Attorneys must now pay greater attention to this issue and its interaction with federal law
Once upon a time, estate planners focused almost exclusively on the federal tax implications of their planning for clients. State1 death taxes, which were simple by comparison, didn't merit similar concern. In the past decade, however, tax law changed so that estate attorneys could no longer give short shrift to the state death tax implications of their planning. The recently enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 TRA), with its lower federal estate tax rate, increased federal estate and gift tax applicable exclusion amount and portability feature, creates further complexities with regard to state death tax planning — but it also provides planners with opportunities.
State Death Tax History
Prior to 2001, almost every state imposed a state death tax that equaled the federal state death tax credit available under Section 2011. Then, in 2001, with the passage of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), Congress phased out the federal state death tax credit, and, by 2005, replaced it with a deduction for state death taxes paid.2 The 2010 TRA maintains this deduction for 2011 and 2012. The impact of replacing the federal credit with a deduction varies among the states, because states have different death tax laws. At present, 25 states continue to tie, or “couple,” their state death tax amount to the current federal state death tax credit. Since there's no federal state death tax credit for 2011 and 2012, there will be no state death tax for those 25 states in 2011 and 2012. Three states have eliminated state death taxes altogether (Arizona, Kansas and Virginia). However, state death taxes remain a significant consideration in the other 22 states and Washington, D.C. A number of states “decoupled” their state death tax from the current federal state death tax credit amount and have tied their state death tax to a different threshold amount. Other states have a separate, “stand-alone” death tax. Planning for individuals who reside or own property in the states that continue to have a death tax requires extra thought by attorneys. “Death Tax States,” p. 29 shows the states that continue to have a state death tax and the tax filing thresholds.3
Effect of combined provisions
Ten years ago, estate planners recognized the need to pay greater attention to the effect of state death taxes on a client's estate plan following the passage of EGTRAA and the phase-out of the federal state death tax credit. The federal estate tax rate and the new federal applicable exclusion amount set in the 2010 TRA, however, exacerbate the problems that can be created if estate attorneys don't properly plan for the effect of state death taxes in an estate.
Aggregate effective maximum rate still near 50 percent
The 2010 TRA sets the federal estate tax rate for 2011 and 2012 at 35 percent. However, in a state that imposes a state death tax, the aggregate effective maximum rate of estate taxation (federal and state) can be as high as 45.40 percent. Most of the jurisdictions that impose a death tax set their death tax filing threshold by reference to the table under Internal Revenue Code Section 2011(b) that was in effect prior to 2005 to determine the credit for state death taxes allowed on the federal estate tax return (see “Credit for State Death Tax,” p. 30). This table starts at a rate of 0 percent for adjusted taxable estates under $40,000 and ends at a maximum rate of 16 percent for amounts over $10,040,000, with 21 different brackets. The maximum 16 percent tax rate would be deductible against the federal estate tax at 35 percent. Thus, at the maximum rates, the effective rate of taxation is 45.40 percent (16 percent × (1 - .35) + 35 percent). This combined rate of taxation that's still high constitutes more than a nuisance tax and will motivate clients to engage in planning to reduce their tax bill.
Effective tax reduction of 8.4 percent, not 10 percent
While the maximum federal estate tax rate has been reduced by 10 percent (from the 45 percent rate that applied in 2009), the maximum aggregate state and federal rate for adjusted taxable estates over $10,040,000 in a state imposing a state death tax by reference to IRC Section 2011(b), has been reduced by only 8.4 percentage points. This effective difference of 1.6 percentage points occurs because the state rate is unchanged, but it's now deductible against a lower federal rate. As a result, the value of the deduction is proportionally decreased, and the impact of the state death tax is increased. In 2009, the maximum combined state and federal estate tax rate was 53.80 percent (maximum state rate of 16 percent, deductible against a 45 percent maximum federal rate, plus the maximum federal rate (16 percent × (1 - .45) + 45 percent). At this writing, the maximum combined state and federal estate tax rate is 45.40 percent (maximum state rate of 16 percent, deductible against a 35 percent maximum federal rate, plus the maximum federal rate (16 percent × (1 - .35) + 35 percent). Therefore, the reduction in the aggregate rate of taxation is 8.40 percentage points (53.80 - 45.40).
