When it comes to death and taxes, most of the focus lately centers on Congress' ongoing battles over the federal estate tax. But many states impose their own taxes and costs when residents die. Estates too small to trigger the federal tax can easily rack up thousands of dollars in state death taxes and probate costs. Far from being repealed along with the federal tax, this state burden is on track to rise over time.
- Some states have their own estate- or inheritance-tax systems that are independent of the federal estate tax system.
- Another group of states is imposing new estate taxes to make up for revenue from the waning federal tax.
The federal estate tax is scheduled to phase out over the next few years and disappear entirely in 2010 -- only to return in 2011 when the temporary repeal expires. Opponents of the estate tax are struggling to make repeal permanent, but are facing stiff opposition in the Senate. (The House has already voted to permanently repeal it.)
A number of states have estate or inheritance taxes that are independent of the federal system. State estate taxes, like the federal version, are assessed on the estate as a whole. But states can have different rules about who pays.
In the past, most of the other states haven't had to impose separate taxes to get a piece of their residents' estates. Instead, the states received a portion of what the estate owed the federal government. This "pickup" tax raised state coffers without the estates owing any extra tax. However, states are losing this boost. The federal law temporarily repealing the estate tax has already phased out the states' ability to take a portion of said tax. That cost states billions in lost revenue. So it's probably not surprising that many states are trying to hang on to their piece of the pie by decoupling their estate tax system from the federal system. In effect, they're pretending that the repeal isn't happening and taking from their residents' estates some of what they used to get from the federal government.
Some states made their decoupling temporary, hoping that revenues would improve enough in coming years so that they wouldn't miss the lost tax. The states also might get a break if efforts to make the federal repeal permanent fail. The full state death-tax credit would return, along with the rest of the federal estate tax system, in 2011.
Regardless of how this issue plays out, properand thoughtful estate planning can serve to minimize the impact of estate taxes while maintaining one's privacy and bypassing probate.
In the coming years, there will most likely be a lot of changes to the way states impose their estate taxes. For example, the substantial changes to the federal estate tax laws enacted in 2001 under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) include the gradual phase-out of the state death tax credit. This means that states with only a pick-up tax in place will entirely lose their estate tax revenues unless additional state estate taxes are enacted (which many have already done). Just keep in mind that the billions of dollars of associated lost state revenues will have to be made up somewhere. (Translation: look for some form of higher state taxes imposed to make up the shortfall.)
