From a federal perspective, estate planning has never been more boring. The federal gift and estate tax exemption and the rules governing estate planning have—for the most part—stayed the same since 2013. The states, however, continue to move the chess pieces around the board. While the majority of U.S. states impose no additional tax at death, some states continue to impose hefty estate or inheritance taxes.
Only the extremely wealthy will incur federal estate tax as the exemption amount is $5.45 million in 2016 (up $20,000 from 2015). Many estates not subject to federal estate tax will incur state estate tax because it often kicks in at much lower thresholds than the federal tax.
Currently, there are 32 states that impose no state estate tax.[i]The big news as of January 1, 2016 is that Tennessee abolished its estate tax, leaving only 18 states and the District of Columbia with separate estate or inheritance tax systems. Of those, 12 impose a so-called "pick-up tax," and the others impose either a stand-alone estate or inheritance tax. The good news is that even in states with an estate tax, the exemptions are migrating higher, meaning fewer estates than ever before are subject to state-level estate tax.
Pick-Up Estate Tax
In 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) phased out the federal state death tax credit, which was the basis of most state estate tax schemes. After EGTRRA, many states "decoupled" their estate taxes from the federal estate tax and continued to impose a pick-up tax based on a prior version of the Internal Revenue Code.
While multiple states have retained a pick-up tax, only three states currently peg their exemptions to the federal estate tax exemption—Delaware, Hawaii and Maine[ii]—but many others are increasing their exemptions, significantly in some cases. Both Maryland and New York are scheduled to increase exemptions incrementally to match the federal exemption by 2019.[iii] Minnesota and Rhode Island have also ticked upward, and D.C. has plans to increase the exemption if the District meets certain revenue goals.[iv]
Stand-Alone Estate Tax
Only Connecticut, Oregon and Washington have left the federal estate tax credit behind and imposed a free-standing estate tax. The structure of the tax is very similar to the federal estate tax, meaning that there's an exemption amount and tax is imposed above that threshold at a graduated rate schedule. Washington state began increasing its exemption amount by the consumer price index in 2014, similar to the federal exemption, and Connecticut stands pat with a $2,000,000 exemption.
Inheritance Tax
Several states impose an inheritance tax, and in limited cases, this tax is imposed in addition to another form of estate tax. Generally, inheritance tax is imposed only on certain testamentary transfers based on the recipient of the bequest (for example, transfers to individuals other than a surviving spouse, grandparents, parents, lineal descendants and their spouses, and siblings), and the amount of the tax may vary based on the recipient of the property. Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania impose inheritance tax at varying levels on transfers to certain beneficiaries.
A Look at the States
Separate State QTIP Election
Most states that continue to impose an estate tax no longer match the federal exemption amount. Thus, for wealthy married decedents, the portion of the estate taking advantage of the marital deduction for federal purposes may be less than the state marital deduction. Therefore, making a separate state QTIP election will help to achieve tax efficiency.
While portability may also be a solution to this problem in some cases, without a separate election, decedents may be forced to incur state estate tax upon the death of the first spouse to die or "waste" a portion of their federal estate tax exemption. Some states, however, like Connecticut and New York, don't allow for a state QTIP election that is inconsistent with the federal election.
