Don’t look now but Maryland, a state that has a reputation for being a little too fond of imposing taxes, is on the verge of enacting a substantial tax reduction. No, this is not an early April Fool’s joke. As improbable as it may sound, the home of the dreaded bag tax, hard surface run-off tax and a plethora of other ways to separate its residents from their money is on the verge of enacting a law that will result in a significant reduction in the amount of estate taxes paid to the state, which is estimated to total more than $100 million per year when the law is fully phased in on January 1, 2019.
Apparently motivated by reports that Maryland’s estate tax may be causing millionaires to abandon the state, on March 20, 2014, the Maryland Legislature passed a Bill (HB 739; SB 602) that would substantially modify Maryland’s estate tax laws. Since 2004 Maryland has imposed an estate tax on estates valued at more than $1 million. In that year, the Maryland estate tax de-coupled from the federal estate tax as the federal exemption (known as the “applicable exclusion amount”) began to increase to levels above $1 million. The $1 million Maryland applicable exclusion amount or exemption has been static, without steps or indexing to keep pace with inflation. The state imposes an estate tax on estates whose value exceeds this exclusion amount which is calculated using graduating rates that top out at 16%.
Since 2004 there has been a gap between the amounts that Marylanders can exclude from the state and federal estate taxation regimes. With the federal exclusion amount, which is indexed for inflation, at $5.34 million for 2014, that gap is now $4.34 million. This gap has caused Maryland residents whose assets fall between the Maryland and the federal exclusion amounts to not only incur a Maryland estate tax, but also to incur additional costs and complexities in their estate planning process if they desire to maximize the benefits under both tax regimes.
If allowed to become law by Governor Martin O’Malley, Maryland’s estate tax applicable exclusion amount would begin to rise gradually until it re-couples with the federal exclusion amount. Under the new Bill, which would take effect on July 1, 2014, the Maryland exclusion amount would begin to rise in 2015, with annual stepped increases until 2019. For 2019 and later years, it would be set at the same amount as the federal applicable exclusion amount and would increase with inflation in accordance with federal law. If not vetoed by the Governor, the Bill would increase the Maryland estate tax applicable exclusion amount as follows:
- In 2015, the applicable exclusion amount would be $1.5 million;
- In 2016, the applicable exclusion amount would be $2 million;
- In 2017, the applicable exclusion amount would be $3 million;
- In 2018, the applicable exclusion amount would be $4 million;
- In 2019, the applicable exclusion amount would be the same as the federal applicable exclusion amount which is projected to be approximately $5.9 million at that time as a result of inflation indexing;
The new Bill would also add the federal concept of portability of the applicable exclusion amount between spouses to Maryland law beginning in 2019. The portability aspect of federal estate tax law allows the estate of the second spouse to die to use the unused portion of the applicable exclusion amount of the first spouse to die on the estate tax return for the second spouse, if certain conditions are met. This is in addition to the second spouse’s own applicable exclusion amount. Adding this concept to Maryland law, would allow a new back-up option for couples who do not adequately address their estate tax planning issues while they are both living.
To illustrate this point, take the example of Mr. and Mrs. Plenty who have a total net worth of $10 million, with Mr. Plenty owning $1.5 million and the other $8.5 million being owned by Mrs. Plenty. If Mr. Plenty dies on June 1, 2014, under federal law his estate would consume only $1.5 million of his applicable exclusion amount for estate tax purposes. If his estate files a federal estate tax return that delineates the unused portion of his applicable exclusion amount and elects to allow it to be used by his spouse’s estate, then when Mrs. Plenty dies on December 31, 2014, her estate will be able to use the remaining $3.84 million dollars of his applicable exclusion amount, as well as her own $5.34 million applicable exclusion amount. The result of this would be that her entire $8.5 million estate would be shielded from federal estate taxes even though individually she could have only shielded $5.34 million.
Taken together these two changes would be a substantial move in an unusual direction for taxation in the State of Maryland. Although, if enacted, only time will tell if they will have any impact on the retirement intentions of Maryland’s millionaire residents. Many retirees after all leave the state for reasons other than taxes, such as to be closer to grandchildren, to live in a more temperate climate or in search of a lower total cost of living. Also, Maryland is still one of only two states in the U.S. that have both an estate tax and an inheritance tax, which in Maryland is a tax on the distribution of one’s assets to remotely related or unrelated non-charity beneficiaries. New Jersey is the other such state. Finally, the Bill did nothing to limit or eliminate the relatively high state and local income tax rates that may be a concern to wealthy Marylanders. However, it would certainly be a move in a positive direction for those millionaires who would prefer to live out their lives in Maryland but are concerned with their overall tax burden.
Governor O’Malley has until May 27, 2014 to decide whether he will veto the Bill or allow it to become part of the law.