This article was originally published on AccountingWeb.
When considering estate taxes, where your client lives has a big impact on how much their estate will owe when they die. There are both state and federal estate taxes, and Congress is considering legislation that would change the federal rules. This article will look at how the state where your client lives (and where they die) plays a part.
First, here are a few points for context:
- You can’t take it with you. Wealth accumulated on earth will be taxed on earth.
- Spousal transfers help. Generally speaking, wealth held jointly can transfer to the surviving spouse without triggering federal estate taxes.
- Your client’s estate is like a giant IRA account. The federal government is patient: If they don’t get paid now, they’ll get paid later. (Actually, they prefer to get paid now and later.) Monies in your client’s retirement account might grow tax deferred, but they need to come out sometime, and when they do, the IRS expects to tax it. Your client’s estate works the same way. They might own assets that appreciate. They might never sell them. When your client dies, these assets become part of their taxable estate.
- If your client can spend it or sell it, they own it. Everything in your client’s name is aggregated into their estate.
- If your client controls it, they own it. Your client can reduce their taxable estate by giving away assets to charity. They can use their lifetime exemption to give assets to others; let them worry about the future appreciation. Your client can set up trusts. According to the IRS, a person owns assets if they can take them back and use them.
- There are ways for your client to have their cake and eat it, too. One example is the charitable gift annuity. Your client can take assets out of their name (and their future estate) by giving them to charity. The nonprofit can place those assets into an annuity, providing your client with income during their lifetime.
Estate Taxes at the State Level
Your client might assume that states’ estate tax laws are aligned with the federal government’s rules, but that’s not the case. All 50 states can approach the law in 50 different ways if they choose, since it’s a moneymaker for them.
According to taxfoundation.org, 11 states (plus Washington, D.C.) have an estate tax that follows a procedure similar to the estate tax at the federal level. The state examines the pool of assets and applies the exemption level, and the remainder is taxed. The exemption level varies by states:
- New York: $5.9 million exemption, 3.06 – 16 percent tax on remainder.
- District of Columbia: $5.8 million exemption, 12 – 16 percent tax on remainder.
- Maine: $5.7 million exemption, 8 – 12 percent tax on remainder.
- Hawaii: $5.5 million exemption, 10 – 20 percent tax on remainder.
- Connecticut: $5.1 million exemption, 10 – 12 percent tax on remainder.
- Illinois: $4.0 million exemption, 0.8 – 16 percent tax on remainder.
- Minnesota: $3.0 million exemption, 13 – 16 percent tax on remainder.
- Vermont: $2.8 million exemption, 16 percent tax on remainder.
- Washington State: $2.2 million exemption, 10 – 20 percent tax on remainder.
- Rhode Island: $1.6 million exemption, 0.8 – 16 percent tax on remainder.
- Massachusetts: $1.0 million exemption, 0.8 – 16 percent tax on remainder.
- Oregon: $1.0 million exemption, 10 – 16 percent tax on remainder.
Five states take a different approach. Instead of taxing the estate, they levy tax on the heirs. It works on a sliding scale:
- Nebraska: 1 – 18 percent tax
- Kentucky: 0 – 16 percent tax
- New Jersey: 0 – 16 percent tax
- Iowa: 0 – 15 percent tax
- Pennsylvania: 0 – 15 percent tax
Are there any “double dippers”? Yes. One state has both an estate tax and an inheritance tax.
- Maryland: $5.0 million estate tax exemption, 0.8 – 16 percent tax on remainder. Inheritance tax is 0 – 10 percent.
No Estate or Inheritance Taxes
There are 33 states that fit into this category. Small wonder many clients choose to move their state of residency as they get older and wealthier. They include: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Georgia, Florida, Idaho, Indiana, Kansas, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin and Wyoming.
The cost of living varies between states and the cities within. You can see the compelling reasons why people make their money in a high-tax state, then relocate, establishing residency in a state with both a lower cost of living and more favorable estate tax rules.
This document is provided for informational purposes only by Dunham & Associates Investment Counsel, Inc. solely in its capacity as a Registered Investment Adviser and should not be construed as legal and/or tax advice. Dunham & Associates Investment Counsel, Inc. does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.