State Estate Tax Changes Make Plans Trickier

Some states are trimming the tax due on estates or inheritances when someone dies, while others are hiking them. Even more change is coming, complicating estate planners’ efforts to preserve as much wealth as possible.

Ohio last week repealed its estate tax, starting Jan. 1, 2013. The tax generated $285 million in 2010. In May, Connecticut lowered its estate tax exemption from $3.5 million to $2 million to take in more estates. Now, some 29 states collect no tax when someone dies, while a shifting array of others apply estate or inheritance taxes. A federal credit for state estate tax that was dropped several years ago is set to return in 2013 if Congress does nothing, raising questions about how states will react.

For estate planners, “the situation is very challenging right now,” says Elizabeth G. Deleery, a partner at Osborne, Helman, Knebel & Deleery, LLP in Austin, Texas.

While her state has no estate or inheritance tax (the latter applies on assets that go to a specific beneficiary, rather than on the whole estate), advisers there may still need to discuss tax issues for out-of-state property with clients. They often suggest clients consult with local tax planners when they move because the rules are very state-specific, she says.

Any plan needs to take into account the relevant states’ rules — and build in some flexibility. A mistake in a plan for a couple, for example, could mean an unexpected tax when the first spouse dies, according to Julie K. Kwon, a partner in the Menlo Park office of law firm McDermott Will & Emery LLP.

Ohio advisers should find their jobs a bit easier because of the estate tax repeal. After all, navigating around state exemptions, rates and deductions that conflict with those at the federal level is a chore. And, the repeal should be a net plus for taxpayers, who are likely to owe less tax, though not by the full amount of the state tax reduction: It decreases federal deductions, causing federal taxes to rise, according to Don R. Weigandt, Managing Director of Wealth Advisory at J.P. Morgan’s Private Bank.

Ohioans may now be in the same good position as those who die in California, which effectively repealed its estate tax several years ago. When California advisers create plans to reduce estate taxes, they can “largely ignore anything at the state level,” says Weigandt.

Some states’ changes have sent angry heirs scrambling to the courts.

Connecticut lowered its estate tax exemption in May, but made the change retroactive to Jan. 1, 2011. The family of a prominent Connecticut developer who died in April, Monty Blakeman, is suing over whether or not the state can collect more tax than it would have before it lowered its exemption. Blakeman left a taxable estate over $3.5 million.

Stephen R. Bellis, a lawyer for the family, says the estate doesn’t want to pay the approximately $115,200 additional tax it will owe as the result of the new, lower exemption. The case is without merit, according to Gian-Carl Casa, a spokesman for the Connecticut Office of Policy and Management.

Advisers are bracing for more change in 2013, when a federal credit for state death taxes may return.

Under the credit system, nearly all states collected a so-called pickup tax equivalent to the federal credit, while a few imposed additional taxes. The pickup tax was a painless source of revenue for states because the federal credit completely offset the state tax.

If the credit comes back, state estate tax will return for states that have not adopted their own estate tax. Advisers will have to see how these states interact with the revived federal credit and if states take further steps to “recouple” with the federal credit.

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