Higher costs to use larger federal applicable exclusion amount
In addition to setting the estate tax rate at 35 percent, the 2010 TRA increased the federal applicable exclusion amount (the federal exclusion) for 2011 and 2012 to $5 million.4 As a result, in most states that impose a death tax filing threshold, there's now a much greater difference between the state death tax exemption and the federal exclusion (only North Carolina and, possibly, Delaware have a $5 million exemption amount). Therefore, in a state that imposes a state death tax and has an exemption limit under $5 million, a married couple will have to pay a greater amount in state death taxes if they wish to take advantage of the full federal exclusion for both spouses.
Example: Oregon, which has a state death tax, provides a death tax exemption amount of $1 million. For a married Oregon couple, funding a bypass trust with the $5 million federal exclusion upon the first spouse's death would require a payment of $391,600 in state death taxes if the state death tax is charged to the bypass trust (that is, resulting in a net funding of $4,608,400).5 Alternatively, it would be possible to fund the bypass trust with a net of $5 million. To do this, the taxable estate would need to be $5,444,091, and the state death tax would be $444,091. The federal death tax would still be zero (since the IRC Section 2058 deduction would reduce the taxable estate to $5 million), but state death taxes would increase by $52,491 ($444,091 minus $391,600).
After 2001, when the federal state death tax credit began to be phased out, attorneys developed strategies to minimize the impact of state death taxes in an estate. Given the increased complexities created by the federal estate tax rate and the change in the federal exclusion amount in the 2010 TRA (along with the existence of the new “portability” option, discussed below), attorneys should carefully review and consider all the planning options available to minimize the impact of state death taxes on a client's estate. Considering each potential planning scenario is particularly important when drafting documents for married couples, since the existence of the marital deduction and the possibility of portability adds layers of complication not present when planning for unmarried clients.
Review Formula Clauses
The wills for many married couples use formula clauses to define how to calculate the size of the marital deduction gift and/or the federal exclusion amount. After the passage of the EGTRRA, commentators recommended that attorneys review the formula clauses in clients' existing wills to determine whether any such clause would cause the imposition of state death tax at the death of the first spouse, and, if so, whether the payment of state death tax at the first spouse's death was the preferred planning option.6 This advice to review the formula clauses currently in clients' wills remains sound, particularly in view of the increased federal exclusion amount. Some clients may have previously decided to provide in their wills that a bypass trust should be fully funded on the first spouse's death even though doing so would mean payment of state death taxes. Clients who decided on this formulation when the federal exclusion amount was $3.5 million may feel differently about fully funding a bypass trust and paying state death taxes now that the federal exclusion amount is $5 million.7
Use of State-only QTIP Election
Currently, 12 states unconditionally allow a separate, state-only qualified terminable interest property (QTIP) election.8 Compared to couples who live in states that don't allow a state-only QTIP election, couples who live in these states have more flexibility to use the increased federal exclusion while deferring state death tax until the surviving spouse's death. To use the state-only QTIP, an attorney can provide in a will that the typical bypass trust would be funded with the state death tax exemption amount (for example, $1 million for Maryland, which allows a state-only QTIP). A second QTIP-able marital trust (the state QTIP trust) would be funded with the balance of the federal exclusion amount (for example, $4 million in Maryland, if no lifetime gifts were made). The remainder of the estate would pass outright to the spouse or into a third trust, which also would be QTIP-able for state and federal purposes. Alternatively, all property in excess of the state exemption amount would pass into one marital trust, and the executor could then divide the trust and make a state-only QTIP election for the portion containing the balance of the federal exclusion amount and a state and federal QTIP election for the trust containing the balance of the estate.
