Determining who is responsible for paying estate and inheritance taxes can be confusing. There can be tension between recipients of specific bequests and recipients of residuary bequests. There also can be tension between recipients who are exempt from taxes and recipients who are not exempt from taxes. In addition, there can be tension between recipients of probate assets and recipients of non-probate assets. Given these competing interests and the potential for confusion, it is essential that fiduciaries and their advisors know the rules governing liability for estate and inheritance taxes.
Maryland Annotated Code Tax-General Article section 7-308 (all section references are to the Tax-General Article) applies to the Maryland and federal estate taxes, but not the Maryland inheritance tax. Section 7-308(b)(1) provides that estate taxes “shall be apportioned among all persons interested in the estate.” Section 7-308(e)(1) provides that “in making an apportionment, allowances shall be made for any exemptions granted and for any deductions and credits allowed.” Section 7-308(e)(2) specifies that “[a]ny exemption or reduction allowed by reason of the relationship of any person to the decedent or by reason of the purposes of the gift inures to the benefit of the person bearing that relationship or receiving the gift.”
Under the apportionment statute, exempt persons do not bear any estate taxes. Otherwise, estate taxes are apportioned among all beneficiaries, whether specific or residuary, and whether probate or non-probate. Importantly, however, pursuant to section 7-308(k), the apportionment statute applies “[e]xcept as otherwise provided in the will or other controlling instrument.” Thus, although the statutory apportionment rules are mandatory, they may be altered or waived completely by the governing instrument.
The Maryland inheritance tax is governed by sections 7-202 and 7-203. Under section 7-202, the inheritance tax is “imposed on the privilege of receiving property that passes from a decedent.” Section 7-203 provides numerous exemptions, including spouses, children, parents, siblings, charities and others. As a practical matter, liability for payment of the inheritance is similar to the general rule regarding apportionment of estate taxes: the recipient of the property pays the tax unless the recipient is exempt.
The Maryland Court of Appeals dealt with the tension between specific legatees and residuary legatees in Johnson v. Hall, 283 Md. 644, 392 A.2d 1103 (1978). The court had to determine whether the federal estate tax would be apportioned among all of the legatees (specific and residuary), or just allocated to the residuary legatees. The court noted that apportionment is mandatory, unless the will provides otherwise. The court stressed that a testator’s intention not to apportion the taxes among all legatees must be plainly stated. The court’s function is “not to try to discern what the testator meant to say, but what he meant by what he did say.” A will must “demonstrate a clear intent to avoid the rule of apportionment.” The will in this case directed as follows: “All estate and inheritance taxes, be paid as soon after my death as can lawfully and conveniently be done.” The court acknowledged that “[n]o magical or mystical word or phrase” is required to shift the burden of taxes from the specific legatees to the residuary legatees. The court concluded that the will language quoted above was not sufficient to avoid apportionment. Accordingly, the estate tax was apportioned among all of the legatees (specific and residuary).
The Maryland Court of Appeals dealt with the tension between exempt legatees and non-exempt legatees in Pfeufer v. Cyphers, 397 Md. 643, 919 A.2d 641 (2007). The will left the residuary estate to four people, three of whom were family members who were exempt from the Maryland inheritance tax, and one of whom was an unrelated individual who was subject to the inheritance tax. Under the general rule noted above, the tax would have been paid solely by the legatee who was subject to the inheritance tax. The will provided as follows: “I direct that all estate, inheritance, transfer, legacy or succession taxes...shall be paid out of the principal of my residuary estate; and such payment shall be made as an expense of the administration of my estate without apportionment.” The court concluded that this tax clause meant that the inheritance tax should be paid “off the top” from the residuary estate before distribution of the residuary estate among the four residuary legatees. As a result, each residuary legatee paid one-quarter of the tax.
As these cases demonstrate, the language of the tax clause is crucial in determining who is responsible for paying estate and inheritance taxes. Thus, attorneys who are drafting wills should ascertain their clients’ wishes concerning who should bear the burden of taxes, and then draft accordingly.
Edwin G. Fee, Jr., is a partner with Whiteford, Taylor & Preston L.L.P., and he is a past Chair of the MSBA Estate & Trust