Tax Clauses

• Jurisdiction: Maryland

4.6 TAX CLAUSES

4.6.1 General Considerations—Remember That the Tax Clause Shifts Wealth

The tax clause determines which property and/or recipient will bear the burden of federal and Maryland estate taxes and the Maryland inheritance tax. For this reason, the tax clause can have the effect of shifting wealth, sometimes dramatically—in the case of an estate that is fully taxable for federal and Maryland estate tax purposes. Consequently, not only must the practitioner understand the effects of the tax clause on an estate, but he or she must discuss these effects with the client so that the will clearly reflects the intent of the testator. In the absence of a tax clause, the burden of paying death taxes will be determined by federal and state law.

If a testator wishes to have assets that would be exempt from tax (such as marital or charitable bequests) bear a share of death taxes, keep in mind that the money used to pay those taxes will not qualify for the deduction, and therefore that its use will increase the total amount of taxes due.

4.6.2 Federal and State Law Considerations

4.6.2.1 Federal Law

Internal Revenue Code § 2002 (hereinafter I.R.C. § ) requires that the personal representative pay the federal estate tax. This obligation to pay the tax extends to that portion of the tax that is generated from non-probate property regardless of whether such property ever came into the personal representative's hands.¹⁸

When dealing with estates of married couples that will be exposed to an estate tax, often a marital trust is used that qualifies for the marital deduction thereby deferring the tax, yet not making an outright bequest of all of the assets to the surviving spouse. Accordingly, a properly designed marital trust may become taxable in the second estate, so the personal representative needs to examine the return of the first deceased spouse as well as examine that spouse's will or trust.¹⁹

Usually, the personal representative pays the tax from estate assets. However, federal law authorizes the personal representative to seek reimbursement for certain taxes from distributees, including from the beneficiaries of non-probate dispositions. For example:

(1) I.R.C. § 2206 grants a right to reimbursement from life insurance beneficiaries.

(2) I.R.C. § 2207 provides that the personal representative may collect reimbursement from the recipient of property over which the decedent had a power of appointment that caused the property to be includible in the decedent's gross estate.

(3) I.R.C. § 2207A affords a right of recovery against a Qualified Terminable Interest Property (QTIP) trust.

(4) I.R.C. § 2207B grants a right to reimbursement when the inclusion in the federal gross taxable estate was based on the retention of a life estate under I.R.C. § 2036.

(5) I.R.C. § 2603(b) states that "[u]nless otherwise directed pursuant to the governing instrument by specific reference to the tax imposed by this chapter, the tax imposed by this chapter on a generation-skipping transfer shall be charged to the property constituting such transfer." (emphasis added.)

The Internal Revenue Service (I.R.S.) has the power to collect unpaid federal estate tax through the Special Estate Tax Lien under I.R.C. § 6324. This is the so-called secret lien because it arises without the necessity of a filing of a notice. It is durational—lasting 10 years from the date of death and covering all estate property.

4.6.2.2 State Law

4.6.2.2.1 The Maryland Uniform Estate Tax Apportionment Act

a. Md. Code Ann., Tax-General § 7-308 (current through legislation effective July 1, 2020) (hereinafter Tax-Gen. § ).

The Maryland Act generally provides that federal and Maryland estate tax should be apportioned among all those interested in the estate in the proportion that each person's interest bears to the total estate value.

(1) "Person interested in the estate" includes recipients of non-probate property, but does not include recipients of adjusted taxable gifts. The literal language of the statute would lead to the conclusion that taxable gifts ought to be included in the apportionment of the tax. This was the dicta of Shepter v. Johns Hopkins Univ., 334 Md. 82, 637 A.2d 1223 (1994). The Maryland apportionment statute was reenacted without change in 1995 to reverse Shepter.²⁰

(2) In apportioning the tax, allowances are made for exemptions and for any deductions and credits allowed by the law imposing the tax. Essentially, no recipient of property that is exempt from the tax or deductible from the estate will bear the tax, thus preserving any marital deduction or charitable deduction.

b. The Maryland Act provides that a personal representative may withhold from a distribution the amount of tax attributable to any particular distributee. In addition, the personal representative may recover taxes due from a distributee directly if the personal representative does not have sufficient assets to offset to pay that portion of the tax. Thus, the personal representative may recover the deficiency from the holders of property acquired by non-probate succession.²¹

c. The Maryland Act gives the court the power to determine the apportionment of the tax and to apportion interest and penalties equitably.²²

d. The statutory apportionment does not apply if the will provides a contrary instruction.²³ The tax clause should clearly state which taxes it is intended to cover and which property will bear the tax burden. General language will not be sufficient to shift the tax burden.²⁴

In Johnson v. Hall,²⁵the Court of Appeals held that a general direction to pay taxes is not sufficient to overcome the default apportionment. More specific language is required. The will in Johnson stated that "I direct that . . . all estate and inheritance taxes, be paid as soon after my death as can lawfully and conveniently be done."²⁶ The Court held that "[n]o magic or mystical word or phrase is required to shift the burden of estate taxes from the legatees and devisees to the residue; however, for [the court] to recognize the testatrix's ritualistic, 'boiler plate' reference to the payment of debts, expenses, and taxes in the first clause of her will states an intent not to apportion would require that [the court] be clairvoyant."²⁷ The tax clause should have a specific direction that the taxes be paid "from my residuary estate" to assure that the direction to pay the taxes from the residue is clear.

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