In Maryland, for example, on the death of the first spouse, the state QTIP trust wouldn't be qualified for the federal estate tax marital deduction, but could be qualified for the Maryland death tax marital deduction by the personal representative making the Maryland-only QTIP election. Upon the surviving spouse's death, the Maryland-only QTIP would be subject to Maryland death tax if the surviving spouse died as a Maryland resident. This approach allows clients to delay the payment of all state death taxes until the second spouse's death, while making maximum use of the first spouse's federal and state exemption amounts and partially sheltering those amounts, together with appreciation and income earned thereon, from future death taxes.9
Given the flexibility afforded by the use of the state-only QTIP, married residents of states that allow the state-only QTIP should consider making use of it in their estate planning. When considering its use, of course, attorneys and their clients should also take into account the disadvantages of the technique. One disadvantage is that the trust must include statutory QTIP language. Therefore, all income of the trust must be paid to the surviving spouse, so that the amount of the distributed income will be includible in the surviving spouse's estate for federal estate tax purposes (to the extent that it hasn't been disposed of prior to death). Additionally, the state death taxes that will have to be paid on the property in the state-only QTIP trust at the death of the surviving spouse may not be deducted on the federal estate return filed for that spouse. IRC Section 2058 allows a deduction on the federal estate tax return for “state taxes paid to any State in respect of any property included in the federal gross estate.” The property in the state-only QTIP will be included in the surviving spouse's estate for state death tax purposes, but not for federal estate tax purposes; hence, the loss of the deduction.10
Further, deferral of state death taxes until the surviving spouse's death may not always serve the client's financial interests. The determination as to whether it makes more sense to pay state death taxes at the death of the first spouse or at the death of the second spouse depends on factors such as the ages, health and degree of wealth of the spouses. Attorneys will need to make specific calculations for each estate to assess whether it makes the most financial sense, in that particular case, to pay state death taxes on the death of the first spouse or at the death of the surviving spouse.11
Possible impact of Revenue Procedure 2001-38 on use of state-only QTIPs
Rev. Proc. 2001-38 provides that in the situation in which a predeceased spouse's estate made a QTIP election that wasn't necessary to reduce the federal estate tax to zero, the QTIP election will be ignored for federal estate, gift and generation-skipping transfer (GST) tax purposes, and the property won't be subject to transfer tax in the surviving spouse's estate.12 Rev. Proc. 2001-38 specifically doesn't apply to protective elections; the situation in which a partial QTIP election was needed to reduce estate tax liability to zero and the executor made the election with respect to more property than was necessary; or to elections that are stated in terms of a formula designed to reduce the estate tax to zero. Some commentators have suggested Rev. Proc. 2001-38 may allow a person to fund a QTIP trust with an amount that equals the difference between the state exemption amount and the federal exclusion amount, make a QTIP election and then take the position that the assets of the trust aren't includible in the surviving spouse's gross estate because of Rev. Proc. 2001-38.13 That way, the property would escape federal and state taxes in both estates. It's not clear, however, that this will work. If a taxpayer gains relief under Rev. Proc. 2001-38, the QTIP election is disregarded for all purposes, including the marital deduction in the first spouse's estate, which means that state death tax would have been imposed on the first estate. Presumably, then, if a taxpayer relied on Rev. Proc. 2001-38 on the second spouse's death, the state (if it learned of relief granted under the revenue procedure) would assert a claim for state death tax owed on the first estate, along with interest (or treat the election as a state-only QTIP election). It's hard to believe that the state and federal governments would allow Rev. Proc. 2001-38 to be used to maximize federal estate tax savings on one estate and to avoid state death taxes at the deaths of both spouses.14
Pay State Death Taxes
Eleven states collect a state death tax but either don't allow a state-only QTIP election, allow such an election only under limited circumstances or are silent as to whether such an election would be allowed. In these states, married residents have fewer options, on the death of the first spouse, for using the full federal exclusion amount without owing state death tax. For residents of those jurisdictions, or even for married residents of a state that allows a state-only QTIP, it may be best simply to pay the state death taxes on the death of the first spouse. A resident of one of these states could plan to fund a bypass trust with $5 million and pay $391,600 to $444,091 (depending on the apportionment of the state death tax to the bypass trust or not). Paying the state death tax at the first spouse's death allows for the sheltering of the full amount passing to the bypass trust from subsequent state and federal estate taxation at potentially higher marginal tax rates on the surviving spouse's death.15
This strategy contains some risk. If the federal estate tax is eliminated in the future, or if the federal exclusion amount increases to an amount that wouldn't subject the surviving spouse's estate to federal estate taxes, then the prepayment of the state death tax would result in no federal estate tax savings and might prove to have been unnecessary. Another risk is that if the surviving spouse changes residency to a state without a death tax, the state death tax on this $5 million will have already been paid. However, if the surviving spouse remains a resident of the taxing state, payment of the state death tax on this $5 million upon the first spouse's death might result in a lower total death tax liability on the aggregate estates, depending on the particular circumstances of the case. Whether the surviving spouse would leave the taxing state is a significant factor to consider in the tax analysis following the first spouse's death.
