New Maine Estate Tax
Background. In recent history (and until December 31, 2001), the Maine Estate Tax dovetailed with the Federal Estate Tax system: the Maine tax equaled the federally established State Death Tax Credit. Under this system, a Maine estate tax was imposed only when there was also a federal estate tax. In such cases, Maine received a portion of the tax which would otherwise have been payable to the IRS, and the IRS received the rest. In effect, estates of Maine decedents paid no additional tax. For example, if the total estate tax of a decedent who died in 2001 came to $560,250 (based on a taxable estate of $2 million), then Maine would have received $99,600 as its tax and the remaining $460,650 would have been paid to the IRS. Were there no estate tax in Maine, the full $560,250 would have been paid to the IRS.
2001 Federal Changes. As part of the 2001 changes to the Federal Estate Tax system, Congress significantly changed the State Death Tax Credit. Under the terms of the 2001 amendment, Congress reduced the State Death Tax Credit by 25% for each of calendar years 2002, 2003, and 2004 and eliminated the credit entirely in 2005, replacing it with a deduction for state death taxes. For states like Maine that depended on the federal estate tax system, the consequence of the 2001 federal tax act was a significant shift in revenues from the state to the federal government. The 2001 Tax Act also increased the federal exemption amount from $675,000 to $1 million, resulting in an overall reduction in the estate tax.
2001 Maine Changes. In response to the 2001 federal act, the Maine legislature amended Maine’s estate tax law in 2001 to provide that, for calendar year 2002 only, the Maine estate tax would equal the Federal State Death Tax Credit without regard to the federal reduction in the credit. Therefore, although the Maine tax for estates of decedents who died in 2002 was imposed only where there was a federal estate tax, the Maine tax increased the overall amount of tax paid by the estate. Using the same example as above, in 2002 the tentative federal estate tax (using the $1 million exemption amount) would have been $435,000. This amount would have been reduced by the State Death Tax Credit of $74,700 (75% of the former credit amount of $99,600), to yield a federal estate tax of $360,300. However, because Maine ignored the reduction of the credit for 2002, the Maine estate tax would have remained at the full $99,600. Therefore, the estate pays $360,300 to the IRS and $99,600 to the State of Maine, an increase in the total tax burden from $435,000 to $459,900.
2003 Maine Changes. In March 2003, the Maine Legislature enacted L.D. 1319 which, among other things, made additional changes to Maine’s estate tax system. Under the 2003 Act, Maine continues to ignore the 25% annual reductions to the State Death Tax Credit, which (as discussed above) leads to an increased overall tax liability. In addition, the Maine Act further decouples the Maine estate tax system from the federal system by utilizing a different applicable exclusion amount (the amount a decedent can shelter from estate tax), which results in a system where a Maine tax may now be due even if no federal tax is due. This Maine change is retroactive, and applies to the estates of persons dying on or after January 1, 2003.
Currently the federal applicable exclusion amount is $1 million. It will increase to $1.5 million in 2004. Under the 2003 Maine Act, the Maine tax is calculated by using the federal tax laws in effect on December 31, 2000. Accordingly, the applicable exclusion amount (for Maine tax purposes) will be $700,000 in 2003 and will increase to $850,000 in 2004. The resulting “gap”: $300,000 in 2003 and $650,000 in 2004, will result in a Maine estate tax on many estates even when no federal tax is due. Below is a table of Maine estate tax liability for 2003 and 2004 for estates without adjusted taxable gifts that would pay no federal tax:
| Taxable Estate | 2003 State Tax | Taxable Estate | 2004 State Tax | |
|---|---|---|---|---|
| $700,000 | 0 | $850,000 | 0 | |
| $750,000 | $18,500 | $900,000 | $19,500 | |
| $800,000 | $22,800 | $1,000,000 | $33,200 | |
| $850,000 | $25,200 | $1,100,000 | $38,800 | |
| $900,000 | $27,600 | $1,200,000 | $45,200 | |
| $1,000,000 | $33,200 | $1,300,000 | $51,600 | |
| $1,400,000 | $58,400 | |||
| $1,500,000 | $64,400 |
Effect of Maine's New Estate Tax
Before Maine’s new law was enacted, a typical estate plan for a married couple with over $1 million in assets provided for the use of a credit shelter trust to hold assets having a total value equal to the federal applicable exclusion amount (currently $1 million), with the balance of the decedent’s estate passing to the surviving spouse and/or a marital trust. This type of plan served to (1) avoid all estate taxes on the death of the first to die and (2) utilize fully the applicable exclusion amount of that first decedent to keep all assets in the credit shelter trust out of the estate of the surviving spouse for estate tax purposes. For example, under the previous system, if a husband who passed away in 2003 with a $5 million estate left the federal applicable exclusion amount ($1 million in 2003) to a credit shelter trust for the benefit of his wife (and possibly descendants), and the remaining $4 million to his wife or to a marital deduction trust for her benefit, there would be no state or federal estate tax due on the husband’s death. On the wife’s subsequent death, her taxable estate would be worth $4 million (assuming she had no other assets), which would be reduced by her federal applicable exclusion amount ($1 million in 2003, $1.5 million in 2004) to determine the estate tax liability of her estate. The assets in the husband’s credit shelter trust (initially $1 million but possibly much more by the time of the wife’s later death) would pass tax free to his designated beneficiaries.
