When you do estate planning, it is important to understand both federal and state estate tax laws, as well as state inheritance laws. Some states have estate taxes and others have inheritance taxes. While these terms are often confused, there is a difference.
Fortunately, federal estate laws allow individuals to use the marital deduction to leave an unlimited amount of assets to their spouse tax-free as long as the spouse is a U.S. citizen. This postpones any potential federal estate and gift tax until the death of the marriage’s last surviving spouse.
For 2013, individuals may leave an estate of up to $5.25 million to heirs who are not spouses without any federal estate tax. Any portion of this excluded amount that is not used by the estate of a predeceased spouse may be added to the exclusion allowed to the surviving widow’s or widower’s estate. However, this is not automatic. The executor of the deceased spouse needs to transfer the unused portion of the exclusion by filing a federal estate-tax return. This should be done even if no tax is due if the surviving spouse wants to maintain the unused portion of the exclusion. By using this exclusion, a married couple can exclude $10.5 million from federal estate taxes. This exclusion amount is adjusted for inflation each year.
Under current law, individuals can make gifts of $14,000 to any individual person (up to a maximum of $112,000) in any single year without reducing the $5.25 million lifetime exclusion. Any gifts exceeding these amounts must be reported on your tax return, and would be subtracted from your lifetime exclusion. Two spouses could gift $28,000 per recipient up to a total of $224,000 in gifts per year. Such gift giving makes sense if you believe your estate can exceed the exclusion limits or if there is an inheritance tax in the state where your beneficiaries live. Currently, only two states tax gifts, Minnesota and Connecticut. Even in these states, however, gifts of up to $14,000 per person are not taxable.
In addition to federal estate tax — or even if no federal tax is due — there may be state estate or inheritance taxes to pay. Estate taxes are levied on the whole estate, before it’s distributed.
Inheritance tax is paid by the heir, sometimes varying in rate based on his or her relationship to the deceased. If you inherit money, you might owe tax to the state in which the owner of the estate died — even if your state has no such taxes.
There are six states with inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. The rates in 2004 ranged from 10 percent (Maryland) to 18 percent (Nebraska). Exemptions range from $0 (Iowa and Pennsylvania) to $10,000 (Nebraska). (Source: CCH Group)
Although the estates of most individuals will not be subject to federal taxes, this is not the case for state estate taxes. Fifteen states and the District of Columbia have state estate taxes. If you are considering moving to another state, either in retirement or for other reasons, this is a factor you should take into consideration. Exemptions for 2014 and top rates can be found in the chart below (Source CCH Group):
Here is a list of states with estate taxes, the 2014 exemption, and the top rate:
• Connecticut, $2 million, 12 percent; Delaware, $5.34 million, 16 percent; Hawaii, $5.34 million, 16 percent.
• Illinois, $4 million, 16 percent; Maine, $2 million, 12 percent; Maryland, $1 million, 16 percent.
• Massachusetts, $1 million, 16 percent; Minnesota, $1 million, 16 percent; New Jersey, $675,000, 16 percent.
• New York, $1 million, 16 percent; Oregon, $1 million, 16 percent; Rhode Island, $910,725, 16 percent.
• Tennessee, $2 million, 9.5 percent; Vermont, $2.75 million, 16 percent; Washington, $2 million, 20 percent; District of Columbia, $1 million, 16 percent.
All states allow surviving spouses to inherit tax-free from their spouses.
If you own property in more than one state, it is important that you discuss state estate tax issues with your attorneys. It would make sense to confer with attorneys from all the states in which you have property. State tax auditors will look carefully at your lifestyle to ensure that your “domicile” is where you say it is. They will look at where your family home is, where you vote, what clubs you belong to and what religious institutions you are a member of. Your attorneys should be able to advise you about steps to take to minimize your potential state estate tax.
Elliot Raphaelson can be contacted at firstname.lastname@example.org.