In Clayton v. C.I.R.,16 the court allowed the marital deduction for a QTIP trust that was funded only to the extent that the executor elected QTIP treatment. Since that decision, planners sometimes use Clayton trusts to maintain flexibility in state death tax planning. Typically, a Clayton trust is a trust created under a will or revocable trust for which a QTIP election can be made, but which provides that the portion of the assets for which a QTIP election isn't made is to pass to a bypass trust. With a Clayton trust, clients can defer, until the death of the first spouse, the decision whether to limit the funding of the QTIP trust so that the full federal exclusion amount passes to the bypass trust (and state death taxes are paid at the first death), or whether to fund the QTIP with enough property that no state death tax is owed at the first death (but additional state and federal estate taxes could be due at the second death, because of the increased size of the QTIP).17Clayton trusts have all of the advantages of a partial QTIP election, but they allow for the portion of the estate that isn't QTIP property to be structured as a typical bypass trust. Thus, there can be beneficiaries other than the surviving spouse, and income can be accumulated. In addition, the surviving spouse may have a limited power of appointment over the assets of the bypass trust, and the executor would have up to 15 months (nine months plus a timely requested six month extension) in which to decide whether to make the full or partial QTIP election.18
There's a potential gift tax problem with a Clayton trust. If the surviving spouse is the sole executor, she may be deemed to have made a gift because of the power she has to direct property away from herself without a qualified disclaimer. In view of this concern, it's advisable to appoint an independent executor or co-executor with sole authority to make the QTIP election.19 As a practical matter, the client may prefer to have an independent executor be responsible for making the decision regarding how much to fund each of the bypass trust and the QTIP trust.
Portability is a new feature created under the 2010 TRA. It allows a surviving spouse to use the deceased spouse's remaining federal exclusion amount, through lifetime gifts or transfers upon death (but there's no GST tax exemption portability). Portability can provide flexibility in planning for state death taxes in de-coupled states. For example, on the death of the first spouse, the bypass trust could be funded with an amount equal to the jurisdiction's death tax exemption (for example, for a Washington, D.C. resident, $1 million). The balance of the estate of the first spouse would pass to the surviving spouse in an outright transfer or general power of appointment (GPOA) marital trust20 or by joint property. The portability election would be made on the estate tax return of the first spouse to die, and the surviving spouse would then make full use of the first spouse's remaining federal exclusion amount, either by means of lifetime gifts or transfers upon death, if the surviving spouse's estate is large enough to make full use of both spouses' remaining federal exclusion amounts.
There are concerns with relying upon portability, most significantly that current law provides for portability only through 2012 and there's no guarantee that Congress will include portability in its next revision of the estate tax law.21 Further, there's a cost to choosing at the death of the first spouse not to make use of the lower brackets under the state death tax table between the first $1 million and $5 million. The rates from $1 million to $5 million are 5.6 percent to 11.2 percent, respectively. By funding the bypass trust on the first spouse's death only with the state exemption amount and relying on the surviving spouse's use of portability for the remainder of the first spouse's federal exclusion amount, an extra $4 million could end up in the estate of the surviving spouse to be taxed at higher rates under the state death tax table (although this extra amount included in the surviving spouse's estate should be deductible against a 35 percent federal estate tax). “Failure to Use Lower Brackets of the State Death Tax Table …,” this page, illustrates that not making use of the lower brackets of the state death tax table may increase the aggregate tax paid by both spouse's estates.
