Maryland Bar Bulletin
Publications : Bar Bulletin

September, 2004

Maryland Estate Tax Increases
By Edwin G. Fee, Jr.

The Maryland General Assembly passed the Budget Reconciliation and Financing Act of 2004 (introduced as Senate Bill 508; enacted as Chapter 430) on April 7, 2004, and the Governor signed the bill on May 26, 2004. More than 80 pages long, this legislation is the state’s general revenue bill. Buried deep within the bill are two significant changes to the Maryland estate tax. One of the changes causes an immediate substantial increase in the Maryland estate tax, and the other change will cause another (though less significant) increase in 2005. Until the passage of this legislation, the exemption from the Maryland estate tax was the same as the exemption from the federal estate tax. The exemptions had been $600,000 since the mid-1980s, and they began to increase in $25,000 increments in the late 1990s. By 2001, the exemptions had reached $675,000. Due to changes in the federal tax law, the federal and Maryland exemptions increased to $1 million in 2002, and to $1.5 million in January 2004. Nevertheless, the legislation passed by the Maryland General Assembly in 2004 reduces the exemption from the Maryland estate tax back to $1 million. A troubling aspect of this legislation is the fact that it is effective retroactive to January 1, 2004. Some Maryland residents died prior to May 26, 2004, at a time when their estates were exempt from the Maryland estate tax, but now their estates owe Maryland estate tax. If those decedents had known about the potential tax increase during their lifetime they could have taken appropriate measures (such as making gifts) to reduce their potential exposure to the Maryland estate tax. After they died, however, there was nothing that could be done. Furthermore, many married couples have wills or trusts that are designed to take advantage of the exemption from the federal estate tax through the use of a trust that is sometimes referred to as a “bypass trust,” a “credit shelter trust” or a “family trust”. As a result of this legislation, those existing wills and trusts inadvertently could cause payment of a significant Maryland estate tax at the death of the first spouse to die. If the bypass trust is fully funded at the first spouse’s death to take advantage of the $1.5 million federal exemption, this will cause a Maryland estate tax of $64,400. There are several ways to deal with this situation. One option is simply to pay the Maryland estate tax at the first spouse’s death, because by doing so the family might save a much greater amount in federal estate tax at the second spouse’s death. Another option is to cap the amount funding the bypass trust at $1 million. This would prevent the imposition of Maryland estate tax at the death of the first spouse, but it would result in wasting a portion of the first spouse’s exemption from the federal estate tax. Still another option is to use a disclaimer bypass trust. This would permit the surviving spouse to determine the amount passing to the bypass trust. The hazard of using a disclaimer technique is that the surviving spouse inadvertently might disqualify assets from being disclaimed (e.g., by accepting benefits of the disclaimed assets, or by missing the deadline for filing the disclaimer). A further option (perhaps not for the faint-hearted) would be to create a bypass trust for $1 million and to create a qualified terminable interest property (QTIP) marital trust for the difference between the federal exemption and the Maryland exemption. The $1 million bypass trust would be exempt from the federal and Maryland estate taxes at the first spouse’s death and at the second spouse’s death. The QTIP trust would receive the marital deduction from the federal and Maryland estate taxes at the first death. Normally, if there is a marital deduction for a QTIP trust in the first spouse’s estate, then the assets of the trust have to be included in the second spouse’s estate. Nevertheless, under Revenue Procedure 2001-38, 2001-1 C.B. 1335, a QTIP election may be void if there are no federal estate tax consequences. Therefore, at the second spouse’s death, one could take the position that the QTIP election was unnecessary to reduce federal estate tax at the first spouse’s death because the assets in the QTIP trust otherwise would have fallen within the federal estate tax exemption. Pursuant to this argument, the assets of the QTIP trust would not be included in the surviving spouse’s estate for federal estate tax purposes. The assets of the QTIP trust probably would be included in the surviving spouse’s estate for Maryland estate tax purposes, but at least the tax would have been deferred from the first death to the second death. Some aggressive practitioners might attempt to argue that because the QTIP trust is not included in the estate for federal estate tax purposes, it should not be included for Maryland estate tax purposes, either. The Comptroller of Maryland likely would contest such a position. In fact, the Comptroller potentially could argue that because the QTIP election was void for federal estate tax purposes, the election also was void for Maryland estate tax purposes. This could result in the retroactive imposition of Maryland estate tax (plus interest, and possibly penalties) as a result of the first spouse’s death. As if the foregoing were not enough, there will be an additional wrinkle in the Maryland estate tax beginning in 2005. At that point, the federal estate tax will be calculated by deducting state death taxes (i.e., state inheritance and estate taxes). This deduction will replace the current 25 percent federal credit for state death taxes. Under the 2004 Maryland legislation, however, the Maryland estate tax will be calculated without regard to the deduction for state death taxes. Although this will simplify calculation of the Maryland estate tax, it will result in an increase in the Maryland estate tax.


Edwin G. Fee, Jr. is a partner in the law firm of Whiteford, Taylor & Preston L.L.P.; he is also Secretary of the MSBA Estate and Trust Law Section Council.
 
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Publications : Bar Bulletin: September, 2004

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