By Richard P. Breed, III, Esq. and Jennifer Civitella Hilario, Esq.
As the federal estate tax exemption climbs, and as the
2010 repeal approaches, many families and their advisors are relieved
that $2 million to $7 million of assets can be inherited federal estate
tax-free. However, residents of most states must still plan for
looming, and often substantial, state death taxes.
In 2000, most states imposed an estate tax to the
extent of the state death tax credit under §2011 of the Internal
Revenue Code (the “Code”). Their estate tax systems were “coupled”
with the Code and “picked-up” an estate tax to the extent of the §2011
Until 2001, the typical estate plan of a married
couple with a federal taxable estate provided for the estate of the
first deceased spouse to be divided into two shares. One share (the
“Credit Shelter Trust”) would be funded with an amount equal to the
applicable federal estate tax exemption. The balance of the deceased
spouse’s estate would fund the “Marital Deduction Trust” which
qualified for the marital deduction, usually achieved by making a “QTIP
election.” As a result of this estate planning technique, both
federal and state estate taxes would be deferred until the death of the
Married Maine resident (a “pick-up” state) died in 2000 with a gross
estate of $3,000,000. Decedent’s Revocable Trust provided for his
estate to be divided into two shares: a Credit Shelter Trust equal to
the applicable federal estate tax exemption at the time of his death
($675,000) and a Marital Deduction Trust equal to the balance of his
estate ($2,325,000). This formula would result in no estate tax
liability at the first spouse’s death and would fully “fund” his federal
estate tax exemption.
The Economic Growth and Tax Relief Reconciliation
Act of 2001 (“EGTRRA”) changed the federal estate tax system
significantly: the applicable federal exemption was increased; the
maximum federal estate tax rate was decreased; and the §2011 state
death tax credit was gradually phased out and replaced with a deduction
under §2058 for state estate taxes paid.
The repeal of the §2011 credit pulled the rug out
from under the “pick-up” states. They were left with two choices: do
nothing, and allow the state’s death tax to evaporate with the repeal
of the §2011 credit, or respond with legislation to “de-couple” from
the federal estate tax system. About one-third of the “pick-up”
states have eliminated their states’ death tax. Several others have
separated entirely from the federal estate tax system and have enacted
their own independent inheritance or estate tax. The remaining
“pick-up” states have “de-coupled” from the federal estate tax, but are
“coupled” with a pre-EGTRRA version of the Code.
Most estate plans drafted prior to 2001 provide for
maximum estate tax deferral based on a “coupled” state-federal estate
tax system. Such estate plans may no longer provide the desired estate
tax deferral because of the new state death tax laws.
Married New Jersey resident dies in 2008 with a gross estate
of $3,000,000. His Revocable Trust directs his estate to be divided
into two shares: the Credit Shelter Trust would be funded with the
applicable federal estate tax exemption ($2,000,000) and the Marital
Deduction Trust would be funded with the balance of the estate
($1,000,000). New Jersey “de-coupled” in 2002 and limited its
applicable exemption to $675,000. The estate tax liability would be
Credit Shelter Trust Planning
A state death tax liability may be looming for older estate plans
which have not been updated since EGTRRA. Estate plans of a married
couple may be amended so upon the death of the first spouse, decedent’s
estate is divided into three shares. The first share (the “Credit
Shelter Trust”) is equal to the applicable state estate tax exemption
and will not be subject to any estate taxes. The second share (the
“State QTIP Trust”) is funded with an amount equal to the difference
between the deceased spouse’s state exemption and federal exemption and
will be subject to the state’s death tax upon surviving spouse’s
death. The third share (the “Federal QTIP Trust”) is funded with the
balance of decedent’s estate and will be subject to both federal and
state estate taxes upon surviving spouse’s death. Complete estate tax
deferral is possible by making a state-only QTIP election to the State
QTIP Trust, thereby qualifying it for the marital deduction for state
estate tax purposes. Both federal and state QTIP elections will be
made for the Federal QTIP Trust.
Married Rhode Island resident dies in 2008 with a taxable estate of
$3,000,000. Pursuant to his updated Revocable Trust, Decedent’s estate
would be divided into the following three shares: the Credit Shelter
Trust would be funded with $675,000, an amount equal to the Rhode Island
estate tax exemption, the Rhode Island QTIP Trust would be funded with
$1,325,000, an amount equal to the difference between the applicable
federal estate tax exemption ($2,000,000) and the Rhode Island
exemption; and the Federal QTIP Trust would be funded with $1,000,000,
the balance of Decedent’s estate.
