State Estate Tax Law Changes Provide New Challenges, Opportunities
September 9, 2003
In 2001, the U.S. Congress enacted a sweeping tax reform that temporarily reduces the federal estate tax, repeals the tax for tax year 2010, and reinstates the estate tax in its previous form for 2011 and thereafter. Most state governments historically have assessed a “death” tax that is tied to the federal estate tax system. These state death taxes are assessed in such a way that most states face either a full or partial loss of revenues as the federal estate tax goes through its modification. The Center on Budget and Policy Priorities, a nonpartisan research organization and policy institute, estimates that the states collectively will lose $19 to $23 billion of death tax revenue between 2003 and 2007. A number of states have revised their death tax laws in order to recapture this source of tax revenue.
|
Death Tax Increase |
|
| Taxable Estate | Tax Increase |
| $10M | $0.5M - $0.8M |
| $25M | $1.6M - $2.6M |
| $50M | $3.4M - $5.6M |
M = Millions
On June 20, 2003, Illinois joined this growing number of states when Governor Blagojevich signed legislation “decoupling” the Illinois death tax from the federal estate tax system. The result of this change is a radical tax increase for wealthy residents of states, like Illinois, which have severed ties to the federal estate tax.
A brief review of prior federal estate tax law is necessary for a complete understanding of the state tax law changes. Prior to 2002, a decedent’s federal estate tax obligation was reduced dollar-for-dollar by a credit for the payment of state death taxes. The maximum allowable state death tax credit was computed by reference to a federal table. Currently, every state assesses a death tax at least equal to the state death tax credit. Thirty-seven states, including Illinois, traditionally imposed a death tax equal to the maximum allowable state death tax credit. This “pick-up” tax provided significant tax revenue for the state, yet it did not impose an additional tax burden on the residents of the state.
In 2001, Congress passed the Economic Growth and Tax Reconciliation Act of 2001 (EGTRA), which temporarily reduces the federal estate tax. This law “sunsets” which means that on January 1, 2011 the estate tax will be reinstated substantially in its form prior to the EGTRA tax law changes. Congress reduced the cost of estate tax reform by accelerating the repeal of the state death tax credit. EGTRA reduces the tax credit by 25 percent in each of the years 2002-2005, and eliminates the tax credit in 2005. Consequently, the 37 states with a “pick-up” estate tax are slated to lose all death tax revenue by the year 2005.
The Illinois legislature, like many other state legislatures, responded to EGTRA by “decoupling” the Illinois death tax regime from the federal estate tax system. In general, for large taxable estates, the new Illinois law computes the Illinois death tax obligation by reference to the federal state death tax table in effect prior to EGTRA. Accordingly, large taxable Illinois estates will pay a substantial Illinois death tax, but will no longer receive a full federal estate tax credit for the taxes paid. Under EGTRA, for tax years 2005 through 2009, estates may claim a deduction for state death taxes paid. A deduction from federal estate tax, however, provides less than one-half of the benefit that a death tax credit provides.
The Illinois death tax will significantly increase the tax obligations of wealthy decedents that resided in the state of Illinois and decedents that resided outside of the state of Illinois who held real estate in the state. The Illinois death tax is currently applicable to taxable estates that exceed $1 million ($1.5 million in 2004 and $2 million in 2006). Most estate plans of married persons defer the payment of estate tax until the death of the surviving spouse by taking maximum advantage of the unlimited marital deduction. Thus, in most cases, the Illinois death tax generally will be imposed only at the death of the surviving spouse or at the death of a single individual. The chart below provides an estimate of the total transfer tax burden (federal and state taxes) for an Illinois decedent and a decedent in a state that has not decoupled, in each case based on the value of the indicated taxable estate.
Taxable Estate
$10,000,000 $25,000,000 $50,000,000
2003: Year of Death
Average Tax Rate, Illinois 48.90% 53.80% 55.40%
Av. Tax Rate - “Pick-Up" State 43.60% 46.80% 47.90%
Illinois Tax Increase $553,800 $1,733,400 $3,733,400
2004: Year of Death
Av. Tax Rate, Illinois 48.70% 55.50% 57.70%
Av. Tax Rate - “Pick-Up" State 40.70% 45.10% 46.50%
Illinois Tax Increase $800,700 $2,600,100 $5,600,100
2005: Year of Death
Av. Tax Rate, Illinois 44.80% 50.50% 52.40%
Av. Tax Rate - “Pick-Up" State 39.90% 44.10% 45.60%
Illinois Tax Increase $491,269 $1,583,969 $3,411,555
Residents of states that have recently “decoupled” from the Federal estate tax system may wish to consider planning opportunities that reduce or eliminate state death taxes. For example, some Illinois residents are becoming residents of Florida. Florida, like certain other states, continues to rely on a “pick-up” tax system imposing a state death tax equal to the state death tax credit. This tax system provides Florida death tax revenues through the year 2004 (the state death tax credit is fully phased out in the year 2005) and does not place an additional tax burden on the decedent’s estate. Florida’s constitution appears to prohibit the enactment of a state death tax in excess of the state death tax credit. A change to Florida residency also may provide substantial income tax and property tax reductions. Certain other planning opportunities are available. It may be appropriate to review estate plans in consideration of these new tax rules.
