In 2013, Kiplinger ranked the states with the scariest "death taxes." At that time, New Jersey topped the list, with an estate tax exemption of only $675,000, and with an inheritance tax imposed upon transfers to other than spouses, charities and lineal descendants at a marginal rate of 16 percent. New York and Connecticut were also ranked among the 10 worst states. But in the last three years, much has changed in the area of state estate taxation.
Federal estate taxes have also changed dramatically. The American Taxpayer Relief Act of 2012 (ATRA) was enacted on January 2, 2013. ATRA retained the existing $5 million exemption for estate, gift tax and generation skipping transfer tax purposes and increased the maximum tax rate for all such purposes to 40 percent.
The federal estate tax and gift tax exemptions, now called the basic exclusion amount, is $5 million, indexed for inflation since 2010. The inflation adjusted exemption amount for the estate, gift and generation-skipping tax exemption for 2016 purposes was $5.45 million. For 2017 purposes the amount has risen to $5.49 million.
For many years married couples have structured their estate plans in a way that applies the exclusion amount to the creation of a bypass, an exemption equivalent or a credit shelter trust to benefit the surviving spouse and sometimes other beneficiaries. In many instances, wills have been drafted with formula clauses designed to give the surviving spouse and sometimes children the maximum amount that could pass free of federal estate tax in a trust, often with the remainder upon the death of the surviving spouse passing to the children of the marriage. In light of the substantial increase in the basic exclusion amount, this type of dispositive scheme may produce different results than the testator intended if the instrument was executed at a time when the basic exclusion amount was substantially less than in 2017 ($5.49 million).
Another significant aspect of ATRA are the provisions concerning portability. Portability permits the unused applicable exclusion amount of a decedent to be used by his or her spouse for gift and/or estate tax purposes. (Portability does not apply to a person's (GST) tax exemption.) This means that a person who dies and does not have assets that fully utilize the exclusion amount may transfer the part of his or her exemption that remains unused at death to that person's surviving spouse. (Portability only applies to transfers between spouses.)
These provisions permit a person to use the unused portion of the applicable exclusion amount of only such person's last deceased spouse. The availability of portability may lead some clients to choose not to utilize bypass trusts as a part of their estate planning, but rather to leave their assets outright to their surviving spouse, since the bypass trust concept is no longer necessary to save federal estate tax for a married couple who wish to pass property estate tax free to their surviving children. For others, the retention of bypass trusts in their estate planning will continue to make sense for other reasons discussed later.
It is important to remember that President Donald Trump communicated in various ways throughout his campaign a commitment to repeal the federal estate tax. In general, this position is consistent with the majority of Republicans in Congress, who have also proposed federal estate tax repeal. While there are budgetary and procedural hurdles to overcome associated with any repeal of the federal estate tax, this subject bears careful monitoring, as a repeal of the federal estate tax would have profound effects upon estate planning for almost all individuals. Open questions remain, including what might happen to the gift tax, and the generation-skipping tax, and whether the so-called "step-up in basis" for assets owned at death would remain the law or be limited or changed in some fashion. It is also possible that any repeal may include a 10-year sunset provision, as did prior efforts to repeal the estate tax.
This update also covers current state inheritance and estate tax laws that apply to the individuals who reside in the metropolitan New York area, Pennsylvania and Florida. Other subjects of interest are included as well.
State transfer tax considerations
Congress repealed the federal estate tax credit for state "death taxes" paid for estates of decedents dying after 2004 and replaced the state death tax credit with a federal estate tax deduction for state death taxes paid. Why is this important?
Most states previously had what were known as "pick up" or "sponge" taxes as their estate tax (although numerous states had inheritance taxes as well). The states that had so called "pick up" or sponge taxes provided that the amount of the state death tax credit reflected on the federal estate tax return for a decedent was the amount of tax due to the state of the decedent's domicile. Those states that provided that their state estate tax was equal to the state death tax credit no longer had a means to collect state estate taxes when the credit for state death taxes was eliminated. As such, various states enacted state inheritance taxes or succession taxes, and some their own state estate tax, in order to continue to...