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Heather A. Kmetz
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State Death Taxes After EGTRRA

October 2003

Heather A. Kmetz
503.243.1661 x 226

Published in the Oregon State Bar Estate Planning and Administration Section Newsletter

In general, states use one of two major mechanisms to collect revenue after the death of a state resident. Each state either (1)  collects the amount allowed as a credit against the federal estate tax under section 2011 of the Internal Revenue Code (the "Code") ("pickup" states) or (2) collects a state-level inheritance tax or estate tax ("decoupled" states). Despite the varying mechanisms, the collection of state revenue was generally transparent to the taxpayer before the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), because the state tax liability was generally equal to the federal credit for state death tax. Now the state death tax collection process has become visibly muddied, as some pickup states with revenues tied to EGTRRA scramble to jump ship before the death tax credit sinks in 2005 and most decoupled states vow to stay dockside in light of significant state revenue shortfalls.

Before EGTRRA was enacted, the state death tax credit generated more than $4 billion a year nationally in state revenues.1 EGTRRA annually phases out the amount of the state death tax credit allowed against federal estate tax liability and schedules the total repeal of the state death tax credit in 2005, replacing it with a deduction. A decedent dying in 2003 may take only 50 percent of the state death tax credit amount; a decedent dying in 2004 may take only 25 percent of the state death tax credit amount. IRC § 2011.

Decoupled Pickup States. When EGTRRA was enacted, 37 states and the District of Columbia had "pickup state" statutory provisions. However, some such jurisdictions-including Oregon and Washington-tied themselves to the federal estate tax law in effect on a certain date, rather than providing for the automatic updating of state law to reflect changes in the Code for estate tax purposes. There are currently 13 decoupled pickup jurisdictions that have not updated their statutory provisions to incorporate the law enacted under EGTRRA: Arkansas, the District of Columbia, Kansas, Maine, Maryland, Minnesota, Nebraska, New York, Oregon, Rhode Island, Virginia, Washington, and Wisconsin.2

Using Washington as an example, there are essentially three major differences between current Washington estate tax law that relies on federal estate tax law effective before the enactment of EGTRRA, see generally RCW ch 83.100, and current federal estate tax law for purposes of this discussion:

  • In 2002, estates with gross values totaling between $700,000 and $999,999 need to file an estate and transfer tax return with the state of Washington, although a federal tax return will not be required for these estates under post-EGTRRA federal law. IRC § 6018.
  • The Washington estate tax is 100 percent of the available state death tax credit rather than the reduced percentage of available state death tax credit under post-EGTRRA federal law. IRC § 2011.
  • Washington will allow the federal estate tax credit effective as of January 1, 2001, not the increased credit amount afforded under post-EGTRRA federal law. IRC § 2010.

In Oregon, the recently passed HB 3072 linked Oregon inheritance tax law to the federal Taxpayer Relief Act of 1997, so that Oregon inheritance taxes are now to be determined using the Code in effect as of December 31, 2000. Therefore, the inheritance tax filing threshold for Oregon is a gross estate of $700,000 for decedents dying in 2003, $850,000 for decedents dying in 2004, $950,000 for decedents dying in 2005, and $1 million for decedents dying in 2006 and thereafter. An amnesty, of sorts, was afforded Oregon decedents dying in 2002. For 2002, no return was required and no tax is due if the taxable estate of the decedent was less than $1 million; for estates of $1 million or more, the inheritance tax was to be calculated based on the Code in effect as of December 31, 2000.

Coupled Pickup States. Statutory provisions for most states provide that state inheritance tax or estate tax liability does not arise unless the estate is subject to federal estate tax. In the case of decoupied pickup states, because federal estate tax liability is determined using the applicable estate tax exclusion amount in effect as of the state's tie-in date, such a provision does not generally prohibit collection of inheritance tax or estate tax even if no federal estate tax is due based on the applicable estate tax exclusion amount for the year of the decedent's death. However, such a provision could be prohibitive for states that are generally tied in to current federal tax law but have a state-level inheritance tax or estate tax system. In a decision unrelated to the scheduled reduction of the federal state death tax credit, the Michigan Court of Appeals recently held that Michigan is not entitled to any state estate tax if no estate tax is due to the federal government as a result of the federal credit for tax on prior transfers. Teets v. Dept of Treasury (In re Estate of Lacks), 662 NW2d 54 (Mich App 2003).

Wealth Preservation Planning in States That Do Not Sail

Wealth preservation planning provisions will generally be unaffected in straight pickup states. For example, Florida tracks with the federal estate tax law as a pickup state. Florida estate tax is not due unless an estate is required to file a federal estate tax return. The federal filing threshold for decedents dying in 2003 is $1 million. Wealth preservation provisions established to maximize the use of a deceased Florida resident's available federal estate tax credit and generation-skipping tax credit will be consistent with planning to minimize state estate tax liability. However, it is a unique challenge to plan for effective wealth preservation of an individual residing in a decoupled state such as Oregon and Washington, because a formula designed to minimize federal transfer tax liability will not likely minimize state tax transfer liability in such jurisdictions.

Funding Formulas. For married couples, state inheritance tax or estate tax liability at the death of the first spouse could be avoided by adjusting a pecuniary or fractional funding formula to minimize state transfer tax (to fund. the credit shelter trust with an amount equal to the federal estate tax credit exemption as determined for purposes of state inheritance tax or estate tax law). For a married couple with a combined estate value of less than their combined available federal applicable estate tax credit amount, this may be a practical solution to avoid state inheritance tax or estate tax liability and federal estate tax liability. However, presuming that the estate tax exemption amount for purposes of calculating federal estate tax liability is greater than it is for purposes of calculating state inheritance tax or estate tax liability-as is currently the case in Oregon and Washington-this drafting strategy would waste federal estate tax exemption at the death of the first spouse.

Disclaimer Trust. For married couples. with a combined estate value exceeding their combined available federal applicable estate tax credit amount, it will likely be best in terms of minimizing combined federal and state tax transfer liability at death-to pay state inheritance tax or estate tax at the death of the first spouse. However, flexibility could be afforded the surviving spouse if a special disclaimer trust that qualifies for the unlimited marital deduction is incorporated into the planning. If -there is a dramatic reduction in the couple's estate value by the time of the first spouse's death, or if the surviving spouse is unwilling to pay any state or federal tax at the death of the first spouse, an amount equal to the difference between the estate tax exemption amount for federal estate tax purposes and that for state inheritance tax or estate tax purposes could be disclaimed, thereby avoiding state transfer tax liability.

The uncertainty as to how state legislatures will juggle budget shortfalls and potential inheritance tax or estate tax reformation, combined with the numerous changes in federal estate tax law scheduled to phase in and out over the next several years,. Require tax-sensitive estate planning to be as flexible as possible.

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1 Mark Garay, lead legislative researcher in the Tax Policy Services Group of Deloitte & Touche, LLP, vouches for the validity of this statement, printed on page 34 of "Seeds of Change: The 2001 Tax Cut," although he is unable to locate the information identifying the original resource on which he relied.

2 Each of these jurisdictions has decoupled from federal tax law for at least one year. However, it is important to note that the. decision to remain decoupled from federal law for estate tax purposes will be an on-going issue taken up in each legislative session, as jurisdictions evaluate their ability to collect and audit tax that may not be tied to federal estate tax reporting.

Related Practice Areas

Estates and Trusts

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