Although the new $5.25 million exemption shields the vast majority of estates from federal taxes, state estate taxes are alive and well. Currently, 21 states and the District of Columbia impose some type of death tax, and most kick in at a level much lower than the fed's trigger.
See Also: Retiree Tax Map
In the past, state estate taxes were a nonissue for most families. Federal law provided an estate tax credit that cut the federal bill by the amount paid in state estate taxes. States were happy to use this "pick up" tax to collect funds that would have otherwise gone to the federal government.
In 2005, though, the credit was repealed, leaving states to their own devices. And in some states that continue to collect estate taxes, the difference between the federal and state tax exemptions is huge. New Jersey taxes estates worth more than $675,000. Rhode Island nicks those worth more than $910,725, and New York's estate tax applies to estates valued at more than $1 million. All three states impose a top rate of 16%.
At those thresholds, you don't have to be a Rockefeller to worry about taxes diminishing the size of your legacy. Remember, the value of your home and retirement accounts is included, notes Richard Behrendt, director of estate planning for Baird's private wealth management group. The proceeds of a life insurance policy could count, too, depending on how the policy is owned and who gets the money.
Inheritance taxes. Complicating matters, eight states impose an inheritance tax. Unlike an estate tax, which is levied on the estate before it is distributed, an inheritance tax is paid by the beneficiaries. Spouses are exempt from inheritance taxes, and in some states, so are children and close relatives. Maryland and New Jersey impose both estate and inheritance taxes.
Behrendt says some seniors take state death taxes into account when deciding where to retire. Florida, Arizona and Texas, for example, impose neither an estate nor an inheritance tax.
If you'd rather not move, you can limit or avoid state estate taxes with proper planning. Connecticut is the only state that imposes a tax on gifts made while you're alive, Behrendt says. (The Constitution State taxes cumulative lifetime gifts of more than $2 million at a top rate of 12%.) In all other states, "you could literally be on your deathbed, give away your fortune, and die with less than the threshold amount," he says. "That does give you a lot of flexibility."
Since deathbed giving isn't considered sound estate planning, it's a good idea to discuss strategies with an attorney who is familiar with your state's laws. Keep in mind, too, that while federal estate taxes appear settled for now, state estate and inheritance taxes are a moving target. That makes it important to update your estate plan periodically. Just last year, for example, lawmakers in Tennessee voted to gradually increase the state's inheritance tax exemption on the way to phasing out the tax completely in 2016. Maine's estate tax exemption increased to $2 million from $1 million on January 1, but legislation has been introduced to roll it back.
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