Lifetime gifts are typically less expensive than gifts given at death, because lifetime gifts are tax-exclusive, while gifts given at death are tax-inclusive. For this reason alone, it makes sense for the surviving spouse to consider using lifetime gifts, relying upon the portability allowance of the 2010 TRA, to dispose of some or all of the deceased spouse's unused federal exclusion. In addition, the increased state death taxes incurred by the surviving spouse's use of portability at his later death can be mitigated if the surviving spouse makes use of the portability feature by means of lifetime gifts. The surviving spouse could make a lifetime gift of the amount by which the first spouse's federal exclusion exceeded the state death tax exemption that was disposed of under the first spouse's will.22 State death taxes on the portion given would be completely avoided in most cases, since most states don't have a separate gift tax. This is preferable to taking advantage of the bracket run in both estates under the state death tax table. Since the portability of the federal exclusion amount of the first spouse to die applies to both estate and gift taxes, there would be no federal gift tax on this portion either. Pitfalls with this approach include: (1) the surviving spouse would likely have to part permanently with the property to avoid IRC Section 2036 inclusion and may not wish to do so;23 (2) the property given will have a carryover basis, so gifts of this kind should best include high-basis assets; and (3) in multiple marriage situations, the first spouse to die may wish to maintain more control over the ultimate disposition of the property.
Gifts made in contemplation of death are subject to the imposition of federal estate tax.24 However, most states don't tax gifts made in contemplation of death, so even “death bed” gifts can escape state death taxation in most states.25 Therefore, end-of-life gifts may make sense for some clients, to reduce state death taxes. To insure that a person can make a lifetime gift even if he's incompetent, the client could have in place a power of attorney that explicitly permits sizeable gifts (that is, over the annual gift tax exclusion). The client should carefully select an attorney-in-fact, both to ensure that the attorney-in-fact doesn't abuse his authority and that the attorney-in-fact isn't a potential donee (in which case, that person could be deemed to have a general power of appointment that would result in adverse tax consequences for the attorney-in-fact).26 The estate-planning attorney should also be sure that any death bed gifts are tax-neutral for federal tax purposes, to avoid any adverse income tax consequences. Finally, since any property given will have a carryover basis, it's advisable that the property given before death be cash or high basis property. One strategy to consider is to borrow funds to enable the gifts in cash. Upon death, the decedent's liability from the borrowing will provide a deduction that reduces the taxable estate value. Yet, the decedent's assets will receive a step-up in basis and can be sold without capital gains exposure to satisfy the liability.
A simple approach to drafting wills for a married couple that enables them to make use of their state and federal exclusion amounts is to have the first spouse leave the entire estate to the surviving spouse (either outright, by joint property or in a GPOA marital trust), but provide that any disclaimed assets will pass into a bypass trust with the surviving spouse and/or descendants as beneficiaries. If the couple lives in a state with a state-only QTIP, the will could include language allowing for a two-tiered disclaimer approach, under which any disclaimed assets would first pass to a QTIP trust and then any portion of the QTIP trust disclaimed would pass to a bypass trust. This allows for a double disclaimer to fund the bypass trust and a single disclaimer to a state-only QTIP trust. This approach gives the surviving spouse nine months (the time period from the date of death for making a disclaimer) to make funding decisions based on the tax law and financial circumstances that exist at the time of the first spouse's death. It gives the surviving spouse the ability to be in control of more fully funding the bypass trust (using the lower brackets of the state death tax table) or relying on the portability election for any unused portion of the federal exclusion amount for the spouse who dies first. In contrast to the Clayton trust, this strategy gives the surviving spouse, rather than the executor, the power to decide how much to fund each trust.
