Chapter 18
State Transfer Taxes
Types of State Transfer Taxes
Tax planning for forest management generally focuses on income and property taxes. As discussed throughout this book, the effect of the Federal estate tax often is overlooked. This is an oversight that can cause serious disruptions in the orderly transfer of forest land at death. In the same way, State transfer taxes also must be considered in estate planning, due to their actual cost and to the possibility that they will upset strategies that address only Federal taxes.
States levy four different types of taxes on the transfer of property: gift taxes, estate taxes, generation-skipping transfer taxes, and inheritance taxes. As with their Federal counterparts, State gift taxes are levied on an individual’s lifetime transfers of property over and above annual and/ or lifetime exclusion amounts; State estate taxes are levied on the right of a decedent’s estate to transfer property; and generation-skipping transfer taxes are levied on the right of individuals to transfer property to persons two or more generations younger than themselves, either through an outright gift or a transfer in trust. An inheritance tax is levied on the right of an individual heir or legatee to receive property from a decedent’s estate.
At the time the last edition of this book1 was published, all 50 States taxed the transfer of forest land and other assets at death, either through an estate tax or an inheritance tax. Of that total, 13 States had both estate and inheritance taxes, and 2 States had two different estate taxes in effect. In addition, 6 States taxed large gifts and 27 States taxed generation-skipping transfers.
1 Haney, H.L., Jr.; Siegel, W.C. 1993. Estate planning for forest landowners: what will become of your timberland? Gen. Tech. Rep. SO-97. New Orleans, LA.: U.S. Department of Agriculture Forest Service, Southern Forest Experiment Station. 186 p.
Effect of the Economic Growth and Tax Relief Reconciliation Act
Before enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; Public Law 107-16), every State had a transfer tax system under which at least one tax was set equal to the maximum Federal credit for State transfer taxes allowed under Internal Revenue Code (IRC) section 2011 or 2604. This approach did not result in any additional tax burden on estates or individuals, but apportioned a part of what would have been the Federal tax bill to the State.
Most States simply set their transfer tax(es) equal to the maximum allowable Federal credit. This approach is called a “pick-up” or “sponge” tax. States with separate stand-alone transfer taxes used a second “piggy-back” transfer tax to make up the difference between their stand-alone tax(es) and the maximum Federal credit.
EGTRRA, however, phased out the Federal credit for State transfer taxes between 2002 and 2005, and from 2005 on, replaced it with a deduction. This change in how the Federal estate tax is calculated threatened to eliminate all State transfer taxes that were tied to the Federal credit, throwing State tax law and tax planning into turmoil.
The individual States have responded very differently to the changes brought by EGTRRA. Some have made no change to their transfer tax systems, allowing estate, inheritance, gift, and generation-skipping transfer taxes tied to the Federal credit to phase out. Others have seen EGTRRA as an opportunity to repeal transfer taxes, while still others have seen it as an occasion to craft new levies on transfers of property.
Current State Transfer Taxes
Estate and inheritance taxes tied to the Federal credit—Tables 18.1 through 18.4 summarize the current (2008) transfer tax laws of States in, respectively, the Northeast, North Central region, South, and West. Each table has separate columns for each type of transfer tax: estate, inheritance, gift, and generation-skipping. States that have a given type of tax are indicated with an X in that column; an accompanying footnote outlines the provisions of the tax and notes if it has been allowed to phase out with the Federal credit. The few States with two taxes of the same type are indicated with two Xs, with the provisions of both outlined in a single footnote. States that do not have a type of tax are indicated with a dash in the column, while States that recently have repealed a tax—or replaced it with a different type of tax—are indicated with a footnote that gives the date of the change.
Table 18-1. State transfer tax systems in the Northeast, 2008
To view Table 18-1 click here. (note: Table 18-1 is in PDF format)
Table 18-2. State transfer tax systems in the North Central region, 2008
To view Table 18-2 click here. (note: Table 18-2 is in PDF format)
Table 18-3. State transfer tax systems in the South, 2008
To view Table 18-3 click here. (note: Table 18-3 is in PDF format)
Table 18-4. State transfer tax systems in the West, 2008
To view Table 18-4 click here. (note: Table 18-4 is in PDF format)
Overall, 32 States—4 in the Northeast, 7 in the North Central region, 11 in the South, and 10 in the West—have kept estate or inheritance taxes tied to the Federal credit on their books, allowing them to phase out. Two States—one each in the South and West—have repealed estate taxes tied to the Federal credit (tables 18.1 through 18.4).
