Expert Insight: States Wrestle with the Inheritance and Estate Tax (A Real Mess Inherited)


In this "Expert Insight," attorney and estate planner Alan Gassman discusses the fiscal cliff legislation's elimination of the state estate tax credit.  Gassman explains the impact on the many states which chose to retain their pick-up taxes and wait for the revival of the state estate tax credit, outlining in detail the changes in state revenue.

Through 2001, federal estate tax imposed and collected by the United States government offset state estate taxes by up to 16% of the taxable value of an estate through an automatic dollar-for-dollar credit against state estate taxes.  All fifty states and the District of Columbia had "pick-up" tax credits and most imposed estate tax explicitly based upon the amount of the federal estate tax credit. This allowed states to collect additional tax revenue without increasing the tax burden on their citizens.

The pick-up credit was set up on a sliding scale. For example, in 2001, a $2,000,000 estate paying estate tax at 55% would owe approximately $728,750 in estate taxes after use of the then-current $675,000 exemption. About $57,040, or 7.83% of total estate taxes, would have gone directly to the state government. For an estate valued at $3,000,000 pre-exemption, 10.13% of total estate taxes would have gone to the state government. For $15,000,000 16% of total estate taxes would have gone to the state government. Based on this sliding scale, the states received approximately $7.5 billion from total estate taxes in 2001.                                  

Starting in 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) phased out the federal estate tax credit by reducing the credit 25% each year until its complete elimination in 2005. At the same time, EGTRRA replaced the credit starting in 2005 with a much less valuable deduction for the amount paid in state inheritance taxes. Also at the same time, the number of taxable returns dropped precipitously due to the increase of the estate tax exemption. Below is a chart illustrating the effect. Note that due to the nine-month estate tax return filing period, many of the returns filed in a year were actually for persons who died in the prior year. This results in a lag period and the credit being applied in the following year.

 

 

Year

 

Amount of Estate Tax Exemption

 

Number of Taxable Returns

 

Credits to States

(in billions)

State Estate Tax Deductions (in billions)

2000

$675,000

52,000

$6.4

N/A

2001

$675,000

51,736

$6.2

N/A

2002

$1,000,000

45,018

$5.7

N/A

2003

$1,000,000

33,302

$4.7

N/A

2004

$1,500,000

31,329

$3.1

N/A

2005

$1,500,000

20,250

$1.8

$0.1

2006

$2,000,000

22,798

$0.3

$2.5

2007

$2,000,000

17,408

$0.0

$3.1

 

About thirty states' estate taxes, including Florida's, were tied directly to the federal dollar-for-dollar credit. When the 2005 elimination occurred, twenty-five states, including Florida, took no alternative action, thereby letting their state estate tax laws become dormant and ceasing collection of estate taxes.  Based on these changes, states only collected $3.9 billion in estate taxes in 2010 (with many states collecting nothing), about $3.6 billion less than in 2001. Note that the $3.9 billion collected in 2010 was additional taxes imposed on taxpayers. In other words, they were state estate taxes paid in addition to federal estate taxes, taxes that did not exist prior to the phasing out of the dollar-for-dollar credit.

EGTRRA's impact was severe on states that did not enact state estate taxes, or states that couldn't due to restrictions such as the state constitution in Florida. As an example, Florida collected $708 million in estate taxes in 2001 and only $3 million in 2010, likely due to audits of tax returns from 2005 or before. States that amended their estate tax statutes or created new statutes did not see as much of an impact, although their taxpayers certainly did. For instance, New Jersey's estate tax collections increased from $478 million in 2001 to $582 million in 2010. New York's estate collections increased from $759 million in 2001 to $866 million in 2010. While the states that did enact or amend estate tax statutes may enjoy the continuing revenue, they must also consider the potential negative impact such taxes have had on their citizen's wallets and the state's populations-estate taxes could be driving citizens out while also discouraging people from moving to the state.

So now the states have been waiting to see what was going to happen.  They've been hoping that the exemption would come back down and that there would be a credit, but that's not what Congress did.  Now there's no credit.  There's a $5,250,000 federal estate tax exemption with a deduction, so the states are really going to have to look seriously at imposing inheritance taxes to take this into consideration. This is particularly true for states that already built estate tax collections into their multi-year budget or counted on the dollar-for-dollar credit eventually returning.

Alan Gassman is a partner at Gassman Law Associates in Clearwater, Florida. He is the author of more than 200 articles in national publications, symposia and law school text books on physician planning, estate tax planning and income tax issues. Mr. Gassman regularly contributes to BBNA as a writer and lecturer, most recently as a co-author of BNA's "Estate Tax Planning in 2011 and 2012."

By Melissa A. Fernley

Follow us on Twitter at: @SALTax 
Join BNA's State Tax Group on LinkedIn