The federal gift and estate tax exclusion is currently very high—$11.58 million for an individual and $23.16 million for a married couple in 2020. As a result, only very wealthy people currently need to be concerned that their estates will be taxable at the federal level, at least until 2026, when the increased exclusion amount is scheduled to return to the $5 million (adjusted for inflation) exclusion in place before the 2017 Tax Cuts and Jobs Act. But even if you are not among those who currently need to plan to avoid federal estate tax liability, some states have their own estate tax and a few have an inheritance tax (there is no federal inheritance tax). Only one state—Maryland—has both an estate and inheritance tax. State exclusion amounts are typically much lower than the federal estate tax exclusion, so it is important to make sure that your estate planning takes this potential tax liability into account.
If you live or own real estate or tangible property (property that can be felt or touched) in a state that has its own estate tax, tax will be due if the value of your estate exceeds the exemption in that state when you pass away. State estate tax is paid by your estate before any distributions are made to your heirs. While the estate is liable for paying the estate tax, the heirs could be liable if money and property are distributed to them before the state estate tax is paid.
The following list includes states (and the District of Columbia) that currently have their own estate tax, as well as the exclusion amounts for 2020:
- Connecticut ($5,100,000)
- Hawaii ($5,490,000)
- Illinois ($4,000,000)
- Maine ($5,800,000)
- Maryland ($5,000,000)
- Massachusetts ($1,000,000)
- Minnesota ($3,000,000)
- New York ($5,850,000)
- Oregon ($1,000,000)
- Rhode Island ($1,579,922)
- Vermont ($4,250,000)
- Washington ($2,193,000)
- District of Columbia ($5,762,400)
Note: Under federal tax law, when one spouse dies, their executor can file a Form 706 to elect portability. This allows the surviving spouse to use any unused portion of the deceased spouse's federal estate and gift tax exclusion—in addition to his or her own—after the deceased spouse's death. However, most states, with the exception of Maryland and Hawaii, do not have a similar law offering portability for their estate tax exemptions. As a result, in most states with their own estate tax, the surviving spouse may not add the deceased spouse's state estate tax exemption to their own exemption to increase the amount of money and property that can be transferred without tax liability.
Unlike estate taxes, the heirs are liable when there is an inheritance tax. An inheritance tax may be due if you inherit money or property from a deceased person who lives in a state having an inheritance tax or if the heir inherits property that is physically located in such a state. It does not matter where the heir lives. The tax is based upon the value of the money or property inherited.
Some heirs are exempt from inheritance taxes: Typically, spouses, children, and grandchildren, as well as charities, are not subject to an inheritance tax. In Nebraska and Pennsylvania, only the surviving spouse and charities are exempt, however. More distant relatives and non-relatives are usually not exempt, with those who are not related paying the highest tax rate. Some asset types are exempt from inheritance tax, depending upon the state. Most of the states do not exempt a certain dollar amount or exempt only a small amount, meaning that for heirs who do have to pay the inheritance tax, the tax will be imposed on their entire inheritance.
The following states have an inheritance tax:
- New Jersey
Create an Estate Plan to Minimize Tax Liability
Make lifetime gifts. Most states (exceptions are Connecticut and Minnesota) do not have a gift tax. The annual 2020 federal gift tax exclusion is $15,000 per recipient, which means that you can give away money or property of that value each year to each of your beneficiaries and it does not count against the $11.58 million federal lifetime exemption mentioned above. As a result, lifetime gifts are a great option for individuals who want to lower the value of their estate to avoid their state estate tax or who want to provide a gift to loved ones who may be subjected to an inheritance tax if they wait to make the gift at death.
Create an irrevocable trust. Any money or property you own that is placed in an irrevocable trust is not considered to be part of your estate and thus will not be subject to an estate tax upon your death. The downside to an irrevocable trust is that you no longer have control over the money and property. However, certain irrevocable trusts, for example, a qualified personal residence trust (QPRT) and a grantor retained annuity trust (GRAT), allow you to continue to benefit from the property. If you transfer ownership of your home to a QPRT, you can remove your home, typically a substantial asset, from your estate yet continue living there for a specified number of years after which the residence is transferred to the trust's beneficiaries. However, if you die before the period of years is up, it will be included in your estate. Similarly, a GRAT allows you to transfer income-producing property, e.g., stock or a business, into a trust for a specific number of years but continue to receive the income from that property. After the trust ends, the property is distributed to the beneficiaries of the trust. However, like the QPRT, if you die before the trust terminates, the property held in the trust will be included in your estate. The QPRT and the GRAT are only two of many potential trust-related strategies that could limit your state estate tax liability.
Consider moving. This may seem like a drastic solution, but it can substantially increase the amount of wealth you could pass on to your loved ones if you are currently living in a state in which your estate may be taxable or that has an inheritance tax. If you were already considering retiring to a state with a milder climate, think about moving to a state that does not impose an estate or inheritance tax. Or, if you have two homes, one of which is in a state with no estate tax, consider clearly establishing that home as your domicile, i.e., your permanent place of residence to which you intend to return when you are absent. If you are domiciled in a state with no estate tax, your estate will only have to pay estate taxes on real property or other tangible property you owned in the state with an estate or inheritance tax. An experienced estate planning attorney can advise you about the steps you should take to establish domicile in a state.
We Can Help
If you live or own real estate or tangible property in a state with an estate or inheritance tax, we can help you determine which estate planning strategies will work best in your particular circumstances to minimize your potential tax liability. Please give us a call to set up a meeting (via phone or videoconference if you prefer) to discuss this or any of your other estate planning concerns.