If one thing is certain about estate tax laws, it's that we can expect them to change frequently. We've seen this particularly since Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "2001 Tax Act").
The 2001 Tax Act not only reduced rates of tax imposed on decedents' estates, but also increased the exclusion amount (the amount that a decedent can pass on free of estate tax) - which was already scheduled to be increased anyway under pre-existing law. In other words, a person who died in 2001 could pass to his or her heirs, tax free, assets up to $675,000, an amount which was scheduled to be increased to $1,000,000 for a person dying in 2006. Instead, under the 2001 Tax Act, the exclusion amount was immediately increased to $1,000,000 for persons dying in 2002 or 2003, then $1,500,000 for persons dying in 2004 or 2005; $2,000,000 for persons dying between 2006 and 2008; and $3,500,000 for persons dying in 2009. (Under both prior law and the 2001 Tax Act, assets can pass to the decedent's surviving spouse tax-free; these exclusion amounts apply to assets passing to other persons.) And, under the 2001 Tax Act, the estates of persons dying in 2010 will not be subject to Federal tax at all.
However, the 2001 Tax Act will sunset on December 31, 2010. After that date, estate taxes are scheduled to revert to what they would have been if the 2001 Tax Act had never existed - which means that there will still be a $1,000,000 exclusion amount, since that had originally been scheduled to take effect in 2006.
Despite the estate tax cuts for persons dying between 2002 and 2010, not all the changes to estate taxes under the 2001 Tax Act have been favorable to taxpayers. One change in particular - the elimination of the state death tax credit - could force some estates to pay more than they would have in the absence of the 2001 Tax Act.
The state death tax credit is a credit which existed under Federal law before the 2001 Tax Act. Pursuant to this credit, an estate would be entitled to reduce its Federal tax due by an amount equal to state estate taxes paid, up to a certain amount as determined based on the value of the estate. As a result, many states, including Illinois, charged estate tax in an amount exactly equal to the Federal tax credit allowed for state estate taxes paid (a "pickup tax").
As a counterbalance to the cuts in the Federal estate tax, the 2001 Tax Act provided that the state tax credit in 2002 would be only 75% of what it otherwise would have been; in 2003, 50%; and in 2004, 25%. Thus, in 2001, the maximum state death tax credit (which would also have been the maximum Illinois estate tax) was $1,082,800 plus 16% of the adjusted taxable estate in excess of $10,040,000. In 2002, the maximum state death tax credit was $812,100 plus 12 percent of the excess over $10,040,000; in 2003, $541,400 plus 8 percent of the excess over $10,040,000; and in 2004, $270,700 plus 4 percent of the excess over $10,040,000.
From 2005 through 2009, there will be no state death tax credit at all; the Federal government will allow a deduction for state death taxes paid, but the tax benefit of a deduction is less than the tax benefit of a credit of an equal amount. (In 2010, there will be no Federal estate tax at all, and so no deduction for Federal tax purposes will be necessary.)
Because of the reduction in the state death tax credit, Illinois has "decoupled" its estate tax from the Federal estate tax, putting into effect a new set of state estate tax brackets, which went into effect for the estates of persons who died in 2003. Under the new Illinois tax brackets, the estate tax due will range from $27,600 plus 5.6% of the taxable estate in excess of $900,000, to $1,082,800 plus 16% of the excess over $10,100,000. In effect, Illinois has enacted adopted the former brackets of the pre-2001 state death tax credit as its own estate tax rates through 2009. On the other hand, Illinois has increased its exclusion amount, but not as much as the Federal government has. In 2003, Illinois did not impose estate tax on estates less than $1,000,000; in 2004 and 2005, Illinois does not impose estate tax on estates less than $1,500,000; and from 2006 through 2009, Illinois will not impose estate tax on estates less than $2,000,000.
Like the Federal government, Illinois has also repealed the estate tax for decedents dying in the year 2010 only. Effective January 1, 2011, however, the state death tax credit will go back into effect at the Federal level, and the Illinois estate tax will revert to being equal to the state death tax credit allowed by the Federal government.
Other states have adopted a variety of responses to the phase-out of the state death tax credit, and their reactions can make a big difference in the estate taxes paid by their residents' estates. For example, in 2004, the top marginal Federal estate tax rate is 48% and the top marginal rate for the state death tax credit is 4% (after taking into account the reductions imposed by the 2001 Tax Act). In a state such as California, which has not decoupled from the Federal estate tax, the maximum net tax rate would thus be 52% - whereas in Illinois, which has decoupled from the Federal estate tax, the maximum net tax rate would be 64%.
Throughout the nation as a whole, the most common reaction has been not to decouple from the Federal estate tax, and, consequently, to have no state estate tax for decedents dying in 2005 - at least 27 states will have no state estate tax for persons dying in 2005. Still, a number of states besides Illinois have decoupled and will continue to impose their state estate taxes - among these are Massachusetts, Minnesota, New Jersey, New York, and Ohio.
When you revisit your estate planning, please keep in mind that, before the intended abolition of the Federal estate tax for the year 2010, followed by its reinstatement in 2011, there will be another congressional election in 2006 followed by a presidential election in 2008 and another congressional election in 2010. Naturally, there will also be gubernatorial and state legislative elections during this period as well. This means that there will be ample opportunity for both the Federal and state governments to either reinstate or abolish estate taxes as they may please. It's said that nothing is certain but death and taxes. Put them together, though, and you'll find that few things are more uncertain than the future of death taxes.
We'll be happy to help you make appropriate assumptions to support your planning, and suggest that you ensure that your plan does all it can for you, now - - without waiting for some definitive resolution of the law, which remains elusive.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.