State Estate and Inheritance Tax Calculations
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 phased out the federal credit for estate taxes for deaths starting in the year 2005. Since then, the patchwork quilt of state taxes has grown more colorful and the estate planner's job has gotten more intricate.
Right now, 20 states have estate taxes (five also have inheritance taxes) that are not tied to the former federal credit. Five other states have inheritance tax-only regimes. Some state estate tax laws are based on the federal credit as of a pre-EGTRRA date; other states have adopted state estate exemptions and rates independent of the federal law. But the rules relating to state death taxes continue to be volatile as a result of new legislation, new regulations and inconsistent administrative enforcement.
The balkanization of state estate and inheritance tax laws after EGTRRA has increased the difficulty of planning for taxes resulting from death and planning organizational forms for holding assets. If a state decouples as to the tax rate, but conforms to the federal increases in the exempt amount, there still will be no federal or state estate tax on a taxable estate equal to the federal exempt amount. Beginning in 2006, however, the exemption in a number of states is substantially less than the federal estate tax exemption -- posing a further dilemma to planners seeking the optimum tax result in the estates of both spouses.
Effect of Increased State Taxation at Death
The effective impact of state taxes at death has been ameliorated by (1) the federal estate tax credit, phased out in 2004, and (2) the deduction of such state taxes from the federal tax base under Internal Revenue Code Section 2058 for the years 2005 through 2009 at marginal rates from 47 percent to 45 percent.
The actual effect of the change from a credit to deduction has been to increase the aggregate marginal rate of federal and state taxes imposed at death. To illustrate, upon the death of the surviving spouse or a single individual (using a marginal state tax rate of 16 percent equal to the top state death tax credit rate of 16 percent in effect in 2001), the marginal combined federal and state estate tax works out to be 54 percent in 2002, 57 percent in 2003, 60 percent in 2004, 55.48 percent in 2005, 54.64 percent in 2006 and 53.8 percent in 2007 to 2009.
The benefit from deduction of state taxes at death from the federal estate tax base declines as the federal rates are lowered. So -- if compromise federal estate tax legislation significantly increases the federal exemption and lowers the federal estate tax rate to a level such as 15 percent -- the impact of the state taxes correspondingly increases. For example, given a state marginal rate of 16 percent, and a federal marginal rate of 46 percent (beginning in 2007), the state effective marginal rate is only 8.64 percent. But if the federal marginal rate is reduced to 15 percent, the effective state marginal rate increases to 13.6 percent and the effective combined rate of federal and state taxes is 28.6 percent. In such an event, planning for control of estate and inheritance taxes becomes increasingly important.
Programs Performing State Calculations
Several of the comprehensive estate-planning programs feature, with varying degrees of sophistication, calculation of state estate and inheritance taxes. They also permit computation of marital deduction funding at the state exemption level, or with state qualified terminable interest property (QTIP) planning.
Full disclosure: Because one of the programs is mine, I am refraining in this e-newsletter from evaluating the programs. Instead, here in alphabetical order is a simple listing of some programs that have state estate-planning features:
BNA Estate Planner, V. 2005.2: Integrated calculation of estate taxes and planning techniques. BNA -- demo available.
Intuitive Estate Planner (IEP), V. 9.0a: Donald H. Kelley and Konrad Schmidt, III: Integrated calculation of estate taxes and planning techniques. Thomson/West -- online demo available.
ViewPlan, V. 4.6.0: Integrated calculation of estate taxes and planning techniques. CCH -- demo available.
zCalc, V. 9.0: Gross value calculation of estate taxes and standalone calculation of various planning techniques. Fast-Tax -- on site demo, 30 day trial available.
The basic state estate tax and inheritance tax calculation features of these programs may be summarized as follows:
|Rates / Exemptions||default||default and manual entry (1)||default and manual entry (2)||default|
|Circularity||as default only||default and as selected||default and as selected||as default only|
|Tax type||Est/Inh or both||Est/Inh or both||Est/Inh or both||Est and Inh|
|Identify beneficiary (bfy)||select class||named bfys||named bfys||no|
|Inheritance (Inh) tax class||enter $ or percent to class||enter $, percent or specific asset to bfy||enter percent only to bfy|
|State QTIP||enter amount||select QTIP or not||no||no|
|Adjustments||as entered||as entered||no||no|
|Deduction of federal estate (Est) tax||default and manual selection||default||no||no|
(1) Allows selection of tax computation and interstate allocation attributes, manual entry of threshold amount for estate tax and manual entry of inheritance tax rates
(2) Allows manual entry of both rates and exemptions for estate tax to override defaults
There also are some noteworthy online resources:
Illinois furnishes the 2005 Decedents Estate Tax Calculator that performs the circular calculation of state estate tax, with deduction of the state estate tax from the state tax base, and that generates an audit trail of this calculation.
The Minnesota Tax Calculator for 2005 computes the federal estate tax and state estate tax credit using pre-EGTRRA tax rate and unified credit tables.
The battle over repeal of the so-called "death taxes" continues to rage at both the federal and state levels. The variation among the states has created a growing perception that having a decoupled state estate tax puts a state at a competitive social disadvantage compared to untaxed states. These issues are addressed in articles on the following sites:
Kiplinger's Personal Finance discusses how to cope with decoupled estate taxes through a change of domicile.
Retirement Information Living Center reviews and compares taxation in the various states for purposes of selection of retirement venue.
