A component of President-elect Donald Trump’s tax proposal is to repeal the federal estate tax (death tax). For the 2015 tax year, the federal estate tax accounted for an estimated $17 billion in annual revenue, according to statistics published by the Internal Revenue Service. With a maximum federal tax rate of 40 percent and the 2016 exemption amount set at $5.45 million, the estate tax is one of the most progressive taxes on the federal level in the United States. At the federal level, a repeal of the estate tax results in decreased revenue, increased wealth transferred at death and an uptick in savings and investment; but what does a federal repeal mean for the states that currently impose an estate tax? The impact of a federal repeal will vary based on the level of interconnectedness that exists between the federal estate tax and the local estate tax.
Before the Bush tax cuts in 2001, every state and the District of Columbia imposed an estate and/or inheritance tax. While most states allowed their estate tax to be repealed with the elimination of the federal credit, several states passed legislation and continued imposing an estate tax. Despite the revival of the federal estate tax, only a minority of states impose an estate tax. Currently, 18 states plus the District of Columbia impose an estate and/or inheritance tax. These 19 jurisdictions collect more than $4.5 billion in revenue annually, according to a report from the Center on Budget and Policy Priorities.
The estate tax regimes across the states vary widely. Many states have drafted their estate tax laws to function independently of the federal estate tax in order to shield them from the impact of a federal repeal. Most commonly this is done by enacting a static I.R.C conformity date as opposed to conforming to the current version of the code. Connecticut, one of a few states with independent estate taxes, would be largely unaffected by a repeal of the federal estate tax because they have codified an automatic change in conformity should the federal estate tax be repealed.
While many states have protected their estate tax from the impact of a federal repeal, others have not. Some states, including Delaware, conform to the code that is in effect as of the date of the decedent’s death. This means that any taxpayer who dies after a repeal of the federal estate tax would not be subject to the state level estate tax. Other states, such as Hawaii, only require a taxpayer to file an estate tax return if one was filed at the federal level, which means that their estate tax would effectively be repealed along with the federal estate tax.
Several states link their estate tax exemption amount to the federal exemption and/or use the federal taxable estate as the starting point to determine the tax due in their state, like New York, which updated its conformity with the Internal Revenue Code in 2014. As a result, changes to the federal estate tax could have a significant impact on the administration of their estate tax.
Whether states will retain their estate tax following a federal repeal is unclear. Recently, there appears to be a shift away from the state estate tax. In the past few years, several states, including Ohio, North Carolina and most recently New Jersey, have repealed their estate tax. Jurisdictions such as the District of Columbia, New York and Maryland are currently phasing in increases to their exemption amounts to match the federal exemption.
While most of the changes in the state estate tax world appear to be leading away from the reliance on estate taxes for revenue, a few states have gone in the opposite direction. For instance, a couple of states, such as Hawaii, reinstated their estate tax in 2010 after allowing it to lapse with the repeal of the federal credit. Despite some tax policy arguments in favor of bringing back state-level estate taxes, there does not appear to be much state movement towards that end.
Although many jurisdictions chose to keep their estate tax after the repeal of the federal credit, it is likely that a repeal of the federal estate tax will stimulate states to look closely at their estate tax and determine whether to continue imposing the tax going forward.
Continue the discussion on the BBNA State Tax Group on LinkedIn: How are states likely to respond to a repeal of the federal estate tax?
For more information on state estate and/or inheritance tax regimes, check out our Estates, Gifts and Trusts Chart Builder. Sign up for a free trial of the Bloomberg BNA Premier State Tax Library.
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