State death taxes: the new planning concern: despite the repeal of the federal estate tax for 2010, don't overlook the other factor in estate planning: your clients can still be hit by the increasing number of state death or inheritance taxes.
In the waning weeks of 2009, Congress failed in its attempts to extend the federal estate tax rules for persons dying during 2010 and later years. In brief, the "sunset" provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) are now in effect. The federal estate tax is repealed for one year (2010), but is scheduled to return with a vengeance in 2011, based on the rules in effect prior to 2001 ($1 million exemption amount and top tax rates approaching 60%).
If more permanent reforms had been enacted in 2009, the exemption amount of $3.5 million and top estate tax rate of 45% (in effect during 2009) would have been retained for 2010 and perhaps later years as well. While many expect Congress to resume consideration of a more stable, long-term tax solution, including a retroactive enactment of some form of estate tax for this year, the story does not end with those developments.
There remains another complicating factor in estate tax planning--one that is often overlooked by planners and their clients. By our count, as of Jan. 21, 2010, 17 states collect their own estate tax, inheritance tax, or both. A much larger slice of American taxpayers may be subject to the state death taxes, even without federal estate tax liability. And with most states dealing with historic budget deficits in this struggling economy, it is not unreasonable to suppose the list of "death tax states" will grow in years to come.
In the past, state death taxes were relatively simple and were often overlooked in planning discussions. State death tax revenues were linked to the federal estate tax rules. In fact, most states collected their portion of estate taxes through the federal estate tax return, which reported the "state estate death tax credit." Based on that amount, the states received their share of the estate tax from the U.S. Treasury, and the state portion was aptly named the "sponge tax" or "pick-up tax."
But in 2001, passage of EGTRRA led to a fundamental change in how various states collect estate tax revenues. This legislation has gradually increased the federal estate tax exemption amount until the one-year repeal of the federal estate tax in 2010 (as originally scheduled by EGTRRA). The phase-out of the federal estate tax was coupled with the reduction, and ultimately the repeal, of most states' sponge tax after 2004. In other words, the revenue-sharing arrangement ended after the federal state death tax credit was phased out after 2004. Unless a pick-up tax state acted to escape out of the now-defunct pick-up tax system (or "decouple"), or enacted its own separate estate tax law, the estate tax as a source of state revenues would end.
State estate taxes
Keeping tabs on all 50 states death taxes is a never-ending task. As of Jan. 1, 2010, 13 states plus the District of Columbia, have some form of estate tax for deaths occurring in 2010. Most are former pick-up states that decoupled from the federal estate tax. Ten of these states (Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, and Vermont) apply some or all of the pre-EGTRRA federal exemptions, tax rates, definitions and deductions. Certain other states (Connecticut, Ohio, Washington, and Washington, D.C.) have enacted their own estate tax rules that are not linked to federal estate tax calculations. Recently, some states (including Virginia and North Carolina) repealed their estate tax; Wisconsin allowed it to expire; and others never had one.
State inheritance taxes
Six states (Indiana, Iowa, Kentucky, Nebraska, Pennsylvania, and Tennessee) collect a separate inheritance tax without an estate tax, and two states (Maryland and New Jersey) collect both an inheritance tax and state estate taxes. Inheritance tax rates, deductions and exemptions vary widely from state to state. There is no federal inheritance tax.
Lack of uniformity
To make matters worse, the tax rates and exemptions are not uniform from state to state. This brings new levels of complexity to estate planning.
The complexity is only expected to increase as more states seek to decouple from the federal rules or enact their own independent tax rules. For instance, let's take a couple with a net taxable estate of $3.5 million upon the second death. No federal estate tax is due, but the state estate tax may surprise you. In Ohio (with the relatively low exemption of $338,000 and top rate of 7%), the state estate tax is $219,700. In states like Maryland with a $1,000,000 exemption, the state estate tax is $229,200, plus Maryland levies an additional 10% inheritance tax on specified non-family heirs. The tax calculations can be particularly onerous if the decedent owns properties located in multiple states.
You say, "My client doesn't reside in a taxing state." Fine, but does your client know for certain where he or she will be domiciled at the time of his or her death? Even if that were a certainty, the legislators of any state without a death tax today may choose to enact one in the future.
Need for state-specific expertise and new strategies
Advisors may find it increasingly common for estates to owe state estate taxes, state inheritance taxes or both--even if there is no federal estate tax liability. While our state-by-state survey shows the tax rates do not exceed 20% (most are around 10%), that does not diminish the importance of estate planning for those clients whose estates appear to be free from federal estate tax. Taking into account debts and liabilities apart from taxes, the executor or heirs may have insufficient liquidity soon after the death, even with relatively low death tax rates.
In states that collect their own estate taxes, conventional "A-B Trust" planning for married couples may not be enough. Where the state exemption amount is less than the federal exemption amount, a portion of the B Trust may be taxed when the first spouse dies. To avoid the tax trap of "overfunding" the B Trust, advisors need to become familiar with newer strategies, such as an "A-B-C Trust" plan.
The need for effective estate planning, particularly the role of permanent life insurance, continues to burn brightly, despite the uncertainty surrounding federal estate taxes. This is especially true in view of the variety of state death taxes on the books today, and those quite possibly added in the coming years.
By The Numbers
17: states that collect their own estate tax, inheritance tax, or both as of Jan. 21, 2010.
* Helpful Definitions
Estate tax: Imposed on the estate of a decedent, and based on the total value of the decedent's entire interest in real and personal property ("estate") upon his or her death.
Inheritance tax: Imposed on each heir's right to receive property transferred to him or her as inheritance. It is calculated separately for each heir and depends on the value of the heir's inheritance, the type of property and category of beneficiary.
By Richard E. Kait, JD, LLM, CLU, ChFC
Richard E. Kait, JD, LLM, CLU, ChFC, is Second Vice President Advanced Sales, and Director of Premium Financing for Protective Life Insurance Company.
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|Title Annotation:||MAIN THEME: ADVANCED MARKETING|
|Author:||Kait, Richard E.|
|Publication:||Life Insurance Selling|
|Date:||Feb 1, 2010|
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