Estate Taxes
They say that two things in life are certain: death and taxes. Just to set the record straight, it was Congress, not me, that chose to combine the two. - G. Reaper
Nobody likes to pay taxes. In particular, no taxpayer of sound mind and body likes to pay estate taxes, also known as death taxes.
Whether you view it as Congress' effort to take your money when you are least able to complain or its noble attempt to redistribute wealth to those less fortunate, our estate tax system essentially penalizes those who have successfully accumulated wealth during their lifetimes. In order to pass on your wealth to your chosen beneficiaries at death, in addition to probate and other estate settlement costs, you (or more correctly, your estate) may have to pay death taxes at the federal level, and possibly also at the state level.
For example, an estate caught with too much wealth in 2007, 2008 or 2009 must pay a top federal estate tax rate of 45 percent. A state estate tax may also be imposed on top of that.
Death taxes come in two main varieties: estate taxes and inheritance taxes. The federal government currently has an estate tax by which the estate is taxed before it is distributed. Several states (and the District of Columbia and Puerto Rico) also have an estate tax, including: Connecticut, Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Rhode Island, Vermont, and Washington. Some states impose an inheritance tax, including: Indiana, Iowa, Kentucky, Louisiana, Maryland, Nebraska, New Jersey, Pennsylvania, and Tennessee. Just over half of the states have neither an estate nor inheritance tax.
Prior to 2005, most states that imposed estate taxes had what was called a "pick-up" estate tax. Although there were different variations of this tax, it was generally designed to tax state residents in an amount that equaled the state death tax credit allowed by federal estate tax laws. So, if a state resident's estate didn't have a federal estate tax liability prior to deducting the state death tax credit, it wouldn't have a liability under the state "pick-up" estate tax, either. In effect, the pick-up taxes took a portion of the federal estate tax and transferred it to the states. Except for having to file another tax return, a state pick-up tax would have little impact on your estate.
By the time the state death tax credit was completely eliminated from federal estate tax law in 2005, several of the "pick-up" states either eliminated their estate tax or "de-coupled" their estate tax from the federal credit. In states that "de-coupled," there is now a higher risk that an estate will be taxed at the state level even if it is not taxable at the federal level.
Since federal and state estate taxes can provide a double-whammy to your estate, don't forget to consider the impact of both when doing your estate planning. We will focus on the federal estate tax first for two reasons: (1) it is potentially applicable to you no matter where you live, and (2) its rates are significantly higher (up to 45 percent in 2007 through 2009) than either the state estate tax rates or the rates of that other tax that we all love to hate, the federal income tax (with its 10 percent to 35 percent rates applicable for individuals through 2010).
So get a pot of your favorite coffee and read the following sections:
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