March 17, 2003
HOW STATES ARE RETAINING A STATE
ESTATE TAX: LEGISLATIVE LANGUAGE USED
by
Elizabeth McNichol
Introduction
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This paper is a technical description of the ways
in which states can preserve their estate taxes despite the phase-out of the
federal “death tax credit” as a result of the 2001 federal tax law changes.
Other Center reports — listed at the end of this report — provide more general
information on estate tax policies and options as well as state-by-state
estimates of the revenue implications of the various options.
Current Law
In 37 states, state estate tax liability is set by
statute to equal the amount allowed as a credit against the federal estate
tax, with there being no other state estate or inheritance tax. These
states are referred to as having only a pickup tax.
The remaining states also have their own
inheritance or estate taxes, a portion of which qualifies as a pickup tax.
In all of these states, the state laws specify that if the amount of
the state tax is less than the credit allowed against federal taxes, the state
tax is increased to the amount of the credit.
Under the federal tax law enacted in June 2001,
the credit for state “death taxes” paid will be reduced to zero by 2005. As a
result, the estate taxes of states that tie their estate taxes to the amount
of the state credit allowed under federal law will be eliminated if they make
no changes in their estate tax law.
How to Decouple
In both types of states — states with only a
pickup tax and states with both a separate state tax and a pickup tax — the
revenue that would have been lost as a result of the federal tax cut has been
retained by “decoupling.” Decoupling means breaking the automatic
connection between the amount of the state estate tax credit in the federal
law and the amount of tax an estate owes to the state.
In most of the decoupled states, the
link has been broken by specifying that the state’s pickup estate tax will be
equal to the amount of the federal credit for state death taxes as it stood
prior to the passage of the federal tax cut bill of June 2001.
For example,
Rhode Island decoupled from the federal
changes by adding the following section to its estate tax law:
“For decedents whose death occurred on or after
January 1, 2002, a tax is
imposed upon the transfer of the net estate of every resident or nonresident
decedent as a tax upon the right to transfer. The tax is a sum equal to the
maximum credit for state death taxes allowed by 26 U.S.C. Section 2011
as it was in effect as of
January 1, 2001.”
The last clause of this new section — “as it was
in effect as of January 1, 2001” — ties Rhode Island’s estate tax to federal
law prior to the enactment of the federal estate tax changes for deaths
occurring after January 1, 2002.
Exemptions by Size of
Estate
Language similar to
Rhode Island’s will ensure that the state
estate tax is not reduced as the state credit is phased out. However, this
type of provision could have been interpreted as adopting the federal
exemption schedule that was in effect under federal law prior to passage of
the federal tax legislation. Under federal law as of January 2001, estates
with values less than the following amounts would have been exempt from the
estate tax: $700,000 for deaths occurring in 2002 and 2003, $850,000 in 2004,
$950,000 in 2005 and $1 million for 2006 and the following years.
Rhode Island, instead chose to retain the
exemption at the 2001 level of $675,000 and, thus, later added the following
phrase, “provided, however, any scheduled increase in the unified credit
provided in 26 U.S.C. Section 2010 in effect on
January 1, 2001 or
thereafter shall not apply.”
Under the federal estate tax law
adopted in June 2001, the exemption level increased immediately to $1 million
and will further increase in steps to $3.5 million by 2010. As a result, in
states that have decoupled by referencing federal law as of January 2001, some
estates will be subject to the state estate tax and not to the
federal tax. Some states felt this could result in administrative
difficulties for the state revenue department or the executors of estates and
have decided to decouple only partially. These states are retaining an estate
tax equal to the full amount of the credit in the pre-2001 law but at the same
time incorporating the federal exemption amount increases that were part of
that law.
There are two ways that states have
addressed this issue. The first is by adopting the federal filing thresholds
as the filing threshold for the state estate tax. Estates are required to
file a federal estate tax return if the gross value of the estate exceeds the
federal exemption amounts. (The gross value is the value of the estate before
deductions or credits are applied.) In states that have adopted the federal
exemption amounts as a filing threshold only estates that must file a federal
estate tax return are required to file and pay state estate taxes. For
example,
Virginia’s estate tax law includes the
following language which establishes state filing thresholds equal to the
federal thresholds:
“The personal representative of every estate
subject to the tax imposed by this chapter who is required by the laws of the
United States to file a federal estate tax return shall file with the
Department, on or before the date the federal estate tax return is required to
be filed: (i) a return for the tax due under this chapter; and (ii) a copy of
the federal estate tax return.”
If a state wants to adopt the higher federal
exemptions and its estate tax law does not already include this type of
provision, it could add similar language. With this language no estate
will be required to complete a state estate tax form unless it is required to
complete a federal form.