Unfortunately, under Maine’s new law, this type of plan no longer works to fully avoid taxes on the death of the first to die. Assume the couple in the above example did not amend their estate plan and the husband passed away with a $5 million estate in 2003. Because the estate plan directs that the federal exclusion amount ($1 million) be transferred to the credit shelter trust, and because the applicable exclusion amount for Maine estate tax purposes in 2003 is $700,000, the husband’s estate would be liable for an estate tax to the State of Maine in the amount of $33,200. If the husband were to pass away in 2004 instead, when the federal exemption is $1.5 million, $1.5 million would pass to the credit shelter trust and $3.5 million would be distributed as a marital distribution. Again, there would be no federal estate due, but because the Maine exemption in 2004 is $850,000, the total estate tax due to the State of Maine would be $64,400. In addition, on the wife’s subsequent death, her taxable estate would be subject to the new Maine estate tax as well as the federal estate tax. If she passed away in 2003 with an estate worth $4 million, her federal estate tax liability would be unchanged, but under the new Maine Act, her state tax liability would be increased by $140,200. Similarly, if she passed away in 2004 with an estate of the same value, her federal tax liability would be unchanged but, under the new Maine Act, her state tax liability would be increased by $210,300. The tables below illustrate how the Maine Act increases the overall tax liability for decedents dying in 2003 and 2004 with no adjusted taxable gifts:
| Taxable Estate | Federal Tax | Maine Tax | Total Tax | Maine Premium |
|---|---|---|---|---|
| $700,000 | 0 | 0 | 0 | 0 |
| $800,000 | 0 | $22,800 | $22,800 | $22,800 |
| $900,000 | 0 | $27,600 | $27,600 | $27,600 |
| $1,000,000 | 0 | $33,200 | $33,200 | $33,200 |
| $1,100,000 | $21,600 | $38,800 | $60,400 | $19,400 |
| $1,200,000 | $59,400 | $45,200 | $104,600 | $22,600 |
| $1,300,000 | $98,200 | $51,600 | $149,800 | $25,800 |
| $1,400,000 | $138,000 | $58,000 | $196,000 | $29,000 |
| $1,500,000 | $177,800 | $64,400 | $242,200 | $32,200 |
| $1,600,000 | $219,600 | $70,800 | $290,400 | $35,400 |
| $1,700,000 | $261,000 | $78,000 | $339,000 | $39,000 |
| $1,800,000 | $302,400 | $85,200 | $387,600 | $42,600 |
| $1,900,000 | $343,800 | $92,400 | $436,200 | $46,200 |
| $2,000,000 | $393,200 | $99,600 | $492,800 | $49,800 |
| Taxable Estate | Federal Tax | Maine Tax | Total Tax | Maine Premium |
|---|---|---|---|---|
| $700,000 | 0 | 0 | 0 | 0 |
| $800,000 | 0 | 0 | 0 | 0 |
| $900,000 | 0 | $19,500 | $19,500 | $19,500 |
| $1,000,000 | 0 | $33,200 | $33,200 | $33,200 |
| $1,100,000 | 0 | $38,800 | $38,800 | $38,800 |
| $1,200,000 | 0 | $45,200 | $45,200 | $45,200 |
| $1,300,000 | 0 | $51,600 | $51,600 | $51,600 |
| $1,400,000 | 0 | $58,000 | $58,000 | $58,000 |
| $1,500,000 | 0 | $64,400 | $64,400 | $64,400 |
| $1,600,000 | $27,300 | $70,800 | $98,100 | $53,100 |
| $1,700,000 | $70,500 | $78,000 | $148,500 | $58,500 |
| $1,800,000 | $113,700 | $85,200 | $198,900 | $63,900 |
| $1,900,000 | $156,900 | $92,400 | $249,300 | $69,300 |
| $2,000,000 | $200,100 | $99,600 | $299,700 | $74,700 |
Planning Under the New Act
1. Limit the Credit Shelter Trust to the Maine Exclusion Amount. If you are married and your combined assets exceed $700,000 and if you and your spouse want to avoid all taxes on the death of the first to die, your estate planning documents should be amended to redefine the amount to be transferred to the credit shelter trust as the lesser of the Maine exclusion or the federal exclusion. If the husband in the example discussed above had done this and passed away in 2003, his credit shelter trust would have been funded with $700,000 worth of assets, and his wife would have received $4.3 million either outright or in a marital trust. On the husband’s death, his estate would not owe any state or federal estate taxes. However, on his wife’s subsequent death, her estate would be worth $4.3 million (rather than $4 million if the full federal exclusion amount were utilized on the husband’s death), and the federal estate tax due on her death would be higher than if more had been sheltered in the husband’s credit shelter trust. In addition, as noted above, her estate will also be subject to the new Maine estate tax.
