Introduction to State Estate Taxes
Estate planning is an essential aspect of financial planning, and it involves determining how your assets will be distributed after you pass on. However, one factor that many people do not account for is how much of their estate will be taken in taxes. While the federal government levies estate taxes, individual states also have their own estate taxes, known as state estate taxes.
First, we will explore what state estate taxes are and how they differ from federal estate taxes. Next, we will examine the different state estate tax approaches and the trends in state estate tax laws. Then, we’ll explore some estate tax planning strategies that can protect your assets and minimize your tax liability. Finally, we will discuss some recent changes in state estate tax laws and what they mean for your estate planning.
What are State Estate Taxes?
State estate taxes are levied on the transfer of a person’s assets upon their death. These taxes are imposed on the value of the estate, which includes assets such as real estate, investments, cash, and personal property. Unlike federal estate taxes, which only affect wealthy individuals, state estate taxes may affect a broader range of estates.
Currently, thirteen states and the District of Columbia have a state estate tax: Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, Washington, and Washington D.C. The state estate tax rates range from 0.8% to 20% and often have a lower exemption limit than the federal estate tax ($11.7 million for individuals in 2021).
How do State Estate Taxes Differ from Federal Estate Taxes?
The federal estate tax is a tax on a person’s estate at the time of their death, and it applies only to estates with a value above the federal exemption limit. For 2021, this limit is $11.7 million for individuals ($23.4 million for married couples). The federal estate tax rate is 40%.
State estate taxes, on the other hand, often have a lower exemption limit than the federal estate tax. This means that estates with a lower value may still be subject to state estate taxes. Additionally, state estate tax rates are generally lower than the federal estate tax rate, but some states have a higher rate than the federal rate.
State Estate Tax Law Changes
In recent years, there have been several changes to state estate tax laws. Some states have increased their exemption limits, while others have eliminated their estate tax altogether. For example, in 2018, New Jersey changed its estate tax law to increase the exemption limit to $2 million, while in 2021, Connecticut increased the exemption limit to $7.1 million.
Other states have repealed their estate tax entirely. Maryland, New York, Oregon, and Connecticut have all repealed their estate tax, and the District of Columbia has repealed its estate tax as of 2022. These changes reflect a trend towards simplifying state estate tax laws and reducing the impact on the average taxpayer.
Different Approaches to State Estate Taxes
Each state that has an estate tax employs a different approach to calculating the tax. Some states use a “cliff” approach, while others use a “graduated” approach. The “cliff” approach imposes the state estate tax on the entire estate if it exceeds the exemption limit, while the “graduated” approach imposes the tax only on the portion of the estate that exceeds the exemption limit.
For example, Washington State has a “cliff” approach, meaning that if an estate is valued at $2,193,000 or more, it will be subject to the state estate tax. In contrast, Vermont has a “graduated” approach, meaning that only the portion of the estate above the exemption limit is subject to the state estate tax. In Vermont, this exemption limit is $5 million for 2021.
Estate Tax Planning Strategies
There are several estate tax planning strategies that can help minimize your estate tax liability. One strategy is gifting, where you transfer assets to family members or other beneficiaries during your lifetime. Currently, you can gift up to $15,000 per year to an individual without triggering a federal gift tax. Over time, gifting can reduce the value of your estate, and therefore your estate tax liability.
Another strategy is to set up a trust. A trust is a legal arrangement where you transfer ownership of your assets to a trustee, who manages the assets on behalf of your beneficiaries. A trust can provide benefits such as income tax savings and protection of assets from creditors. It can also help reduce your estate tax liability by removing the assets from your estate.
Life insurance can also be an effective tool for estate tax planning. The proceeds from a life insurance policy are generally paid to the beneficiary tax-free, so they can be used to pay estate taxes or provide financial security for your beneficiaries.
Conclusion
In summary, state estate taxes are an important consideration for any estate planning strategy. Thirteen states and the District of Columbia currently have a state estate tax, with rates ranging from 0.8% to 20%. While state estate taxes may not affect as many estates as the federal estate tax, they can still have a significant impact on your estate’s value.
Over time, state estate tax laws have changed, with some states increasing their exemption limits, and others repealing their estate tax altogether. Each state employs a different approach to calculating the tax, with “cliff” and “graduated” approaches being the most common.
To minimize your estate tax liability, it is important to consult with a qualified estate planning professional and consider strategies such as gifting, trusts, and life insurance. Keep in mind that estate tax laws are subject to change, so it is essential to stay informed and keep your estate planning strategies up to date.
Inheritance tax laws, like other tax laws, can be determined by the government within each jurisdiction. Although Federal inheritance tax laws apply to all inheritance across the country, each state may also impose a separate inheritance tax law. Although the Federal inheritance tax law is set to expire in 2010, there are still several states that impose a separate inheritance tax law.
It appears that the lack of a Federal inheritance tax law, sets the percentage of Federal tax on inheritance at zero. It is likely that the Federal government will act quickly and enact new inheritance tax rates and laws in the immediate future. In fact, it is likely that the law will apply even to those that may have been exempt from paying the tax, because the inheritance tax law will be retroactive. Each beneficiary must also pay a state inheritance tax if the inheritance tax laws in their state mandate it.
A little over one fifth of the states have an inheritance tax law. Many states had let their inheritance tax laws expire but some of those states have reenacted their laws. For example, Delaware allowed the inheritance tax to lapse, but the state’s government enacted an inheritance law that will be in effect until 2013.
At that time, the state may again allow the inheritance tax law to expire, or they may choose to continue to impose the inheritance tax. In contrast, some states have lowered the burden to beneficiaries by raising the exemption limit. Several states have allowed beneficiaries to inherit more money without facing a tax based on inheritance tax laws. In addition, some states have allowed their inheritance tax law to expire and have failed to reenact those laws.
Beneficiaries in each state will likely be subject to differing state inheritance tax laws. Those laws may have differing maximum exemptions and may impose an inheritance tax at varying rates. Â In 2010, around nine state had a maximum exemption of $1,000,000. There are even a few states that allow beneficiaries to inherit up to $3,500,00 tax free.
Conversely, states like New Jersey only allow an inheritance tax exemption up to $675,00 dollars. Some states impose both an estate tax before the inheritance reaches the beneficiaries and an inheritance tax once the property is in ownership of the beneficiary. In Kentucky, both taxes are imposed by there are exemptions for immediate family members that inherit property.
Like other tax laws, inheritance tax laws may vary between the Federal government and each state’s government. In theory, an individual could be exempt from one inheritance tax but be subject to the other. In some cases, beneficiaries must pay both a state and Federal tax on inheritance.