However, even with this type of
provision, there could be some estates that will owe state estate taxes but no
federal estate taxes. This could occur if an estate has a gross value before
deductions that exceeds the federal exemption amount but has a value after
deductions that is less than the federal exemption amount.
In this case, the estate would owe no federal tax but would owe state tax if
the state has adopted the federal exemptions as the filing threshold but has
not explicitly stated that the amount of the state estate tax cannot exceed
the amount of federal tax owed. Some states that have decoupled wanted to
avoid this situation as well and thus included language stating this
explicitly in their decoupling language (see
Maryland below). Other states that have
decoupled accomplished this by changing their estate tax law to set the amount
of the tax equal to the credit as it existed prior to the federal changes of
2001 but retained their reference to the remainder of the federal estate tax
law as it exists on the date of death. This incorporates both the provisions
of the federal tax change that increased the federal exemption and those that
provide that the amount of the state death tax credit cannot exceed the amount
of federal tax owed.
North Carolina accomplished this by adding
the highlighted language below to its state estate tax law.
“The amount of the estate tax imposed
by this section for estates of decedents dying on or after
January 1, 2002, is the
maximum credit for state death taxes allowed under section 2011 of the Code
without regard to the phase-out of that credit under subdivision (b) (2) of
that section.”
Adopting the current federal exemption schedule
would, of course, reduce the amount of revenue that a state would retain from
its estate tax.
In addition, it should be noted that in 2011 — and
the following years if the federal estate tax repeal is made permanent — no
estates will be required to file a federal return or pay federal estate tax.
As a result, the estate tax of a state with either of these provisions would
be repealed as well. To avoid this, the state could require that
starting in 2011 all estates above a certain value, say $3.5 million, must
file a state estate tax return and pay a state tax equal to the pre-2001
credit regardless of whether they are required to file a federal return.
Alternative Language
Another way states have decoupled is
by adopting legislation that explicitly lays out the state’s intention to not
conform to the federal changes. For example,
Maryland’s decoupling legislation added the
following section to its state estate tax statute, which decouples, adopts the
exemption schedule on the new federal law, and retains the
Maryland estate tax when the federal tax is
repealed.
§ 7-309
(a) Notwithstanding an Act of Congress
that repeals or reduces the federal credit under § 2011 of the Internal
Revenue Code, the provisions of this subtitle in effect before the passage of
the Act of Congress shall apply with respect to a decedent who dies after the
effective date of the Act of Congress so as to continue the Maryland estate
tax in force without reduction in the same manner as if the federal credit had
not been repealed or reduced.
(b) (1) Except as provided in
paragraph (2) of this subsection, after the effective date of an Act of
Congress described in subsection (a) of this section, the
Maryland estate tax shall be determined
using:
(i) the federal credit
allowable by § 2011 of the Internal Revenue Code as in effect before the
reduction or repeal of the federal credit pursuant to the Act of Congress; and
(ii) other provisions of
federal estate tax law, including the applicable unified credit allowed
against the federal estate tax, as in effect on the date of the decedent's
death.
(2) If the federal estate tax is
not in effect on the date of the decedent's death, the
Maryland estate tax shall be determined
using:
(i) the federal credit
allowable by § 2011 of the Internal Revenue Code as in effect before the
reduction or repeal of the federal credit pursuant to the Act of Congress; and
(ii) other provisions of
federal estate tax law, including the applicable unified credit allowed
against the federal estate tax, as in effect on the date immediately preceding
the effective date of the repeal of the federal estate tax.
Section 7-309 B 1 (ii) above is the
part of
Maryland’s new law that determines that the
current law federal unified credit will apply. (The unified credit is the
provision of federal law that determines the exemption amount.) As noted
earlier, one drawback of adopting the changes in the federal exemption amounts
is that all estates would be exempted when the federal estate tax is repealed
in 2010. To address this concern,
Maryland added section (2) of this law in
order to ensure that the
Maryland estate tax would remain after the
repeal of the federal tax.
For Further Information
Publications: The Center on
Budget and Policy Priorities has prepared a number of papers on the decoupling
issue. These are available in a special section of the Center’s website:
https://www.cbpp.org/decoupling.htm.
These papers include:
States Can Retain Their
Estate
Taxes
Even as the Federal
Estate
Tax is
Phased Out. This paper explains in more detail how
states laws are linked to the federal law and includes state-by-state
estimates of the revenue that states could retain by decoupling.
Many States are Decoupling from the
Federal
Estate
Tax Cut
— This fact sheet lists the states that are decoupled from the federal
law.
Why States Should Act Now to Preserve their
Estate and Inheritance Taxes — This paper details some of the reasons
states should consider decoupling.
Contact for further assistance:
Liz McNichol, a senior fellow with the State
Fiscal Project of the Center on Budget and Policy Priorities, is familiar with
the decoupling legislation that has been adopted in a number of states and is
available to provide further information. She can be reached at
[email protected].