Can You Eliminate Your State’s Estate or Death Tax?

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Can You Eliminate Your State's Estate or Death Tax?

Edith Windsor was prominent at the Supreme Court hearing on the Defense of Marriage Act in March. Ms. Windsor married her same-sex partner, Thea Clara Spyer, in 2007. When Ms. Spyer passed away in 2009, she left her entire estate to her spouse, Ms. Windsor. Because federal law does not recognize same-sex marriages, Ms. Windsor was required to pay federal estate tax of more than $363,000. Fortunately, they lived in New York State which does recognize same-sex marriages; otherwise New York would have added another $500,000 of death taxes to the bill.

State estate and inheritance taxes can come as a big surprise for taxpayers in 21 states and the District of Columbia where separate state levies are still a big concern. Thanks to the fiscal cliff tax deal, the federal estate tax only hits individuals who die with more than $5.25 million of assets (2013 – indexed for inflation). Some of the states with inheritance taxes offer no exemptions. The inheritance tax starts on the first dollar. States with estate taxes typically exempt $1 million or less per estate from their tax and impose a top rate of 16%. Two states, Maryland and New Jersey, impose both. Maryland imposes an estate tax of up to 16% above a $1 million exemption, and a 10% inheritance tax on every dollar left to a niece, nephew, friend or partner, but no inheritance tax on money left to children, grandchildren, parents or siblings. Yikes!!!

However, with a little planning you may be able to make the state tax bill go away. Here are some recommendations:

Change residency

There are 29 states without a death tax. Some of them probably have a very nice climate. You cannot merely state that you are changing your legal state of residency and stay in your former state. You’ll need to provide proof you are a resident of another state. This is usually evidenced by changing your driver’s license, registering to vote, and changing your automobile registration to the new state. Be sure to have your will updated stating you are a resident of the new state.

Annual gifting

Every taxpayer can give $14,000 a year (2013 – indexed for inflation) to as many people as they like without federal gift tax. Connecticut is the only state with a gift tax on cumulative gifts over $2 million. Gifts can be made into a trust for those concerned about recipients squandering the money. The trust must be irrevocable and the donor cannot have control for the trust to be considered a completed gift. The gifts must be outright gifts with no strings attached

Review your estate plan

It was not long ago when the federal estate tax exemption was $1 million. To stretch this exemption, married couples would establish credit shelter trusts (also called bypass trust or A/B trusts) to protect the $1 million exemption of the first person to pass away. The American Taxpayer Relief Act of 2012 made the federal exemption portable. The credit shelter trust is no longer needed for the federal estate tax but it is still a viable strategy for residents of states with an estate tax and a $1 million exemption. $1 million from the estate of the first spouse to die goes into the bypass trust and is exposed to tax. The exemption shelters this transfer from tax. The trust holds the funds to ultimately go to the heirs but the income can be paid to the surviving spouse until their death. With this strategy, no state taxes are paid at the first spouse’s death

Use Life Insurance

Leave your assets to charities and set up an irrevocable life insurance trust for heirs. This strategy calls for setting up a trust to hold a life insurance policy on your life and gifting the premiums to the trust each year. The policy pays the trust upon your death and the proceeds are distributed to the heirs. Your assets pass to charity outright tax-free. The cost of life insurance will play an important role in determining the effectiveness of this strategy. If the premiums are too expensive either because of age or health it may be cheaper for the heirs to pay the estate/inheritance tax.

Your estate plan should include a provision to deal with your state’s death tax. You should consult with your estate planner on other ways to deal with this important issue.

Rick’s Insights

  • 21 states and the District of Columbia have a death tax. You should find out if your state is one of them.
  • You need to provide evidence you have changed your state of residency. Changing your driver’s license, registering to vote, and changing your automobile registration to the new state provide proof.
  • Bypass trusts may not be needed for the federal estate tax anymore but they may offer protection from state death taxes.

You’ve worked hard to save for retirement. How can you turn your wealth into an income that’s designed to last your lifetime?

Now that retirement is a reality, or will be soon, you probably have questions. Here on our website, you can find generalized advice, but don’t you deserve advice tailored just to you?

Since 2002 Mark Eisenberger has been helping people just like you get answers. Simply call him at 717-560-3800 or 1-888-876-3437. He’ll answer your questions and, if you wish, can arrange for up to two hours of initial consultation with no cost or obligation and no sales pitch.

2025 Lititz Pike, Lancaster, PA 17601
Phone: 717-560-3800, Toll-Free: 888-876-3437