts under its estate tax law and thus does not include the value of lifetime gifts for estate tax purposes. This contrasts with federal law which has unified its gift and estate taxes.
The Impact Of The Federal Estate Tax On Maryland Estates
Maryland’s estates and trusts are also subject to the federal estate tax. Under current federal law, the threshold for taxability is $11 million indexed for inflation. In 2019, inflation increased the credit amount so that an individual can shield $11.4 million for 2019. As with the Maryland estate tax, the federal estate tax provides for portability of any unused unified credit amount. To elect portability, a surviving spouse must file a timely federal estate tax return making the election to carry forward the unused credit. The tax rate for the federal estate tax is 40%. When combined with the Maryland estate tax, the combined rate approximates about 50% of the value of the taxable assets.
Income Taxes Apply To Estates And Trusts
Maryland estates and trusts are also subject to income taxes, which taxes are separate and apart from death taxes. The income generated by the principal of the estate or trust is subject to income taxation. For example, a stock held by an estate receives a dividend. That divided may be subject to both the Maryland and federal income tax. Accordingly, Maryland fiduciaries may need to file Maryland and federal estate/trust income tax returns (IRS Form 1041 and Maryland Form 504).
An Estate Administration Lawyer Can Help You Navigate Through the Various Estate/Trust Taxes
During the estate or trust administration, the personal representative of the probate estate and/or the successor trustee of a revocable trust serving as a will substitute makes decisions on how various taxes are handled. Some of the taxes are interrelated. Therefore, a decision made on one tax issue may influence the tax due on a different issue. Furthermore, the tax rates for the various taxes vary widely and it may be cheaper, for example, to pay income taxes then pay estate taxes. Thus, it is important that the person handling the estate or trust administration obtain competent counsel for guidance on these issues.
For over 35 years, the law firm of Franke Beckett LLC has concentrated on the law of estates and trusts – including helping hundreds of clients with Maryland taxes during estate and trust administration. We prepare estate and trust federal and Maryland tax returns with our in-house CPA so we can offer seamless administration services from beginning to end. Our Maryland estate administration attorneys and staff have the experience, training and knowledge to guide clients through the process to ensure that the Maryland estate and trust administration is handled properly. In order to schedule a consultation, call 410-263-4876 to get in touch with our Annapolis office.