As with any technique, there are potential concerns with relying on disclaimers. For a disclaimer to be valid, it must meet a number of technical requirements under IRC Section 2518. Not the least of these is that the spouse can't accept the property or any of the benefits of the property that's disclaimed.27 Thus, the surviving spouse may not receive any of the property of the first spouse until it's definitively determined that the surviving spouse won't disclaim that property.28 This could be a hardship to some surviving spouses. In addition, if the surviving spouse disclaims property into the bypass trust, the trust shouldn't include a limited power of appointment, which would disqualify the disclaimer.29
Change of Domicile
Taxpayers with sufficiently large estates who live in a jurisdiction that imposes a death tax may benefit from changing their state or jurisdiction of residence to one without a death tax. For example, a resident of Washington, D.C. or Maryland could move across the Potomac River to Virginia, which has eliminated death taxes (a Virginia resident realizes 100 percent of the federal reduction in estate tax rates, while a Washington, D.C. or Maryland resident only realizes 84 percent of the reduction). This is the cleanest solution to the problem of planning for state death taxes.
Example: The estate of an unmarried Washington, D.C. resident decedent in 2011 with a $100 million taxable estate would pay a total estate tax of $43,303,420 ($27,836,620 federal and $15,466,800 Washington D.C.). Had the same decedent died a Virginia resident (Virginia isn't more than, say, five miles from the most distant part of Washington, D.C.), the estate tax bill would have been $33,250,000 (all federal), saving $10,053,420.
Clients, however, may be loathe to move, for various reasons. When advising clients of this relocation option, planners should remember that saving state death taxes is but one factor in a person's decision to move and may not be compelling enough to those with established roots.
Many clients who live in states that don't impose a state death tax may have real property or tangible personal property located in a state that imposes a state death tax. The resulting state death tax could be quite significant. Since state death taxes are generally only imposed on real or tangible personal property of a nonresident decedent, planners should take steps to change the ownership of the property into an intangible asset. Often this ownership change can be accomplished by placing the property in a limited liability company, limited partnership or S corporation. An estate attorney should carefully study applicable state law however, to make sure that this step would be successful. In New York, for instance, an Advisory Opinion (TSB-A-08(1)M (Oct. 24, 2008)) provides that an interest in an S corporation owned by a nonresident and containing a condominium in New York is only an intangible interest if the S corporation has a “real” business purpose. If the sole purpose of the S corporation is to own the condominium, New York may not find the requisite “real” business purpose, and the property would be subject to New York death tax.
Currently, 22 states and Washington, D.C. impose a death tax. Given the fiscal problems currently facing state governments, it's possible that more states may impose more or higher death taxes. Therefore, estate attorneys should take into account the impact of state death taxes when planning for their clients. Advising clients regarding planning for state death taxes is complicated by the fact that federal estate tax law is complex and uncertain. No one can predict exactly what will happen with federal estate tax law in 2013, when the current law expires. Estate-planning attorneys have a variety of planning tools available to minimize the impact of state death taxes. Amid all this complexity and unpredictability, perhaps the best advice for attorneys is to analyze the circumstances of each client's estate carefully in the context of state law, to tailor an estate plan to that client's particular needs and to use these existing planning tools to build as much flexibility into each client's estate plan as possible. While changes in estate tax law can't be fully anticipated, estate-planning attorneys can, with ample effort, define the potential contingencies for their clients.
- For the purpose of this article, the term “state” will include Washington, D.C.
- Internal Revenue Code Section 2058.
- Information for “Death Tax States” was obtained from 2011 State Death Tax Chart Revised May 4, 2011; www.mcguirewoods.com/news-resources/publications/taxation/state_death_tax_chart.pdf.
- The federal exclusion amount in 2012 will be indexed for inflation.
- This assumes the state death tax is computed by reference to the table under IRC Section 2011 and that there's no deduction of the state exemption amount in the computation process (that is, tax is paid on the whole $5 million).
- Charles D. Fox, IV, Robert C. Pomeroy and Susan L. Abbott, “Ramification for Estate Planners of the Phase-Out of the Federal State Death Tax Credit: Boom, Bust or Unknown?” 29 ACTEC Journal 26, 28-32 (Summer 2003), www.actec.org/public/ACTECJournalContents.asp.