2. Use Disclaimer Trusts. Another technique for a married couple to consider is the use of so-called disclaimer trusts in their estate planning documents. This technique is a “wait and see” approach which provides a surviving spouse with an opportunity to engage in “post-mortem” estate planning by evaluating a situation after the death of a spouse and deciding at that point whether and with how much to fund a credit shelter trust. Under this type of plan, each spouse would have a fairly simple Will, or Will and revocable living trust, leaving his or her entire estate outright to the surviving spouse. The estate planning documents would also contain a provision enabling the surviving spouse to “disclaim” assets if he or she desired to do so. If the spouse chose to disclaim assets, which must be done in writing within nine months of the decedent’s death, those assets would pass to the credit shelter trust for his or her benefit for life, and would not be included in his or her estate at death.
For example, the surviving spouse in the example above might choose to disclaim enough assets to fund the credit shelter with the federal exclusion amount ($1 million), thereby causing her husband’s estate to be liable for an estate tax to the State of Maine, but recognizing that her own estate will likely have a lower value for estate tax purposes when she later passes away. On the other hand, she may decide that she cannot forgo any liquidity at the time of her husband’s death, and therefore may chose to fund the credit shelter with only the amount of the Maine exclusion ($700,000), thereby avoiding all taxes upon his death and possibly increasing the tax due on her later death. In any event, the point is that she has the choice after her husband’s death and after analyzing the actual numbers to decide which approach best suits the family’s needs. This technique is not foolproof and is not without certain risks. Therefore, you should fully discuss the pros and cons of this approach with your estate planning attorney to determine if it fits your particular situation.
The two techniques discussed above are not mutually exclusive and one or both may be utilized at the same time. For example, it may make sense to amend your documents to limit the amount to be transferred to the credit shelter trust as the lesser of the Maine exclusion or the federal exclusion, and at the same time, include a disclaimer provision in the documents giving the surviving spouse the option to disclaim additional assets and provide that any assets so disclaimed will be added to the credit shelter trust. Combining these two techniques will provide some certainty in that a credit shelter trust will be established with at least the amount of the Maine exemption, thereby eliminating some of the risk in using a pure disclaimer approach, while at the same time still giving the surviving spouse some flexibility after the death of the first spouse.
3. Lifetime Gifts. Whether you are married or single, it may make sense for you to make gifts during your lifetime to reduce the overall value of your estate and possibly use some of your federal exclusion amount while you are living.1 If the husband in the example discussed above who had a $5 million estate had made a $300,000 gift to someone other than his wife during his lifetime (including an irrevocable credit shelter trust designating his wife as beneficiary), he would have “used up” $300,000 of his federal exclusion and would have had $700,000 ($1,000,000 - $300,000) remaining when he died (assuming he died in 2003). Thus, his credit shelter trust at death would be funded with $700,000 and the rest of his estate ($4 million) would be distributed to his wife, either outright or in a marital trust. This technique would reduce, but not eliminate, the Maine estate tax.