Susan Kimsey Smith, Citizens Finance Review Commission Analysis of Proposed State of Arizona Estate Tax addresses the political factors involved in enactment of a decoupled state tax.
Vermont Estate Tax Brief includes an analysis of the issues to be considered in the enactment of a decoupled estate tax.
The case for state estate taxation (with statistical data) is presented in Elisabeth C. McNichol and Joseph Llobrera, Why States Should Act Now to Preserve Their Estate and Inheritance Taxes (Center on Tax Policy 2003).
Background Literature and Resources
There are a number of websites that present information on state estate and inheritance taxes including analyses of state death taxes, summaries of state death tax laws and links to state legislation:
CCH State Estate Taxes has current summaries of the state death tax laws of all states.
Findlaw offers free links and citations to estate, inheritance, and similar statutes for Washington, D.C. and all states.
For a review of the death taxes in the decoupled states, a discussion of the impact of state tax rates and a table of state death tax legislation, see Linda B. Hirschson, The Decoupling of the Federal and State Estate Taxes.
Charles D. Fox IV, State Death Tax Laws, summarizes all state estate and inheritance tax laws (updated through Feb. 4).
Stephen C. Hartnett and Dennis M. Sandoval, Reports of its Death Are Greatly Exaggerated: The State Death Tax Lives On (CCH Estate Planning/Feb/Mar 2004).
Elisabeth C. McNichol and Daniel Tenny, Many States Are Decoupling From The Federal Estate Tax Cut, Center On Budget And Policy Priorities, updated as of May 23, 2005, and other reports.
Drafting for the Decoupled State Estate Tax
With state death taxes unrelated to the federal estate tax law, formula clauses may need to be included in dispositive documents that will create family shares sufficient to assure the availability of the state exemptions in both spousal estates and address the disparity between the federal and state exemptions. Suggestions from Natalie B. Choate for such clauses may be found.
For suggestions on marital deduction planning in a time of changing federal and state tax laws, see Howard M. Zaritsky's Estate Planning While You Wait, What To Do While Congress Debates Repeal.
Unlike the federal estate tax rule, many states do not allow a marital deduction for QTIP property for the state estate tax per se. Some states, however, permit a separate QTIP election for state estate tax purposes. The credit shelter trust, or the portion of the credit shelter trust for which a state, but not a federal QTIP election is intended, may be drafted so as to qualify for the state marital deduction. See Linda B. Hirschson, The Decoupling of the Federal and State Estate Taxes.
Tax Situs of Property
An obvious possible method to deal with the impact of decoupled state taxes is for clients to move their domicile to a non-tax state. But, even though the taxpayer resides in a state imposing no death tax, land and tangible personal property owned by the decedent in a decoupled state may generate tax in the state of tax situs of such property.
Another method would be to constructively move the taxable situs of assets from a decoupled tax state to a state imposing no estate or inheritance tax at death. This can be done through techniques of equitable conversion, such as installment sale or placing such property in a trust, limited partnership, limited liability company (LLC) or corporation. The reverse methodology when the client is domiciled in a decoupled state is to purchase land or tangible personal property in a non-tax state with the property titled directly to the client.
Through such devices the tax situs of the land or tangible personal property may be different than the tax situs of ownership interests resulting from installment sale of the property or the transfer of such property into trust or business entity form. Resources on the Internet discussing interstate planning for state estate and inheritance tax minimization through change of domicile, or tax situs of property, include the following:
Thomas E. Rutledge, To Boldly Go Where You Have Not Been Told You May Go: LLCs and LLPs in Interstate Transactions (ALI/ABA 2005).
Alan R. Lipman, Planning Seminar for the Florida Snowbird addresses issues relating to domicile and multistate estate taxation.
Situs of a partnership for Pennsylvania income tax purposes (capital gain) is discussed at Pennsylvania Personal Income Tax, No. PIT-05-003, Sale of Partnership Interest - Nonresident.
TAX INFORMATION RELEASE NO. 2000-3, December 29, 2000, RE: Application of Hawaii Estate Taxes to a Nonresident's Interest in a Partnership That Owns Hawaii Real Property ruled that Hawaiian land held in a partnership is subject to Hawaiian estate tax.
The current legislative climate requires an increasing emphasis on the effect of state estate and inheritance taxes on estate planning. The software packages listed in this newsletter will calculate the state taxes at death and demonstrate the effect of such taxes on the estate plan. The Internet includes a variety of text resources that will help you obtain a perspective on the place of state taxes at death in the general scheme of estate planning and methods of planning in this time of increasing uncertainty in the interrelated regimes of federal and state estate and inheritance taxes.
Trusts & Estates magazine is pleased to present the monthly Technology Review by Donald H. Kelley -- a respected connoisseur of the software and Internet resources wealth management advisors use to further their practices.
Kelley is a lawyer living in Highlands Ranch, Colo. and is of counsel to the law firm of Kelley, Scritsmier & Byrne, P.C. of North Platte, Nebr. He is the co-author of the Intuitive Estate Planner Software (Thomson-West 2004). He has served on the governing boards of the American Bar Association Real Property Probate and Trust Section and the American College of Tax Counsel. He is a past regent and past chair of the Committee on Technology in the Practice of the American College of Trust and Estate Counsel.
Trusts & Estates has asked Kelley to provide his unvarnished opinions on the tech resources available in the practice today. His columns are edited for readability only. Send feedback and suggestions for articles directly to him at [email protected]
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