States continue to claim their share through the estate tax

JAN 16, 2014
Thanks to a deal hammered out while the nation teetered at the edge of the fiscal cliff in December, a historically generous $5.25 million exemption now exists for federal estate taxes. However, residents of 19 states must still contend with some form of death taxes. Fourteen states and Washington, D.C., assess estate taxes, seven impose inheritance taxes — which are paid by heirs, not the estate — and Maryland and New Jersey remain the only two states that collect both. State estate taxes, on average, exempt estates up to only $2 million, with five of them at $1 million and New Jersey's kicking in at $675,000. “People should definitely re-look at their estate plans, because they may focus on the federal exemption and not the state exemption,” said Bill Hart, a partner at Bulkley Richardson and Gelinas. “There are many people who are comfortably well-off who will never pay federal estate tax now but who will pay Massachusetts estate tax.” Massachusetts' tax kicks in on estates worth more than $1 million. It has a top rate of 16%.

MORE TAX-FRIENDLY

A few states have become more tax-friendly in recent years, at least in death. Ohio and North Carolina both dropped their estate taxes beginning this year, and Indiana repealed the inheritance tax that it had imposed on residents. Dela-ware's estate tax was scheduled to fade away in July, but in March, the state Legislature voted to keep the levy, which has a $5.25 million exemption and a top rate of 16%. Wealthy clients often own homes in different states, so estate and tax planning regularly include a discussion of which should be their official domicile, said Lena Barnett, an estate attorney with an eponymous firm. “But we would not recommend a client change his or her life only for tax-planning purposes,” she said. Financial planning may also include making sure insurance proceeds do not increase the estate tax liability of the client, and that the full insurance death benefit is available for beneficiaries. Maryland's estate tax, which has a $1 million exemption and 16% maximum rate, is written in such a way that it allows a couple to fully fund their federal exemption and put off owing Maryland estate tax until the second death. “With proper planning and document drafting, it is possible for a couple to fully utilize their federal estate tax exemptions without triggering Maryland estate tax at the death of the first spouse,” Ms. Barnett said. “Maryland and federal estate taxes may have to be further addressed upon the death of the surviving spouse, depending on the tax laws and client financial circumstances.” Maryland's inheritance tax takes a 10% haircut off the amount that a state resident leaves to a nonlineal relative, such as a niece or even a friend. New Jersey, the only other state to levy both an estate tax and an inheritance tax, has a $675,000 exemption and top estate tax rate of 16%. It also has a 16% inheritance tax.

EXCLUSIONS

Most of the dozen states, plus the District of Columbia, that collect just an estate tax set exemption amounts ranging from just under $1 million up to $5.25 million. They are: Connecticut, Delaware, Hawaii, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Washington and Vermont. In a change that will take effect in 2014, Washington state will increase its top estate tax rate to 20%, from 19%. The estate tax rate begins at 10%. Its $2 million ex-emption will also be indexed to annual inflation, and some family-owned businesses can be exempted up to $2.5 million.

BENEFICIARY RATES VARY

Five states — Iowa, Kentucky, Nebraska, Pennsylvania and Tennessee — impose just an inheritance tax, which generally increases for beneficiaries the further removed they are from the deceased. Rates range from 9.5% to 18%, and some states exempt a certain amount of inheritance from the tax. Tennessee plans to phase out its inheritance tax — and it's scheduled to cease altogether as of Jan. 1, 2016. Tennessee also repealed a state gift tax last year. Oregon last year switched from imposing an inheritance tax to an estate tax. The state set a 10%-16% rate range on estates greater than $1 million.

MULTIPLE LEVIES

Some estates will owe taxes to multiple states because the deceased person owned a vacation home or other tangible property such as a boat outside the state in which they lived when they died. Intangible property, such as securities and money in bank accounts, is taxed in the state where the individual legally resided at death, regardless of where the investments are physically located. Many states this year have reacted to the U.S. Supreme Court ruling June 26 stipulating that same-sex married couples deserve the same federal benefits afforded heterosexual married couples, including estate tax treatment.

REFUNDS

Vermont, one of the 13 states plus the District of Columbia where gay marriage is legal, has since said it will refund any overpayment of Vermont estate taxes as a result of the Supreme Court decision. The state Department of Taxes said that any surviving spouse of a same-sex marriage who did not receive a marital benefit at the federal level in an estate in which Vermont was paid may be due a refund. The other states that allow same-sex marriages are: California, Connecticut, Delaware, Iowa, Maine, Maryland, Massachusetts, Minnesota, New Hampshire, New York, Rhode Island and Washington. J.T. Hatfield Charles, founder of financial advice firm Financial 360, said advisers of gay clients in those states that allow same-sex marriage should look into whether their clients may have previously overpaid state estate taxes. Proactively, gay married couples may need to reassess their estate tax planning overall with a tax professional. “Typically, on estate tax returns, you'll come out ahead,” he said. Of course, there's one important caveat. “Keep in mind that looking back could open the client up to additional audits,” Mr. Charles said.

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