Making significant gifts may also prove advantageous in lowering estate taxes for an unmarried person with a large estate. The following example will illustrate this point: Assume an unmarried individual passes away in 2003 with an estate valued at $1 million having made no lifetime gifts. The federal estate tax would be $0 and the Maine estate tax would be $33,200, for a total estate tax liability of $33,200. Now assume that same individual made $500,000 worth of taxable gifts early in 2003 (i.e., gifts beyond the annual exclusion) and passed away later in 2003 with a remaining estate worth $500,000. Now the total federal gift and estate taxes would still be $0 but the Maine estate tax would be reduced to $10,000, for a total tax savings of $23,200.
4. Establish an Irrevocable Life Insurance Trust. Whether you are married or single, if you own life insurance in your own name (rather than in a trust), the value of the death benefit of the policy will be included in the total value of your estate for estate tax purposes when you pass away. Therefore, you may want to consider transferring ownership of your life insurance to an irrevocable life insurance trust (“ILIT”) in order to reduce the overall value of your estate. You may be familiar with this technique and may have already established an ILIT. Or, you may have discussed it with your attorney and decided not to pursue it on the theory that your life insurance could be used to fund your credit shelter trust and most, if not all, of your assets would be sheltered from estate taxes. Under the new Maine law, however, using taxable insurance proceeds to fund a credit shelter trust may no longer be as effective to minimize taxes.
Again, an example may prove helpful: A husband owns a life insurance policy with a death benefit of $1.5 million. In addition, he owns investments worth $400,000. His wife has a $500,000 life insurance policy, and owns their home which is worth $350,000. Each of their estate plans provides for a credit shelter trust to be funded with the federal exclusion amount and provides that life insurance be used to fund the credit shelter trust, to the extent necessary, and an outright marital distribution. If the husband were to die first in 2003, his credit shelter trust would be funded with $1 million, and his wife would receive $900,000. There would be no federal estate tax liability, but his estate would owe $33,200 to the State of Maine. If, alternatively, the husband had transferred ownership of his life insurance to an ILIT2, his estate would have been worth $400,000 on his death which would have been used to fund the credit shelter trust. The $1.5 million of life insurance would be held in a separate trust for the benefit of his spouse (and possibly descendants) and would not be subject to an estate tax either in his estate or hers. When she later passes away, her estate would be worth $850,000 ($500,000 of her own life insurance and $350,000 of real estate) and both his credit shelter trust and the life insurance trust would pass to their descendants, free of estate taxes.
5. Establish Residency in Another State. Florida, for example, has not decoupled from the federal estate tax system. Florida imposes a tax equal to the actual State Death Tax Credit allowed by the IRS, and if there is no federal estate tax, there is no Florida estate tax. So far, there is no Florida estate tax premium, as there is in Maine. We understand it would require a state constitutional amendment to change Florida’s estate tax system, approved by a statewide vote. We think it would be difficult for Florida to revise its state estate tax system as Maine has done.
However, you should be aware that Maine Revenue Services has become very hostile and aggressive in pursuing former Maine taxpayers who claim to have changed their domicile to another state, even threatening criminal tax fraud prosecutions in a number of cases. If you already spend part of the year in another state, or plan to do so, and want to consider changing your state of residence for tax purposes, this is worth considering. But we urge that you seek advice about such a change. It is very important to attend carefully to the details, given the level of scrutiny and hostility your decision may prompt from Maine Revenue Services.
If you would like to discuss how these recent changes affect your estate plan, or if you would like to discuss the options outlined above, please do not hesitate to call us at 772-2800.
.1. There is an annual gift tax exclusion of $11,000 per recipient (formerly $10,000) for so-called “present interest” gifts. Husbands and wives can pool their annual exclusions to give away up to $22,000 per recipient per year without generating a taxable gift. Annual exclusion gifts remain a valuable tool in reducing an individual’s taxable estate.
2. There is a three year transfer rule on life insurance. This means that if you transfer an existing policy into an irrevocable trust and pass away within three years of the transfer, the death benefit will still count as part of your estate for estate tax purposes. If however, you establish an ILIT and the ILIT purchases a new policy, the three year rule does not apply
Disclaimer: Nothing in this Client Alert should be taken as legal advice for any individual case or situation. The information in these articles is intended to be general in nature and should not be relied upon for any specific set of circumstances. You should consult with an experienced attorney before applying the information in this Client Alert to your own situation.