Seven States—Minnesota, New Jersey, New York, North Carolina, Rhode Island, Vermont, and Wisconsin—have decoupled estate or inheritance taxes from the current Federal estate tax provisions, tying them to Federal law as it existed on January 1, 2002, or earlier. Another five States— Illinois, Maine, Maryland, Massachusetts, and Oregon—also have decoupled estate or inheritance taxes from current Federal estate tax provisions, tying them to Federal law as it existed December 31, 2001, or earlier, but recognizing a higher exclusion amount. And four States—Connecticut, Kansas, Nebraska, and Washington—have replaced taxes tied to the Federal credit with stand-alone estate taxes (tables 18.1 through 18.4).
The net result of these changes is that 34 States that once levied estate or inheritance taxes tied to the Federal credit no longer do so, at least for the present. Only the 16 States listed in the preceding paragraph still levy estate or inheritance taxes descended from tax laws tied to the Federal credit—12 by decoupling their tax from current Federal law and 4 by passing a new stand-alone tax (tables 18.1 through 18.4).
Stand-alone inheritance and estate taxes—Montana, New Hampshire, and South Dakota have repealed stand-alone inheritance or estate taxes. Twelve States— Connecticut, Indiana, Iowa, Kentucky, Louisiana, Maryland, Nebraska, New Jersey, Ohio, Oklahoma, Pennsylvania, and Tennessee—still levy taxes of this type (tables 18.1 through 18.4).
Gift taxes—Delaware, Louisiana, and New York have repealed their gift taxes, while Connecticut has replaced its gift tax with a unified estate and gift tax. Only North Carolina and Tennessee continue to levy gift taxes (tables 18.1 and 18.3).
Generation-skipping transfer taxes—Of the States that levied generation-skipping transfer taxes at the time the last edition of this book was published, 21 have allowed their taxes to phase out with the Federal credit, while Arizona, Kansas, and Washington have repealed their laws. Only Illinois, Nebraska, and Vermont still levy generation- skipping transfer taxes. Illinois and Vermont decoupled their taxes from current Federal provisions, tying them to Federal law as in effect on an earlier date—although Illinois recognizes a higher exclusion amount. Nebraska replaced a tax tied to Federal law with a stand-alone tax (tables 18.1 through 18.4).
State Transfer Taxes and Estate Planning
The specific provisions of State transfer taxes differ sub- stantially, even among States with similar tax systems. In most instances, coordinated planning that takes both Federal and State tax provisions into consideration will be required in order to obtain the best results.
The need for coordinated planning is, of course, reduced to the extent that a specific State has repealed transfer taxes or allowed them to phase out with the Federal credit. The latter situation will likely change, however, as Congress addresses the 1-year repeal of the Federal estate tax and subsequent return to prior law scheduled under EGTRRA.
Coordinated planning will continue to be necessary in States that have decoupled from current Federal law and tied their transfer taxes to provisions that existed at an earlier date, as well as in States that have retained or enacted stand-alone transfer taxes. In States that have decoupled from current Federal law, provisions such as the applicable credit amount (provided by IRC section 2010; see chapter 3), marital deduction (provided by IRC section 2056(a); see chapter 6), special use valuation (permitted under IRC section 2032A; see chapter 12), and deferral and extension of tax payments (permitted under IRC section 6166; see chapter 13) remain available indirectly at the State level. The marital deduction is not limited, but for the other provisions the level of the benefit is that in effect on the date to which the State tax is tied rather than that provided under current Federal law.
In States that have retained or enacted stand-alone taxes, the provisions available may be quite different from those allowed under Federal law. Some States do not have applicable credit or marital deduction provisions, with the result that estate value deferred at the Federal level may be taxable by the State. Some States have their own special use valuation and deferral and extension provisions, while others lack such provisions or explicitly deny them. Thus, in States which have decoupled from current Federal provisions, and in those with stand-alone taxes, a State estate or inheritance tax may be incurred even if no Federal estate tax is due. Trusts, joint ownerships, aggressive gifting (including charitable bequests), intergenerational transfers, and other measures discussed elsewhere in this book also produce mixed results when State transfer tax provisions are not explicitly incorporated in the planning process.
Because of the increasing variability in State transfer tax laws and because some State laws work counter to Federal provisions, it is imperative that estate planners be familiar with the details of State transfer taxes and how they impact forest properties.