Changes in Tax Laws

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"What is the Impact of Estate Tax Elimination?"

Phasing out of the federal estate tax credit and reducing of the federal tax has many states and their residents in a quandary.

States that tie their estate tax revenue to the federal state death tax credit are faced with the loss of revenue and are enacting new legislation that is causing serious impact on many individual estate plans. A majority of states have had a pick-up tax law. Using this tax, states can take part of the federal tax levy. Therefore, they are generally said to have "no" inheritance tax. But, the reality is that they are taking part of the amount that is calculated as federal estate tax.

All 50 states, and the District of Columbia, impose a tax on the estate of a decedent, either in the form of an inheritance tax or an estate tax. An inheritance tax is a tax on the assets received by a person. An estate tax is a tax on the assets of the decedent. Since the enactment of the 2001 Tax Act, many states faced with losing revenues are revising their tax laws to unlink ("decouple") them from the federal system.

Making smaller estates subject to tax

Some estate tax states have also changed their tax laws to impact a greater number of estates by lowering their exemption amounts. Under the old tax structure, many of these state tax systems mirrored the federal tax system. However with the new legislation of keeping exemption amounts from rising to match the federal system, some estates that will not owe federal tax will find that state taxes may still have to be paid. For example, New Jersey enacted legislation to keep its exemption at $675,000. So, in 2004, while an estate valued at $1.5 million is exempt from federal tax, it will still be subject to state tax.

What can you do in this changing tax environment?

Even though the combined amount of state and federal estate taxes may be lower, individuals who live in states that have decoupled may end up paying more in state tax. Furthermore, some estates may be subject to state taxes even if their assets are exempt from federal taxes.

Married couples using a credit shelter trust may need to revise their estate plan

Many estate plans created prior to the 2001 Tax Act utilized the maximum allowance that could pass free of federal estate taxes by allocating that amount to a credit shelter trust. However, in states that have decoupled from the federal changes there may be state death taxes due at the death of the first spouse. These taxes are on the portion that the federal exemption exceeds the state exemption. This is a complicated subject and the effect on individual estates varies over time and is dependent on the estate size.

Example: Bob dies in 2004 with assets that total $1.5 million. Bob's will provides that the maximum amount of his estate that can pass free of federal estate taxes be allocated to the credit shelter trust. However, Bob lived in a state that imposes a death tax on estates valued at more than $1,000,000. Assuming no other variables and a state death tax rate of 16 percent, Bob's estate would owe state death taxes of $80,000 ( 16% of $500,000). Because Bob's entire estate passes to the credit shelter trust, Bob's spouse may have difficulty paying the taxes.

This situation can be avoided by revising the estate plan to provide that only amounts that can pass free of both federal and state estate tax be allocated to the credit shelter trust.

Caution: This may not be the best answer for all estates. Because the federal estate tax rates are generally higher than state death tax rates, some couples may choose to pay death taxes to the state at the death of the first spouse and enjoy greater savings by paying federal estate tax at the death of the surviving spouse.

If you have employed these techniques, or are otherwise concerned about the changing tax environment, you should consult a qualified estate planning professional and your attorney to discuss what changes to documents, if any, are appropriate.

As a friend of Gospel for Asia, we will offer you, without obligation, an initial conversation with one of PhilanthroCorp's Estate Specialists. This will give them an opportunity to review your current situation and tell you very simply whether or not they would be able to help. To contact a PhilanthroCorp Estate Specialist, call 800-876-7958 ext 2127 or email (click here)

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