David R. Evanson
Privately Published, Summer, 2004
In a simpler time, investors could think about estate planning within the context of one set of laws. This was true because the states operated under the approach of what’s good for the goose is good for the gander. Specifically, the states levied estate taxes as prescribed by federal laws. And because the federal laws generally counted estate tax payments to the states as a credit against federal estate taxes owned, this arrangement provided states with an important revenue stream.
However substantial changes to the federal estate tax laws enacted in 2001 under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) are changing this equilibrium. The federal government is raising the estate tax exemption – the level above which estate taxes are owed. If states conform to federal tax law changes, as they have done in the past, it will result in a loss of revenue for them. As a result, some states are sticking to their existing exemptions, creating new estate tax liabilities that were not present before.
This means that as an investor, you need to need to look more closely at your estate planning. Your state’s exemption may now be different than the federal estate tax exemption. If this is true, you will need to take steps now to manage your estate’s state tax liability.
As a case in point, consider the state of Washington. Starting January 1, 2002, the state “de-coupled” with federal estate tax laws. Therefore today, while the federal exemption (the level below which no federal estate taxes are owed) is $1.5 million, the threshold in Washington below which no taxes are owed, is $850,000. What this means in practical terms is that the difference between the floor of the state tax exemption, and the ceiling of the federal tax exemption represents a portion of an estate that is exposed to state tax liabilities. As an example, an estate worth $1.1 million in 2004 would be exempt from federal estate taxes. However, $250,000 of this estate ($1.1 million estate value – $850,000 Washington State exemption) would be subject to Washington’s estate tax.
Estate taxes ranges from 18% to 55% in Washington according to the state’s revenue code (RCW 83.100). Based on the example above, the state tax liability could make a substantial dent an estate (http://dor.wa.gov/docs/reports/2002/tax_reference_2002/estate.pdf) and perhaps deny survivors of financial benefits which their predecessors worked so hard to leave them.
Unfortunately, the changes in Washington’s estate taxes are not an isolated incident. In May of this year, Maryland enacted legislation that will affect the Maryland estate tax statutes for decedents dying after December 31, 2003. The state’s announcement reads, “The requirement to file a Maryland estate tax return will no longer be dependent on the federal filing requirement, which is currently $1,500,000. This, in effect, ‘de-couples’ Maryland from the federal filing threshold.” Maryland’s threshold is $1 million. This means that estates in Maryland above $1 million in value, but less than $1.5 million may escape federal estate taxes but not Maryland’s. Estates over $1.5 million are subject to state and [italicize and] federal income taxes.
For better of for worse, the tax system in the United States is very delicate. Changes to one aspect of it often provoke changes somewhere else. In this case, the change in the level of the federal exemptions has caused some states to take action which introduce new state tax liabilities.
Because the federal exemption continues to rise until 2010, when it is repealed for one year, (and then unbelievably re instituted in 2011 at 2002 levels) other states may follow suit, or may already have major changes in their statures underway. For all these reasons, at T. Rowe Price we are urging investors to be on the lookout for changes which may affect their situation, and to plan now while they have the opportunity.