Financial advisors with wealthy clients whose estates exceed the unified tax credit of $5.49 million (for an individual) or $10.98 million for a couple shouldn’t necessarily expect those estates will have no tax liability.
Eighteen states plus the District of Columbia levy an inheritance tax, estate tax or both, but their numbers are declining, according to a new report from the conservative-leaning Tax Foundation. Delaware recently passed legislation to do away with its estate tax beginning in 2018, the same year that New Jersey ends its estate tax though its inheritance tax continues.
“Since 2005, states have been moving away from estate and inheritance taxes, a trend that is likely to continue,” Jared Walczak, Senior Policy Analyst with the Center for State Tax Policy at the Tax Foundation and author of the report.
Estate taxes are imposed on the net value of an estate, after any exclusions or credits, before there is any distribution to heirs. Inheritance taxes are paid after that distribution and paid by the beneficiaries, based on their share of the inheritance and, often, their relationship with the deceased. Transfers to spouses are exempt from both taxes.
In addition to the pending elimination of some of these taxes, several states – Maryland, Hawaii and New York -- plus Washington, DC, have raised the exemption level for their estate taxes.
Up until 2005, estates received a credit for state inheritance and estate taxes paid against federal estate tax liability, but that was eliminated under provisions of the Economic Growth and Tax Relief Reconcilation Act of 2001 in a gradual phasing out.
Before 2005 many states levied a so-called “pick-up tax” on estates, which was essentially a revenue-sharing arrangement with the IRS that allowed states to collect revenues on estates larger than the federal exemption without creating their own estate tax. After 2005, some states chose not to collect any estate taxes; others chose to have their own.
“The elimination of that credit combined with the increased unified tax credit has brought to the focus of estate taxes back to where it was a century ago,” according to the Tax Foundation report.
Estate tax rates and inheritance tax rates for the states that still impose them vary widely, as you can see by the chart below.
Washington State has the highest rate, while Maine has the lowest.
Exemptions from the estate tax also vary, with some states like Hawaii and Maine using the same credit as the federal estate tax – $5.49 million for individuals – while Oregon exempts just $1 million and Rhode Island $1.15 million.
Altogether state inheritance and estate taxes collected $5.1 billion in fiscal 2016, accounting for 0.6% of state tax recollections, and federal estate taxes brought in $21.4 billion, or less than 0.7% of federal tax revenues. Though these numbers are relatively tiny, the effect of state inheritance and estate taxes is much larger, according to the Tax Foundation.
Among other things estate and inheritance taxes can drive wealthy residents out of their states, which then lose revenues they might otherwise have collected, and they inspire “estate planning and tax avoidance strategies” that create "dead-weight losses, reduce economic efficiency, and in some instances break up farms and family-owned businesses,” according to the Tax Foundation report.
--- Related on ThinkAdvisor: