Though the federal estate tax exemption rose to $5.34 million in 2014, a number of states retain much lower thresholds that can hit forest landowner estates hard.
By Tamara L. Cushing
When major legislation was enacted to reduce the federal estate tax in 2010, following a long political battle, landowners rejoiced.
It was hard not to be happy over the reduction of the so-called “death tax,” which placed an undue burden on those who inherited large tracts of land and were sometimes forced to sell property that had been in the family for generations just to pay a tax bill.
For 2010 only, there was a no federal estate tax on estates of any size. In 2011, the federal estate tax exemption rose to a more $5 million and landowners were glad that the threatened 55 percent tax rate was only 35 percent on assets over the exemption amount even though the exemption and rate were only temporary, set to expire in December 2012.
Legislation in 2012 made permanent the 2011 exclusion of $5 million with the provision that each subsequent year would be adjusted for inflation. This legislation increased the top rate from 35 percent to 40 percent. Given the potential for a reversion to the modest $1 million exemption and a whopping 55 percent rate, there was little disappointment at the time in the 5 percent increase in the top rate. Not only that, the law added portability of unused exemption between spouses.
Lurking in the background, however, and receiving little attention from the forestry community, media, and even some tax advisors, was the lingering bogeyman of state estate tax laws (or state death taxes). Even after the federal estate tax burden was lifted for 2011 and beyond, a number of states retained – and still retain – more oppressive estate tax burdens.
Historically, the federal income tax code has included a credit for taxes paid to the state upon the death of a taxpayer (estate taxes). By January 1, 2005, this credit was phased out and a deduction for state death taxes paid was put into effect. With the possible reversion to 2001 conditions tax-wise looming before 2010, we almost saw a return of the credit. Why would that have mattered to anyone?
The states responded to these federal changes in one of two ways. Twenty-three states did nothing. This lack of action effectively killed the state death tax since they had linked the state tax to the federal credit. When the federal credit was eliminated, the state could no longer collect state estate taxes. However, should the federal estate tax again include a credit for state death taxes, these states would once again collect revenue from their state death tax.
Other states chose to respond to the removal of the federal credit for state death taxes by creating a stand-alone estate tax. As of August 2014, fourteen states and the District of Columbia have a state death tax. Table 1 shows the current status of states with an estate tax in place and the amount of their exemptions and tax percentages.
A few states tied their state death tax exemptions to the federal exemption at a specific point in time. For example, Minnesota uses the federal estate tax law as it was on December 31, 2000. At that point in time, the federal law included an exemption for estates with less than $675,000 in assets. This level was set up to rise in steps to a $1 million exemption by 2006.
What is the impact of that on estates in Minnesota? Because Minnesota is tied to the pre-2001 federal law, an estate in 2011 (when the federal law allowed a $5 million exemption) would pay state taxes at the rate of 41 percent on the first approximately $93,000 over the $1 million exemption. Rates then drop and increase to a top rate of 16 percent. In March of 2014, the governor signed a law that increased the exemption to $1.2 million for 2014 with $200,000 increases until it reaches $2 million in 2018. This is an improvement, to be sure. But at a time when the federal exemption is more than $5 million, it’s easy to see where a Minnesota resident is going to have to plan with the state death tax in mind.
Thankfully, some states have recognized the problem in tying the state death tax to the federal exemption at a specific point in time. The failure was not revisiting the state death tax level periodically to adjust to changing income levels. Provisions should exist to force state legislators to review these exemption levels. To date, that hasn’t happened.
|District of Columbia||$ 1,000,000||0.8-16|
|Hawaii bc||$ 5,340,000||10-15.7|
|Minnesota e||$ 1,200,000||9-16 f|
|New Jersey||$ 675,000||4.8-16 f|
|New York cdg||$ 2,062,500||5-16|
|Rhode Island h||$ 921,655||0.8-16|
|Vermont i||$ 2,750,000||0.8-16|
|Washington b||$ 2,012,000||10-19|
|aExemption was decreased in 2011|
|b Indexed for inflation|
|cAlso taxes non-residents on in-state property|
|dIncreasing to the federal exemption by 2019|
|e Increasing to $2 million by 2018|
|fHigher rate on first dollars over exemption|
|gIf value of estate exceeds 105% of current exemption, exemption is not available|
|hAdjusted by CPI|
|iLinked to federal estate tax exemption as long it is greater than $2 million but less than $3.5 million|
The good news is that two states have the state exemption indexed for inflation and tied to the current federal exemption. Even better news is that since 2005, Kansas, North Carolina, Ohio, Wisconsin, Virginia and Oklahoma have phased out or repealed their state death taxes. Even if the federal credit for state death taxes is re-instituted, these states will not have a state estate tax. In addition, New York has planned a phase-out of the state death tax.
