Estate Planning Blog Articles

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What States Make You Pay an Inheritance Tax?

Let’s start with defining “inheritance tax.” The answer depends on the laws of each state, so you’ll need to speak with an estate planning attorney to learn exactly how your inheritance will be taxed, says the article “States with Inheritance Tax” from yahoo! finance. There are six states that still have inheritance taxes: Iowa, Kentucky, Nebraska, New Jersey, Maryland and Pennsylvania.

In Iowa, you’ll need to pay an inheritance tax within nine months after the person dies, and the amount will depend upon how you are related to the decedent.

In Kentucky, spouse, parents, children, siblings and half-siblings do not have to pay inheritance taxes. Others need to act within 18 months after death but may be eligible for a 5% discount, if they make the payment within 9 months.

Timeframes are different county-by-county in Maryland, and the Registrar of Wills of the county where the decedent lived, or owned property determines when the taxes are due.

Only a spouse is exempt from inheritance taxes in Nebraska, and it has to be paid with a year of the decedent’s passing.

New Jersey gets very complicated, with a large number of people being exempted, as well as qualified religious institutions and charitable organizations.

In Pennsylvania, rates range from 4.5% to 15%, depending upon the relationship to the decedent. There’s a 5% discount if the tax is paid within three months of the death, otherwise the tax must be paid within nine months of the death.

As you can tell, there are many variations, from who is exempt to how much is paid. Pennsylvania exempts transfers to spouses and charities, but also to children under 21 years old. If one sibling is 20 and the other is 22, the older sibling would have to pay inheritance tax, but the younger sibling does not.

There’s also a difference as to which property is subject to inheritance taxes. In Nebraska, the first $40,000 inherited is exempt. Pennsylvania exempts certain transfers of farmland and agricultural property. All six exempt life insurance proceeds when they are paid to a named beneficiary, but if the policies are paid to the estate in Iowa, the proceeds are subject to inheritance tax.

Note that an inheritance tax is different than an estate tax. Both taxes are paid upon death, but the difference is in who pays the tax. For an inheritance tax, the tax is paid by heirs and the tax rate is determined by the beneficiary’s relationship to the deceased.

Estate tax is paid by the estate itself before any assets are distributed to beneficiaries. Estate taxes are the same, regardless of who the heirs are.

There are twelve states and the District of Columbia (Washington D.C.) that have their own estate taxes (in addition to the federal estate tax). Note that Maryland has an inheritance, state and federal estate taxes. The rest of the states with an estate tax are Connecticut, Hawaii, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Washington and Vermont.

The large variations on estate and inheritance taxes are another reason why it is so important to work with an experienced estate planning lawyer who knows the estate laws in your state.

Reference: yahoo! finance (Jan. 6, 2021) “States with Inheritance Tax”

Some States Have No Estate or Inheritance Taxes

The District of Columbia already moved to reduce its exemption from $5.67 million in 2020 to $4 million for individuals who die on or after Jan. 1, 2021. A resident with a taxable estate of $10 million living in the District of Columbia will owe nearly $1 million in state estate tax, says the article “State Death Tax Hikes Loom: Where Not To Die In 2021” from Forbes. It won’t be the last change in state death taxes.

Seventeen states and D.C. levy their own inheritance or estate taxes in addition to the federal estate tax, which as of this writing is so high that it effects very few Americans. In 2021, the federal estate tax exemption is $11.7 million per person. In 2026, it will drop back to $5 million per person, with adjustments for inflation. However, that is only if nothing changes.

President Joseph Biden has already called for the federal estate tax to return to the 2009 level of $3.5 million per person. The increased tax revenue purportedly would be used to pay for the costs of fighting the “pandemic” and the “infrastructure improvements” he plans, but many believe such a move would potentially destroy family businesses, farms and ranches that drive and feed the economy in the first place. If that were not troubling enough, President Biden has threatened to eliminate the step up in basis on appreciated assets at death.

This change at the federal level is likely to push changes at the state level. States that don’t have a death tax may look at adding one as a means of increasing revenue, meaning that tax planning as a part of estate planning will become important in the near future.

States with high estate tax exemptions could reduce their state exemptions to the federal exemption, adding to the state’s income and making things simpler. Right now, there is a disconnect between the federal and the state tax exemptions, which leads to considerable confusion.

Five states have made changes in 2021, in a variety of forms. Vermont has increased the estate tax exemption from $4.25 million in 2020 to $5 million in 2021, after sitting at $2.75 million from 2011 to 2019.

Connecticut’s estate tax exemption had been $2 million for more than ten years, but in 2021 it will be $7.1 million. Connecticut has many millionaires that the state does not wish to scare away, so the Nutmeg state is keeping a $15 million cap, which would be the tax due on an estate of about $129 million.

Three states increased their exemptions because of inflation. Maine has slightly increased its exemption because of inflation to $5.9 million, up from $5.8 million in 2020. Rhode Island is at $1,595.156 in 2021, up from $1,579,922 in 2020. In New York, the exemption amount increased to $5.93 million in 2021, from $5.85 million in 2020.

The overall trend in the recent past had been towards reducing or eliminating state estate taxes. In 2018, New Jersey dropped the estate tax, but kept an inheritance tax. In 2019, Maryland added a portability provision to its estate tax, so a surviving spouse may carry over the unused predeceased spouse’s exemption amount. Most states do not have a portability provision.

Another way to grab revenue is targeting the richest estate with rate hikes, which is what Hawaii did. As of January 1, 2020, Hawaii boosted its state estate tax on estates valued at more than $10 million to 20%.

If you live in or plan to move to a state where there are state death taxes, talk with your estate planner to create a flexible estate plan that will address the current and future changes in the federal or state exemptions. Some strategies could include the use of disclaimer trusts or other estate planning techniques. While you’re at it, keep an eye on the state’s legislature for what they’re planning.

Reference: Forbes (Jan. 15, 2021) “State Death Tax Hikes Loom: Where Not To Die In 2021”

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