Question:

A gift of an existing life insurance policy within 3 years of death is included in the gross estate and taxable at the federal level. It is also included in the Massachusetts gross estate to determine if the threshold has been met. Is it also taxable if the donor dies within that 3-year window? I would appreciate if you could clarify this issue.

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Response:

Yes, the policy would be taxable. Massachusetts has a strange estate tax system. The threshold for taxation is $1 million. But if the estate exceeds this threshold, everything is taxed back to the first dollar, albeit at a relatively low rate of 0.8 to 5.6%. Massachusetts also does not have a gift tax. However, gifts over of the $16,000 annual federal gift tax exclusion per individual are brought back into the estate solely for purposes of determining whether the estate exceeds the $1 million Massachusetts threshold, even though these gifts are not taxed.

But what about gifts of life insurance? There, the federal tax system has a special rule that brings the insurance proceeds back into the estates of anyone who transferred the policy within the three years prior to death. This also means that such policies are taxable in Massachusetts because the Massachusetts estate tax is based on the federal taxable estate. So, if it’s in the federal estate, it’s in the Massachusetts estate, even if the estate totals far below the current federal estate tax threshold of $12.06 million (as of 2022). To reiterate, the answer to your question is yes, the estate would be taxable.

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