A few months back I wrote about how estates up to $3,500,000 are not subject to federal estate tax and that the tax will be eliminated in 2010.  For this reason, when people call our office to discuss estate planning they will often begin by saying that they are not concerned about estate tax.  I have to correct them, however, because most states have their own estate tax that may kick in on smaller estates where the federal tax isn’t a concern.  So, how big might such an estate tax bill be?

            First, a little background.  Under the previous law, Congress permitted a dollar for dollar credit towards the federal estate tax for any state estate and inheritance taxes paid up to a certain limit.  So, many states established their estate tax structures to “soak up” the maximum credit that Congress permitted.  In essence, the federal government shared a portion of its tax revenue with the states.  When it raised the federal exemption, however, Congress decided it could no longer share a smaller tax revenue with the states so it phased out this credit.  Many states, in response, changed their tax laws to preserve their revenue stream.  New Jersey now has an estate tax that kicks in on estates greater than $675,000 and New York on estates greater than $1,000,000.

            New Jersey’s estate tax  starts out at 4% and gradually increases to a maximum of 16%.  New York’s estate tax also maxes out at 16%.  As I explain to our clients, we usually see federal estate taxes in the six figure to seven figure range and state estate taxes in the tens of thousands of dollars on the low end, and hundreds of thousands of dollars on the higher end.

            What can you do to reduce, or even eliminate this tax?  Well, for starters, in the case of married couples, a bypass or credit shelter trust should be employed.  This will save substantial amounts of tax that would be paid by children at the death of the second parent to die.  But you must have this trust set forth in your will before you pass away.  

Ever since Congress passed the current estate tax legislation in 2001 it was the belief of many, including myself, that legislators would have to go back and pass changes to the law before 2010.  You see, in 2010 there is no federal estate tax.  But, the elimination of the tax applies only to that one year.  In fact, in 2011 the federal exemption, the amount one can pass free of federal estate tax, goes back to $1,000,000.  It doesn’t take much imagination to see why that can be a dangerous thing. A little explanation is required.

 

            In 2001 the federal exemption amount was $675,000 and heading towards $1,000,000 by 2006.  President Bush came to office having promised during his presidential campaign in 2000 to push for legislation eliminating the estate tax.  However, he couldn’t get his bill passed through Congress and had to reach a compromise.  That is why the current law gradually raises the exemption until, in 2010, the tax is eliminated.  But, the law contains a “sunset provision”, meaning it expires on December 31, 2010.  The previously law becomes effective once again.  Bush intended to go back and eliminate the tax permanently after midterm Congressional elections, which he hoped would increase the Republican majority in Congress.  As we all know, 9/11 and the Iraq war changed everything and in the last year the economy has sunk into recession.

 

            The federal estate tax is a pretty hefty one.  The tax rate is 45% so the tax can very quickly reach six and seven figures.  So, if Dad dies in 2010 there is no tax, but if he dies in 2011 the tax can be hundreds of thousands or millions of dollars.  Legislators often change the tax laws to influence public behavior.  We make so many financial decisions based on the tax impact (too many, in my opinion).  So, what will happen if families know that they can save millions in taxes if Mom or Dad dies on December 31, 2010, rather than January 1, 2011? 

 

            That is one reason why I always felt that change would happen before 2010.  Well, we’re 6 months away and still, no change.  Last year there was some talk about extending the exemption through 2015 at $3,500,000.  With the economy worsening, and government deficits increasing, however, that doesn’t seem likely.  The latest proposal is to put the exemption amount at $2,000,000.  But what if change doesn’t happen this year?  Can the law be passed after the beginning of next year?  Experts believe it can because estate tax is due 9 months after death, meaning the first 2009 returns are due October 1, 2009.

 

            Things will certainly be interesting so stay tuned.  And keep in mind that even if your estate is below $1,000,000 many states have their own estate tax which kicks in at amounts lower than the federal exemption amount.