Tax Law

State DeathTax Considerations in Making Lifetime Transfers

Phasing out, and the eventual repeal, of the former state death tax credit in favor of a state death tax deduction has significantly impacted estate planning considerations for clients who now live in states that impose a state estate or inheritance tax. The elimination of the state death tax credit has also had a significant impact on state revenues. It is estimated that permanent repeal of the state death tax credit has cost states upwards of $3 billion in annual state revenues. [See N. Francis, Back from the Dead: State Estate Tax After the Fiscal Cliff, Urban-Brookings Tax Policy Center (Nov. 14, 2012), http://www.urban.org/uploadedpdf/412694-back-from-the-dead.pdf; E. McNichol, I. Lay, D. Tenny, Repeal of the Federal Estate Tax Would Cost State Governments Billions in Revenue, Center on Budget and Policy Priorities (Dec. 12, 2000), http://www.cbpp.org/cms/index.cfm?fa=view&id=2128#Table%201.]

[1] State Response to Repeal of the State Death Tax Credit

The reduction in and eventual elimination of the state death tax credit as of 2005 as made permanent in 2013, has seen a varied response among states...

States reacted to the elimination of the state death tax credit in two different ways. Some states did not take any active steps and saw an elimination of the state estate tax, leaving the state either with no revenue from transfers on death or with revenue only from any previously separately enacted state estate or inheritance tax. Others responded by taking steps to enact a separately imposed estate tax. Annually Forbes.com updates its state map of states "where not to die" indicating those states imposing a state estate or inheritance tax. The map is changing as politicians respond to public sentiment. For example, in 2013 Indiana [Indiana House Bill 1001 (2013), http://www.ai.org/legislative/bills/2013/HB/HB1001.2.html] and North Carolina [North Carolina Session Law 2013-316 (2013)] repealed state estate tax provisions, as did Kansas in 2009.

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States continue to consider, revise, repeal and reenact state estate and inheritance tax rules...

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Given the impact of state estate tax, planners must keep one eye on opportunities to plan for avoiding state estate tax...

[2] Taking Domicile Into Consideration as Part of an Estate Plan

Clients who live and own assets entirely within one of the 31 states that do not impose a state estate or inheritance tax need not concern themselves with state death tax issues. It is important for advisors in those states to remind clients who are planning to move to or purchase a residence in a state that does impose an estate or inheritance tax to make sure to revise their estate plan to take into account the state tax, and also to take steps to clearly establish the state of domicile.

Along the same lines, clients who live in a state that imposes an estate or inheritance tax but who own a second home in a state that does not impose such a tax should also clarify that they are domiciled in the state that would result in a lower overall tax burden. Domicile is important in determining both state estate or inheritance tax consequences and state income tax consequences. Both state taxes should be considered in choosing state of domicile assuming the client is willing to arrange the client's living arrangements and business and social affairs to change domicile.

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[3] Impact of Lifetime Transfers to Minimize State Estate Tax

Clients who live or own property in states imposing a state inheritance or state estate tax must consider how to plan for such a tax. Even though the client may escape imposition of Federal estate tax because the client's gross estate and aggregate lifetime transfers do not exceed the federal applicable exclusion amount, the same client may face a state estate tax because the state imposes a lower exemption amount than the Federal exemption. States imposing a lower exemption amount include Connecticut, District of Columbia, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Oregon, Rhode Island, Vermont and Washington. Clients may also pay a state estate or inheritance tax even though no federal tax is owed because the client's estate plan employs the use of a QTIP trust for which a marital deduction is allowed for federal estate tax purposes, but not for state estate tax purposes. States recognizing an exemption or deduction for QTIP property include:

  • Illinois [35 Ill Comp Stat 405/2(b)],
  • Maine [Me Rev Stat Ann Tit 36 § 4062],
  • Massachusetts [Mass Ann Laws ch 65C § 3A],
  • Minnesota [Minnesota Dept of Rev Notice 12-05 (2012)],
  • New Jersey [See New Jersey Tax Handbook 7-3],
  • New York [TSB-M-10(1)M, New York State Department of Taxation and Finance (March 16, 2010)], and
  • Washington [Wash Rev Code § 83.100.47].

In states where the exemption for state estate tax purposes is less than the federal applicable exclusion amounts, the planning choices for clients continue to require lifetime transfers as between spouses to ensure full use of the state exemption regardless of which spouse predeceases. Testamentary plans in those states should also typically employ a credit shelter trust in order to fully use the state exemption on the death of the first spouse to die and ensure the continued ability of the surviving spouse to benefit from the use of those assets if necessary. A formula clause would divide assets as between the credit shelter trust and those assets passing to or for the benefit of the surviving spouse in conjunction with a portability election.

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RELATED LINKS: For a full examination of the use of lifetime transfers to achieve federal and state estate tax savings, see:

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