David Shayne, Of Counsel is based in our Chicago office.
The new $5 million federal estate tax exemption effective through 2012 relieves many families of the threat of a large federal estate tax burden. Married persons can exempt up to $10 million of their assets provided they plan carefully, and the tax rate on any excess is 35 percent versus 45 percent as previously imposed. This is particularly significant for owners of small businesses and valuable real estate, that could be subject to sale to pay the estate tax.
Beware of a False Sense of Complacency
There are still many states, however, that have either an estate or inheritance tax that continues to be a concern, due to their much lower exemptions, albeit with lesser rates. To be exact, there are currently 23 states plus the District of Columbia that impose an estate or inheritance tax or both. It is particularly important that residents of these states do not get lulled into a false sense of complacency with regard to keeping their estate plans current.
Illinois is the most recent state to re-enact its estate tax effective January 1, 2011, with a $2 million exemption. Nine states and the District of Columbia impose a tax on estates of $1 million or less. Typically, the tax rate range is from 6.4 percent to 16 percent. The top marginal combined federal and state tax rate is about 47 percent. The actual tax varies with the amount of the exemption, the rate of the state tax and whether or not the state allows the deduction of its tax to reduce its own taxable estate which thereby reduces its tax, a circular computation.
One consequence of the mismatch between the federal and state estate tax exemptions is that even where no federal estate tax is due, the state estate tax may be as much as $391,600. (This tax is more likely to be imposed on unmarried individuals, as married individuals with appropriate estate planning can take advantage of the marital deduction from estate and inheritance taxes.)
Another drawback is that a federal estate tax return may need to be prepared in order to calculate the state estate tax even when no federal return needs to be filed. A federal return may be required as well in order to pass a predeceased spouse's unused estate tax exclusion to the surviving spouse under the new federal concept of "portability." No state as yet permits a surviving spouse to claim the deceased spouse's unused state estate tax exemption. As a result, establishing a separate trust in the first estate equal at least to the state exemption may be desirable.
The Future Is Unpredictable
Unless changed by Congress, the federal estate tax rate is scheduled to revert to 55 percent on estates over $1 million in 2013. The President's budget proposal would instead return to the 2009 regime: a 45 percent tax on estates over $3.5 million and $1 million gift and generation-skipping transfer tax exemptions. Based on past performance, Congress probably will not make a change until shortly before the expiration of the existing law in 2013. And, of course, in their search for more revenue more states may add an estate tax. No one can safely predict what will come in this area. There is even a remote possibility of estate tax being levied on previously non-taxable gifts, often referred to as a "clawback."
Moving to a state with no estate tax, such as California, Florida or Texas, may appeal to particularly tax-averse individuals. In their golden years, many people head to the sunshine states that happen to be tax havens, but they do not effectively cut all their ties with their former residence. It is not always simple to rid oneself of a long-standing domicile. Contrary to common supposition, it is not simply a matter of how many days one is absent from the state of origin. In one famous court case, an estate was forced to pay estate tax in two states when the U.S. Supreme Court refused to break the deadlock.
Even those who live in a jurisdiction without an estate tax – but who own real property or tangible personal property, such as an automobile, pets or art located elsewhere – may subject part of their estates to tax where the property is located.
Minimize Tax With Lifetime Gifts
One way to minimize or avoid state estate tax altogether is to make large lifetime gifts. Only Connecticut and Tennessee have a gift tax so it may be possible, even just before death, to drastically reduce the state estate tax by a tax-free gift. Deathbed gifts, however, are not effective in Maine which has a one year look-back for gifts.
Another solution is to limit the non-marital gift to the amount of the state estate tax exemption. This may, however, severely burden the estate of the surviving spouse. Five states – Illinois, Maryland, Massachusetts, New Jersey and Oregon – permit a separate state tax exempt marital trust that can serve to take full advantage of the federal exemption and defer the state estate tax until the surviving spouse's death or possibly avoid it altogether.
Some examples of the estate tax situation in selected states and a list of the states that impose an estate or inheritance tax, or both, follows:
Estate tax: CT, DC, DE, IL, KS, ME, MA, MN, NY, NC, OH, OK, OR, RI, VT, WA
Estate and inheritance tax: MD, NJ
Inheritance tax only: IN, IA, KY, NE, PA, TN
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
