Don’t Forget to Plan for Your State’s Estate Tax

Keeping on top of state death tax rules can be difficult.

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The Research Institute of America recently reported increases to a number of tax limits beginning in 2014. The federal estate tax in 2014 will only apply to estates over $5,340,000. That’s an increase of $90,000 over the 2013 limit. Married couples using the new portability rules won’t have to worry about estate taxes until their joint estate exceeds $10,680,000. Those with a smaller net worth will need to focus their estate planning on state inheritance or estate taxes (death taxes) if they apply.

The Tax Policy Center reports only 15 states and the District of Columbia collect death taxes. Some impose an inheritance tax and others an estate tax. Only Maryland and New Jersey collect both estate and inheritance taxes. Many states tax an estate’s worth far less than the federal exclusion. New Jersey’s estate tax has the lowest threshold in the nation, taxing estates over $675,000.

Keeping on top of state death tax rules can be difficult. Every state linked their estate tax to the federal tax with a credit until 2001. This basically gave each state the right to collect around 20% of whatever the taxpayer owed the federal government. The credit was phased out completely by 2005 and Congress never relinked federal and state estate taxes. Some states opted to enact separate estate taxes after the credit was phased out.

To minimize their state’s estate tax, credit shelter trusts may still be needed for couples with a net worth of $5 million. A credit shelter trust captures assets when the first spouse dies, but allows the survivor to access income while living. The trust assets ultimately flow through to the heirs after the second spouse dies. However, the trust captures the first spouse’s exclusion and minimizes the tax bill when the second spouse dies.

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