Revised June 28, 2002

COMBINED FEDERAL AND STATE ESTATE TAXES WILL DECLINE FOR THE VAST MAJORITY
OF ESTATES EVEN WHEN A STATE
DECOUPLES FROM THE FEDERAL ESTATE TAX CUT
by Daniel Tenny

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Most states currently tax estates exclusively through a "pickup" tax linked to the federal tax code. The amount of this tax in most states equals the "state death tax credit", a provision of the federal estate tax law that allows taxpayers to subtract the amount of estate tax paid to a state from their federal estate tax liability, up to a limit. A pickup tax imposes a tax equal to the maximum amount that can be subtracted from federal liability. This amount varies depending on the size of the estate and is determined by a schedule in the federal tax code.

The 2001 federal tax law phases out the federal estate tax over 10 years but eliminates the state credit over four years. As a result, states that retain their link to the federal tax code will see their pickup taxes reduced, and eliminated by the fourth year. During this time of fiscal crisis, states cannot afford this revenue loss imposed on them by the federal government. To address this problem, about a dozen states have fully or partially "decoupled" from the federal changes and retained their state estate taxes as they were in effect before the federal tax bill was enacted. Other states are considering similar actions. Some opponents of the decoupling have argued that states that decouple are undermining federal efforts to reduce estate taxes by subjecting some estates to a tax increase when combined federal and state estate taxes are considered. This brief analysis responds to this concern.

Example: Federal and State Tax Liability for Estate
Of $2 Million in 2003 in State That Decouples
Pre 2001 law Post 2001 law Change
A. Federal estate tax before state credit $551,000 $435,000 -$116,000
B. Allowable State credit $99,600 $49,800 -$49,800
C. Federal tax after state credit (A - B) $451,400 $385,200 -$66,200
D. State estate tax $99,600 $99,600 $0
TOTAL TAX (C + D) $551,000 $484,800 -$66,200