Some states permit estates to make a state-only
QTIP election. However, not all states permit an independent state
QTIP election to be made when a federal QTIP election has not been. For
residents of these states, the decision must be made whether to pay
state estate taxes at the first spouse’s death or defer estate taxes
until the surviving spouse’s death. The drawback to complete deferral
is the increase in the size of the surviving spouse’s taxable estate
for federal estate tax purposes.
A married New York resident dies in 2009 with a taxable estate of
$5,000,000. Pursuant to her pre-EGTRRA Revocable Trust, Decedent’s
estate would be divided into two shares: the Credit Shelter Trust would
be funded with $3,500,000, an amount equal to the available federal
estate tax exemption; and the Marital Deduction Trust would be funded
with $1,500,000, the balance of her estate. Federal and New York QTIP
elections would be made for the Marital Deduction Trust. Since New
York has “de-coupled” and frozen its estate tax exemption at
$1,000,000, the New York estate tax liability would be $229,200.
Assume the same facts as above, except Decedent’s estate plan has
been amended since EGTRRA. The Credit Shelter Trust would be funded
with an amount equal to the lesser of the federal estate tax exemption
or the New York estate tax exemption at the time of Decedent’s death,
$1,000,000. The balance of Decedent’s estate would fund the Marital
Deduction Trust, $4,000,000. Federal and New York QTIP elections would
be made for the Marital Deduction Trust. At the time of Decedent’s
death, the applicable federal estate tax exemption is $3,500,000.
$2,500,000 of this exemption would be unused. Depending on the size of
the surviving spouse’s taxable estate when he dies, this may be up to
an additional federal estate tax of $1,125,000, significantly higher
than the estate tax liability at the first death in Example 4.
Planning for the Patchwork State Estate Tax
A significant state death tax liability may arise as a result of a
decedent having assets in multiple states. The estate tax rules of many
states assume that all states are based on the §2011 state death tax
credit. For example, the Massachusetts estate tax applicable to its
residents is based on the decedent’s federal gross estate, i.e., all of
decedent’s property, no matter where located. The Massachusetts estate
tax liability is decreased by death taxes paid to other
jurisdictions. What if decedent has property in a state in which there
is no death tax?
Widowed Massachusetts resident dies in 2008 with a $3,000,000
taxable estate consisting of a $1,000,000 Miami condominium and
$2,000,000 Massachusetts property. Massachusetts “de-coupled” in July
2002 and froze its estate tax exemption at $1,000,000 beginning in
2006. Florida does not have a state death tax. For Massachusetts
estate tax purposes, the Miami condominium is included in Decedent’s
gross estate. The Massachusetts estate tax would be $182,000,
although the tax on Massachusetts property would be $99,600.
Widowed Florida resident dies in 2008 with a $3,000,000 taxable
estate consisting of a $2,000,000 Boston condominium and $1,000,000
Florida property. Decedent does not own the condominium outright; she
owns it as the sole member of a Limited Liability Company (“LLC”), used
for holding title because it is rental property. The Massachusetts
estate tax applicable to non-residents applies to Massachusetts real
estate; it does not apply to intangible personal property, such as a
membership interest in an LLC. There is no state death tax liability.
Advisors cannot assume that because a client does not have a federal
taxable estate, state death taxes are not relevant, especially as
states feel the “pinch” from the post-EGTRRA drop in revenue. A
careful analysis is necessary to determine the proper plan to minimize,
defer or pay state death taxes. Such analysis should also consider
both the applicable estate taxes of the client’s domicile and the estate
taxes of all states in which the client may own property.
Richard P. Breed, III
is a shareholder and co-founder of Tarlow, Breed, Hart & Rodgers
P.C. of Boston, which was established in 1991. He concentrates his
practice in the field of estate and business planning and advises
owners and their families on the complexities of estate planning and
administration, taxation and corporate law.
Jennifer Civitella Hilario
has been an associate with Tarlow, Breed, Hart & Rodgers P.C.
since 2006. She concentrates on estate planning, tax planning and estate
A version of this article appeared in the April/May 2008 issue of Private Wealth.