State property taxes are not yet dead
To paraphrase Mark Twain: Reports of the death of state estate taxes are greatly exaggerated. In fact, there are recent signs that states are starting to strengthen their inheritance tax laws instead of cutting them. This, of course, is bad news for wealthier Americans, who were hoping state lawmakers would continue to bury these taxes.
But all is not lost for retirees who have accumulated assets over the years. A majority of states do not have their own death taxes, and for those that do, at least the trend for higher exemption amounts continues in several states. So while you shouldn’t hold your breath while waiting for your state’s inheritance tax repeal, you may be able to avoid tax eventually.
The road to extinction
In 2000, each state and the District of Columbia imposed an inheritance tax. And why not? Federal inheritance tax law allowed a dollar-for-dollar credit of up to 16% of inheritance and inheritance taxes paid by the state. This, in essence, allowed states to levy their own inheritance taxes without imposing an additional tax burden on their residents. It was obvious to the States.
But that all started to change in 2001. Legislation enacted that year gradually eliminated the federal credit (it was completely repealed in 2005). From that point on, if a state wanted to impose an inheritance tax, it meant âadditionalâ taxes on the inheritance of residents beyond federal tax. Nonetheless, more than 20 states have taken this route. But the fear of wealthy residents to move elsewhere due to the additional tax burden has finally sparked a wave of inheritance tax repeal measures in many of these jurisdictions. For a while, it looked like state property taxes could go the dinosaur’s way.
Things have slowed down a bit at the moment, however. Delaware and New Jersey repealed their inheritance taxes starting in 2018. However, since then no other state has gotten rid of their inheritance tax, leaving 12 states and the District of Columbia that still tax the estate. ‘tax. One reason may be that states are less worried these days about losing wealthy residents. A recent study by the National Bureau of Economic Research suggests that in the long run, states have an interest in keeping their inheritance tax even if some wealthy residents move because of it. The study concludes that, for most states, the “one-time gain in tax revenue on the death of a wealthy resident” exceeds the “income tax revenue lost over the remaining lifespan of those who move.” .
A few states are even tightening or improving their inheritance tax laws. For example, Bruno Graziano, senior analyst at Wolters Kluwer Tax & Accounting, notes that Connecticut adopted a ânarrower loopholeâ in 2019 that clamps down on ânon-residents who placed properties in flow-through entities in an attempt to evade estate tax â. Hawaii also added what it describes as a “surtax” on estates worth more than $ 10 million. And New York has renewed a “clawback” feature that Graziano says “will tax gifts made within three years of death.”
Exemption amounts continue to increase to some extent
While state estate taxes may not be completely phased out, the trend to tax fewer estates continues. Inheritance tax exemption amounts increase in 2020 in half of the states with tax. Inflation adjustments explain slight exemption increases this year in Maine ($ 5.7 million to $ 5.8 million), New York ($ 5.74 million to $ 5.85 million) and Rhode Island ($ 1,561,719 to $ 1,579,922). Larger increases in 2020 in Connecticut ($ 3.6 million to $ 5.1 million), Minnesota ($ 2.7 million to $ 3 million) and Vermont ($ 2.75 million at $ 4.25 million) are the result of recent legislation.
However, most states are unwilling to increase their exemption amount too high. The New York $ 5.85 million exemption is the highest yet for 2020. In addition, the lowest exemption amounts – in Massachusetts and Oregon – remain at $ 1 million This year.
And don’t look for many states to increase their exemption amount to the current federal level, which is $ 11.58 million for 2020 ($ 23.16 million for married couples). Prior to 2018, it was not uncommon to match or at least approach the federal amount. However, when the 2017 Tax Cuts and Jobs Act doubled the federal amount, Graziano believes it was “a bridge too far” for most states. The states were âwilling to follow the federal government to a point,â he says, âbut now they’re backing off a bit. “
States are also cautious because the amount of the enhanced federal exemption is only temporary. By 2026, the federal exemption is expected to drop to $ 5 million (adjusted for inflation). However, no one knows if the law will change by then. This puts states in a “waiting pattern” right now, Graziano says, as they “wait and see what happens on the federal side.”
States are also not jumping on the âportabilityâ bandwagon. By opting for portability at the federal level, the unused amount of the estate tax exemption of a deceased spouse is transferred to the surviving spouse. This effectively doubles the amount of the exemption for the surviving spouse’s estate and prevents the exemption for the first spouse to die from being wasted. However, at the state level, only Hawaii and Maryland currently offer portability of their inheritance tax exemptions, and there is no indication at this time that other states will join them.
Don’t forget the inheritance tax
Even if you escape state property taxes, your heirs may still have to pay state inheritance tax. While inheritance tax is paid by the estate and based on the overall value of the estate, inheritance tax is paid by an individual heir on the property he or she inherits.
Six states currently impose an estate tax – Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania – and rates can reach 18%. (Maryland has both an estate tax and an estate tax.) So be sure to factor this potential tax into your estate planning.
However, even if your state has an inheritance tax on the books, some parents who inherit your property might still not have to pay it. There is a good chance that your closest relatives will be exempt from tax when you die, while more distant family members are unlikely to be so lucky. For example, in Iowa, the spouse, parents, children, and grandchildren of a deceased person do not have to pay state inheritance tax. But other heirs, such as nieces, nephews, uncles, aunts and non-parents, have to pay.
State inheritance tax rates may also be higher for more distant relatives or for more valuable property. In Nebraska, for example, the tax on heirs who are immediate relatives is only 1% and does not apply to property valued under $ 40,000. For distant relatives, the tax rate is 13% and the amount of the exemption is $ 15,000. For all other heirs, tax is imposed at the rate of 18% on property valued at $ 10,000 or more.
For more details on death taxes in the states that levy them, see the Kiplinger Retiree Tax Card.