A Couple With $4 Million Discovers State’s Estate Tax Could Cost Heirs $280,000

With the federal estate and gift tax exemption sitting at $15 million per person, most families assume estate tax is a problem for richer people. But don’t forget about state estate taxes. Twelve states and the District of Columbia run their own estate taxes with far lower thresholds.

This scenario appears constantly on retirement forums. A Bogleheads thread recently featured a Massachusetts widow learning mid-probate that her late husband’s failure to fund a trust had cost her family roughly six figures. Massachusetts exempts estates up to $2 million per individual, far lower than the federal threshold. Without specific trust planning, a surviving spouse and/or heirs can be stuck with a big tax bill.

Here’s a typical scenario:

• Household: Married couple, both age 70, residing in Massachusetts
• Net worth: Approximately $4 million across home, IRAs, and brokerage
• Federal estate tax exposure: $0
• State estate tax exposure at second death: Roughly $280,000 without trust planning
• What’s at stake: Whether heirs receive $4 million or closer to $3.72 million

How a $2 million exemption becomes a $280,000 bill

At the first spouse’s death, everything passes to the survivor under the unlimited marital deduction. No tax. The trap springs at the second death, when the survivor owns the full $4 million but has access to only a single $2 million exemption. The first spouse’s exemption evaporated because nothing was done to capture it.

The state’s rate schedule starts at the $40,000 mark of the old federal credit table and works up to 16% on amounts above $10 million. So  the taxable $2 million produces approximately $182,000 in Massachusetts estate tax, with the federal credit-table gross math pushing the effective figure to roughly $280,000.

Inflation worsens this over time. State exemptions are fixed in statute and do not index. With headline PCE inflation running at around 3.5% year over year, the real value of that $2 million exemption shrinks every year. Each year of inaction widens the taxable gap.

Three strategies that could move the number

For most couples in this position, trust planning is the highest-leverage move because it is essentially free money. Properly drafted documents, executed during life, can convert a $280,000 problem into a $0 problem.

1. Fund a credit shelter trust at the first death. A credit shelter (or bypass) trust funded with the first spouse’s $2 million exemption keeps those assets out of the survivor’s taxable estate while letting the survivor use the income. Properly executed, it doubles the couple’s effective exemption from $2 million to $4 million in Massachusetts. For a couple at $4 million, that single document erases the tax.
2. Change domicile in retirement. Moving to Florida, Texas, or another no-estate-tax state eliminates the problem entirely. This is realistic for retirees with grown children and flexible roots, less so for those tied to grandchildren or medical care in New England. Domicile changes are scrutinized by state revenue departments, so half-measures tend to fail.
3. Use lifetime gifting to drain the estate below $2 million. Massachusetts does not have a state gift tax, so annual exclusion gifts and larger transfers to children or 529 plans can systematically shrink the taxable estate without triggering state tax during life. This works best when started in the mid-60s.

An irrevocable life insurance trust (ILIT) to fund the bill is a potential fallback. It pays the tax rather than avoiding it, by transferring assets from the retiree to a trust that uses a life insurance policy to efficiently distribute the proceeds at death.

Here are two concrete actions to take today. First, pull your current estate documents and check whether they include a credit shelter or qualified terminable interest property (QTIP) trust provision. Many wills drafted before 2013 contain this language. Many wills drafted after 2013 do not, because attorneys stopped including it once federal estate tax stopped applying to ordinary affluent clients.

Second, see if your state has an estate tax and verify your state’s current exemption.

The common mistake is assuming the federal exemption protects you when state thresholds operate independently. Discovering a six-figure tax bill after a spouse’s death derails plans. The fix costs a few thousand dollars in legal fees. The failure to fix it could cost a quarter of a million.