- Steve R. Akers, “Estate Planning Effects and Strategies Under the ‘Tax Relief … Act of 2010,’” Bessemer Trust Company, N.A. 2011 (February 2011).
- States that allow a state-only qualified terminable interest property (QTIP) election are: Illinois, Indiana, Kentucky, Maine, Maryland, Massachusetts, Ohio, Oregon, Pennsylvania, Rhode Island, Tennessee and Washington. New Jersey allows a state QTIP only to the extent permitted to reduce federal estate tax. New York allows a separate state QTIP only when no federal estate tax return is required to be filed.
- Linda B. Hirschson, “The Decoupling of the Federal and State Estate Taxes,” Practicing Law Institute (March 22, 2005), at p. 6.
- Catherine Grevers Schmidt and Jill Choate Beier, “Falling Into the Gap of State Death Taxes,” New York Law Journal (Jan. 26, 2009).
- Hirschson, supra note 9.
- Revenue Procedure 2001-38, 2001-1 C.B. 1335 (June 1, 2001).
- Fox, Pomeroy and Abbott, supra note 6 at pp. 32-33; Jeffrey M. Cheyne, “State Credit Article,” www.samuelslaw.com/news/articles/articles.php?a=3.
- Cheyne, supra note 13.
- Clayton v. C.I.R., 976 F.2d 1486 (5th Cir. 1992).
- Fox, Pomeroy and Abbott, supra note 6 at p. 31; Schmidt and Beier, supra note 10.
- Schmidt and Beier, supra note 10.
- We suggest not relying upon a QTIP trust within the scope of Rev. Proc. 2001-38. If the estate is left to a QTIP trust and the amount is less than the remaining federal exclusion, the fiduciaries may not be able to use portability by making a QTIP election. The estate of the surviving spouse would always be able to argue the election is void under Rev. Proc. 2001-38. It's unlikely that the taxpayer gets to use this ruling to the government's disadvantage. If the QTIP goes down in value before the surviving spouse dies, then keeping the election in place and relying on portability is better. If the QTIP substantially appreciates, then the taxpayer may wish to argue the election is void. With portability being available, it's possible that the government could be hurt with this one-sided, after the fact ability to declare the election is void.
- The future of portability is unclear, but making portability permanent is a proposal that was included in the Obama Administration's Fiscal Year 2012 Revenue Proposals. See General Explanations of the Administration's Fiscal Year 2012 Revenue Proposals, Department of the Treasury (February 2011), at p. 123.
- In the context of a gift, it's not clear whether the inherited exclusion amount or the surviving spouse's applicable exclusion is used first or if both are used pro rata. The Joint Committee on Taxation issued an ERRATA on March 23, 2011, wherein it proposed replacing the reference to the basic exclusion amount of the last deceased spouse in IRC Section 2010(c)(4)(B)(i) with the applicable exclusion amount of the last deceased spouse. With this change there would no need for an ordering rule. Unless this change occurs, however, if the surviving spouse hasn't used his applicable exemption amount previously, it may be that the surviving spouse has to make a gift sufficiently large to exhaust his applicable exclusion amount before the inherited exclusion amount is used or sufficiently large to use an amount of the surviving spouse's applicable exclusion amount equal to the inherited exclusion amount.
- There are exceptions, however. See, e.g., Private Letter Ruling 200944002 (Oct. 30, 2009) and Gideon Rothschild, Douglas J. Blattmachr and Mitchell M. Gans, “IRS Rules Self-Settled Alaska Trust Will Not Be in Grantor's Estate,” 37 Est. Plan (January 2010).
- IRC Section 2001(b) provides that taxable gifts form part of the unified tax base for calculating federal estate tax, and, pursuant to IRC Section 2035(c), gift taxes paid within three years of death are includible in the gross estate.
- The following states tax certain transfers as gifts made in contemplation of death: Indiana, Iowa, Kentucky, Maryland, Massachusetts, Nebraska, New Jersey, Ohio, Pennsylvania and Tennessee.
