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A little-noticed
aspect of the $1.35 trillion tax cut package championed by President
George W. Bush was the phaseout of state estate-tax credits, which
had been tied to the federal tax code for nearly a century.
The change had the effect of ending state-level taxes on
inherited assets on Dec. 31, 2005, even though the federal tax on
inherited property remains in effect through 2009, Kevin M. Bohl
writes in the Elder Law
Journal, published by the
University of Illinois College of Law.
State legislatures have responded to the phaseout in different
ways. "Some states revised their local estate taxes to compensate
for the loss of tax credits, others absorbed the increased financial
burden, and a few states chose a cautious course and revised their
laws for temporary periods," wrote Bohl, the editor-in-chief of the
journal.
The net effect is "much more complexity and uncertainty" in the
planning of a wealthy family's financial affairs.
Illinois, for example, has decoupled from the federal code and
imposed its own tax on estates worth $2 million or more. (Estates
under $2 million are not subject to any Illinois tax.)
The tax on estates of people dying in 2010 is eliminated in both
Illinois and on the federal level, but only for one year. Starting
on Jan. 1, 2011, the Illinois and federal estate taxes are scheduled
to return, with just a $1 million exemption.
The time periods are not the only complexity arising from the
2001 law. Heirs with family property located in several states run
the risk of getting caught in the "death tax trap." Bohl cited the
example of a person with a $20 million estate who lives in Florida
but has $2 million worth of property in New York. Under New York
law, the entire state tax credit will be taken by New York and then
reduced by the amount of tax paid to other states.
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 But because Florida has not decoupled from the federal code, the
estate tax paid to Florida is equal to zero dollars. Therefore, New
York will collect all of the state taxes owed. "The end result is
that the Florida resident ends up paying the equivalent of a New
York resident estate tax on the entire estate," Bohl noted.
There are political reasons behind the confusion. In order to
pass the tax bill, Congress "sunsetted" the law, which brings the
old tax rules back in force in 2011.
The first week of May, President Bush called on Congress to make
the tax cuts permanent and to repeal the estate tax altogether. The
Bush proposal is certain to spark a fight. Proponents of keeping the
tax say that it covers only a small number of super-rich families
and that repeal of the tax would cost the federal government at
least $50 billion a year.
Of the 2.4 million Americans who are expected to die this year,
only about 6,500 of their estates would be subject to the federal
estate tax.
Bohl urged state governments to help bring "predictability" to
estate planning by either decoupling from the federal tax code or
eliminating state estate taxes altogether.
His article is titled, "The Resurrection of the Death Tax:
Decoupling and the Economic Growth and Tax Relief Reconciliation Act
of 2001."
[University
of Illinois news release]
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