There’s still reason for concern with proposals are on the table to make changes. Some states are revisiting their state death tax exemptions and rates. We’ve seen action in recent months from several states to increase the exemption and in at least one case to expedite the phasing out of the state death tax. As if that won’t make planning confusing enough, there are federal proposals on the table to change both the rate and the federal exemption.
One thing appears certain: Oregon will not be phasing out its death tax. The Beaver State has a relatively low exemption amount ($1 million). In 2012, voters defeated a ballot measure to repeal the state death tax. For landowners in forest-rich Oregon, it’s vital that estate planning recognize this lower threshold for paying tax in the state.
The exemption amount in these states isn’t the only issue. Rates range from 5 to 19 percent on the first dollars that exceed the exemption amount. For taxpayers in New York the situation is more troubling. The state death tax exemption goes away for taxpayers with more than 105 percent of the exemption amount. There also are some steep rates applied to the first few dollars that exceed the exemption amount in New Jersey and Minnesota.
Just because you live and subsequently die in a state without a death tax doesn’t mean your assets are safe. Several states, most notably high-rent New York and Hawaii, will tax non-residents who own property in their state. Landowners with property in New York but who live in Florida, which has neither a state income tax nor a state death tax, still must plan for the state death tax implications.
Kiplinger’s magazine produces an annual listing of the most and least tax-friendly states. In 2013, nine of the 10 states considered least tax-friendly had a state death tax. (The exception was tax-happy California, which still ranked No.1 on the list). As for the 10 most tax-friendly states, meaning states where citizens pay the least in taxes, nine of those 10 states do not have a state death tax. (Delaware, listed the most tax-friendly does have a state death tax).
Let’s look at the impact of a state death tax on a $3 million estate in two different states. This $3 million estate is well below the 2014 federal exemption amount ($5.34 million) but well above the exemption amounts in Oregon and New Jersey. For both states the total assets are first reduced by the allowable 2014 exemption in that state. The result is the taxable estate. Next the tax is calculated based on the published rates for each state.
Oregon’s rate schedule is fairly simple while New Jersey’s is more complicated. The estate would pay $205,000 in Oregon death taxes or $182,000 in New Jersey. Even though New Jersey has a lower exemption and the first bracket is taxed at a high rate of 37 percent, the lower rates on the rest of the estate result in a lower overall tax than Oregon.
Of course, “lower” rates is little consolation considering most states have no death tax. Our late Oregon landowner with a $3 million estate ends up paying a death tax of 6.8 percent in Oregon or 6.1 percent if he lived in New Jersey.
How can landowners deal with this complexity and constant changing of the rules of the game? It starts with having an estate plan, preferably one prepared and regularly reviewed by someone with legal knowledge in the state you reside in as well as in the states in which you own property. These professionals should be up-to-speed on the current status of the state death tax in the state in which they are licensed to practice. Second, the plan should be flexible enough to move with changes in the law.
That means you shouldn’t have specific numbers in the plan when working with the provisions. A good plan says to “leave the current federal exemption amount up to x number of dollars to Sally” rather than “leave $5,340,000 to Sally.” The problem with the second method is that in 2015, the exemption amount will increase. Wording it rather than putting in numbers allows the estate to move with changes in the law.
That tackles dealing with the federal uncertainty. A similar thought process works applies at the state tax level. However, it is important to think through the decisions and not let the relatively low tax rate from the state death tax drive you to a decision that doesn’t make sense. In the worst-case scenario from a rate standpoint, the estate would be taxed 19 percent by the state (Washington). That still is substantially less than the federal rates of 40 percent.
Many forest landowners have been under the belief that very few of them will have to worry about the estate tax with the federal exemption now set at over $5 million and adjusting for inflation each year. Programming efforts (mine included) have shifted to focus on succession planning rather than the traditional programs to explain how to minimize taxes on transfer at the time of death.
Don’t fail to account for state death taxes just because you are below today’s federal estate tax exemption, especially if you live in a state with a death tax – or own land in one that does.
Tamara L. Cushing is the Starker Chair of Private and Family Forestry and Extension Specialist in Forest Economics, Management and Policy at Oregon State University.