- Hirschson, supra note 9 at pp. 11-12.
- IRC Section 2518(b)(3).
- Importantly, Treasury Regulations Section 25.2518-2(d)(1) provides that in the case of residential property held in joint tenancy, a joint tenant won't be considered to have accepted the joint interest merely because the tenant resided on the property prior to disclaiming his interest in the property.
- Cheyne, supra note 13; Schmidt and Beier, supra note 10.
Richard S. Franklin is a member of McArthur Franklin PLLC in Washington, D.C. Molly B. F. Walls is of counsel to McArthur Franklin PLLC in Washington, D.C.
Death Tax States
Twenty-three jurisdictions and their filing thresholds
|State||Type of tax||2011 estate tax filing threshold||State-only QTIP allowed|
|Connecticut||Separate estate||$2 million||No|
|Delaware||Estate||$3.5 million or |
|District of Columbia||Estate||$1 million||No|
|Hawaii||Separate estate||$3.5 million||No|
|Illinois||Estate||$2 million||Authorized by legislation|
|Indiana||Inheritance||Authorized by legislation|
|Maine||Estate||$1 million||Authorized by legislation|
|Maryland||Estate and inheritance||$1 million||Authorized by legislation|
|Massachusetts||Estate||$1 million||Authorized administratively|
|New Jersey||Estate and inheritance||$675,000||Allowed only to extent permitted to reduce the federal estate tax|
|New York||Estate||$1 million||Allowed only when no federal estate tax return is required to be filed|
|North Carolina||Estate||$5 million||No|
|Ohio||Separate estate||$338,333||Authorized by legislation|
|Oregon||Estate||$1 million||Authorized by legislation|
|Pennsylvania||Inheritance||Authorized by legislation|
|Rhode Island||Estate||$859,350||Authorized administratively|
|Tennessee||Inheritance||Authorized by legislation|
|Washington||Separate estate||$2 million||Authorized by legislation|
|*It's not yet clear whether Delaware's exemption amount is $3.5 million or $5 million; the Delaware Division of Revenue is expected to clarify that issue.|
— Richard S. Franklin and Molly B. F. Walls
Credit for State Death Tax
The rates range from 0 percent to 16 percent, depending on the adjusted taxable estate
|Adjustable taxable estate amount bracket||Tax rate||Tax on amount below lowest possible amount permissible in taxable estate|
— Richard S. Franklin and Molly B. F. Walls
Failure to Use Lower Brackets of the State Death Tax Table …
May increase the aggregate payment by both spouses' estates
|$10 million estate; married couple||Pay state death tax on each spouse's death||Pay state death tax on 2nd spouse's death|
|1st spouse's death|
|Gross estate value||$5,000,000||$5,000,000|
|Maryland estate tax||391,600||-|
|Federal estate tax||-||-|
|Total estate tax||391,600||-|
|2nd spouse's death|
|Gross estate value||5,000,000||5,000,000|
|Marital deduction transfer from 1st spouse||-||4,000,000|
|Maryland estate tax||391,600||916,400|
|Federal estate tax||-||-|
|Total estate tax||391,600||916,400|
|Total estate tax for both spouses||783,200||916,400|
Note: Assumes portability of $4 million of exclusion from 1st spouse to die.
|$100 million estate; married couple||Pay state death tax on each spouse's death||Pay state death tax on 2nd spouse's death|
|1st spouse's death|
|Gross estate value||$50,000,000||$50,000,000|
|Maryland estate tax||391,600||-|
|Federal estate tax||-||-|
|Total estate tax||391,600||-|
|2nd spouse's death|
|Gross estate value||50,000,000||50,000,000|
|Marital deduction transfer from 1st spouse||45,000,000||49,000,000|
|Maryland estate tax||14,666,800||15,306,800|
|Federal estate tax||26,366,620||26,142,620|
|Total estate tax||41,033,420||41,449,420|
|Total estate tax for both spouses||41,425,020||41,449,420|
Note: Assumes portability of $4 million of exclusion from 1st spouse to die.
— Richard S. Franklin and Molly B. F. Walls