Jan 19, 2023
State estate taxes – Will you have to pay?
The Tax Cuts and Jobs Act of 2017 likely made the federal estate tax less relevant from a planning perspective since it raised each person’s exemption from the tax to more than $11 million.1 So, estate taxes are nothing to worry about, right? Not so fast, since several states continue to levy their version of the tax. Given the additional revenue that estate tax can generate, it appears that some states just don’t want to let go of this tax!
What is an estate tax?
Estate taxes are levied at death on the wealth accumulated by an individual. Contrast such taxes to gift taxes, which are levied on lifetime transfers to non-spouses. The estate tax rate charged by most states with such tax is 16%.2 Some states have a low exemption from the tax, such as Massachusetts and Oregon, which give each resident a $1,000,000 exemption.3 So, if a person owns a home worth $500,000 and has savings and investments of more than $500,000, the state estate tax could snare some of that wealth for state coffers.4
Tax complacency
Many people forget about state taxes that may apply to estate taxes, especially those in high-tax jurisdictions that don’t tax retirement income. Many forms of retirement income in Illinois, for example, are not subject to Illinois income tax. So, many of those living in the Land of Lincoln have developed a sense of complacency regarding Illinois taxes that may apply. Illinois taxpayers retiring on distributions from large IRAs or qualified plans will pay no state income tax on such income but could be subject to a hefty state estate tax.5 Contrast that with a state like Ohio, which taxes retirement income but does not levy estate taxes.6
State gift taxes
States generally do not tax gratuitous transfers of assets to non-spouses. However, as always, there are exceptions. Connecticut is currently the only state that expressly levies a gift tax, while a state like Illinois “sneaks” in a tax on lifetime transfers by adding them back in the taxable estate when calculating the state estate tax.7 The Illinois tax has the effect of taxing transfers made during life, just like gift taxes do.8 Other states factor lifetime gifts in when determining estate tax. So, caution is advised when planning gifts as part of an overall estate plan.
State estate taxes and wealth management
Since state estate taxes can have a material effect on the amount of wealth transferred to future generations, how can such taxes be avoided? Changing residency and moving assets to a non-taxing jurisdiction might be the easiest strategy. States generally do not levy estate taxes on assets such as real estate that are located in another state. However, if out-of-state real estate is owned in an entity situated in a “taxing” state, such real estate could fall into an estate tax trap. Careful planning with your tax advisor and Wealth Advisor may help lessen the state estate tax bite. It’s important to know the state estate taxes that may apply and plan accordingly!9
1 https://www.forbes.com/sites/forbesfinancecouncil/2018/06/27/how-the-tax-cuts-and-jobs-act-of-2017-affects-estate-taxes
2 https://en.wikipedia.org/wiki/Estate_tax_in_the_United_States
3 https://www.mass.gov/guides/a-guide-to-estate-taxes
4 https://www.oregon.gov/dor/programs/individuals/pages/estate.aspx
5 https://www.chicagotribune.com/politics/ct-graduated-income-tax-seniors-20201008-bifo72zvbfhxngdish3lse6pjq-story.html
6 https://tax.ohio.gov/professional/estate
7 https://portal.ct.gov/DRS/Individuals/Individual-Tax-Page/Connecticut-Gift-Tax
8 https://www.ilga.gov/legislation/ilcs/ilcs3.asp?ActID=609&ChapterID=8
9 https://www.realsimple.com/work-life/money/money-planning/retirement/states-with-no-estate-or-inheritance-taxes
ABOUT THE AUTHOR
BDF LLC is a private wealth management firm. We provide personalized investment management and financial planning. We manage approximately $5.9 billion in assets for business owners, women, individuals and families, and institutions.
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