State Inheritance and Estate Tax Rates

Inheritance and Estate Taxes

An inheritance tax is an assessment made on the portion of an estate received by an individual. It differs from an estate tax which is a tax levied on an entire estate before it is distributed to individuals. It is strictly a state tax. Eleven states still collect an inheritance tax. They are: Connecticut, Indiana, Iowa, Kansas, Kentucky, Maryland, Nebraska, New Jersey, Oregon, Pennsylvania and Tennessee. In all states, transfers of assets to a spouse are exempt from the tax. In some states, transfers to children and close relatives are also exempt.

In 2010 estate and generation skipping (GST) taxes were repealed and the gift tax rate is equal to the highest income tax rate of 35%. Assuming Congress does not change the law on Jan. 1, 2011, the estate, GST and gift tax laws that existed on Jan. 1, 2001 will be reinstated. The estate and gift tax exemptions would be reunified again at $1 million and the GST exemption would be $1 million, indexed for inflation.

The estate and gift tax rates would range from 39% to 55% depending on the taxable gift or estate with taxable transfers in excess of $3 million taxed at the top rate. For taxable transfers between $10 million and $17,184,000, there would be a 5% additional tax imposed to bring the tax to 60%. In 2011 the GST tax rate would be 55%, the highest estate tax rate.

Even though almost everyone thought Congress would act before 2010 so that repeal of the estate and GST taxes would never actually take place, Congress got caught up in the health care bill and failed to act. Congress has indicated that it will attempt to pass an estate tax bill that is retroactive, so that there is no repeal for any part of 2010 (though passing any bill will be harder after the election of a Republican senator from Massachusetts).

Even if a retroactive bill is enacted the effectiveness of a retroactive provision is not entirely clear. There is a U.S. Supreme Court decision (Carlton v. U.S.) indicating that a retroactive increase in the estate tax rate would be permitted under the Constitution. However, because the estate tax does not exist at the present time, any bill would impose (or in this case "re--impose") a new tax, rather than just raise the rate. Though retroactivity is still likely, one can expect a challenge to retroactivity on these grounds.

In most states, estate and inheritance taxes are designed in such a way that states face either a full or partial loss of estate tax revenues as this credit is phased out. States can avert this loss of revenue by "decoupling." Decoupling means protecting the relevant parts of their tax code from the changes in the federal tax code, in most cases by remaining linked to federal law as it existed prior to the change.

Seventeen states and the District of Columbia have retained their estate taxes after the federal changes. Of these, 15 states -- Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Vermont, Virginia, and Wisconsin -- and the District of Columbia decoupled from the federal changes. Two states -- Nebraska and Washington -- retained their tax by enacting similar but separate estate taxes.

Of these, 12 states acted to decouple from the federal changes. Illinois, Maine, Maryland, Massachusetts, New Jersey, Rhode Island, and Vermont enacted legislation linking their estate taxes to the federal estate tax as in effect before the 2001 tax bill. Minnesota, which passes a tax conformity package each year, explicitly elected not to change its estate tax to conform to the federal changes. North Carolina elected to decouple at least through 2005, and Wisconsin has decoupled through 2007. Nebraska decoupled by creating a separate state estate tax on estates that exceed $1 million based on the federal law before the 2001 changes. In 2005, Washington enacted a separate tax with a somewhat different rate structure that applies to estates that exceed $2 million after the state's original decoupling was nullified in court.

In addition, five states and the District of Columbia will remain decoupled unless they take legislative action. In five states -- Kansas, New York, Ohio, Oregon, and Virginia -- and the District of Columbia, estate tax laws are written in such a way that the state will not conform to the federal changes unless it takes legislative action.