state estate tax and business succession planning · state estate tax and business succession...

STATE ESTATE TAX AND

BUSINESS SUCCESSION PLANNING

Panelists

Hugh Drake Brown Hay & Stephens, LLP

Springfield, IL

Shelby Wilson Berchem, Moses & Devlin, PC

Westport, Connecticut

Lisa Rico Gilmore, Rees & Carlson P.C.

Wellesley, MA

Tye Klooster Katten Muchin Rosenman LLP

Chicago, IL

ABA JOINT MEETING – FALL 2011 DENVER, COLORADO

OCTOBER 21, 2011

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NUTS AND BOLTS OF STATE ESTATE TAX

Shelby Wilson Berchem, Moses & Devlin, PC,

Westport, Connecticut


OCTOBER 21, 2011

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Introduction

This panel will discuss state decoupling of federal and state estate taxes. The panelists will begin by briefly outlining the nuts and bolts of state estate taxes, including a brief history of state estate taxes. The discussion will then turn to the impact of EGTRRA on the differing federal and state exemption amounts, and will provide an overview of the recent estate tax developments in individual states. Through the use of various fact patterns, the panelists will then address various planning techniques to consider in planning for clients, with a particular emphasis on business succession planning issues.

I. Nuts and Bolts of State Wealth Transfer Taxes

A. Three Basic Types of Wealth Transfer Taxes 1. Estate Tax- Tax on the right to transfer property at death. This is a tax based

on value of all of decedent’s property. Liability for payment of the tax belongs to the executor of the estate of the decedent.

2. Inheritance/Succession Tax- Tax on the transfer of property during lifetime or at death. The payment of the succession tax is typically the responsibility of the transferor (if an inter vivos transfer), or the executor of the estate of the decedent. The rate of tax may differ based on relationship between the transferor and the beneficiary. For example, some states that either had an inheritance or succession tax, or in states that still have these regimes in place, transfers to spouses and children may be exempt, while transfers to collateral family members and non-relatives may be subject to higher tax rates depending on the degree of kinship between the decedent and the beneficiary.

3. Gift Tax- Tax on the inter vivos transfer of property. Based on the fair market

value of the property transfer on the date of the gift and any resulting tax liability is the responsibility of the transferor.

B. 26 U.S.C. § 2011

1. § 2011(a) - Estate tax imposed by § 2011 shall be credited with the amount of any estate, inheritance, legacy, or succession taxes actually paid to any State or the District of Columbia, in respect of any property included in the gross estate (not including any such taxes paid with respect to the estate of a person other than the decedent).

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2. § 2011(b)- Limits amount that may be credited for state estate taxes paid based on percentage of adjusted taxable estate. Top marginal rate prior to the 2001 Act was 16%.

Adjusted Taxable Estate Maximum Tax Credit

Up to $90,000 8/10ths of 1% in excess of $40,000

Over $90,000 up to $140,000 $400 plus 1.6% in excess over $90,000

Over $140,000 up to $240,000 $1,200 plus 2.4% in excess of $140,000


Over $440,000 up to $640,000 $10,000 plus 4% in excess of $440,000


Over $840,000 up to $1,040,000 $27,600 plus 5.6% in excess of $840,000

Over $1,040,000 up to $1,540,000 $38,000 plus 6.4% in excess of $1,040,000


Over $2,040,000 up to $2,540,000 $106,800 plus 8% in excess of $2,040,000





Over $5,040,000 up to $6,040,000 $402,800 plus 12% in excess of $5,040,000





Over $10,040,000 $1,082,800 plus 16% in excess of $10,040,000

3. § 2011(b) - “adjusted taxable estate” defined as the taxable estate minus $60,000.

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4. § 2011(c) - Estates must claim credit within four years of filing the federal estate

tax return, with three exceptions:

a. If the estate files petition with the U.S. Tax Court, credit must be claimed within 60 days of decision;

b. If the estate has secured an extension of time to pay the estate tax pursuant to § 6166 or §6161, then the estate has until the expiration period of the extension to claim credit; and

c. If the estate files a timely claim for refund for overpayment of estate tax, § 2011 claim can be made within 60 days of receiving notice that claim was disallowed or 60 days from date of hearing disallowing the claim, whichever is later.

C. A Brief History of State Estate Taxation Prior to the Economic Recovery Tax Act of 1981 (“ERTA”), several individual states had

their own estate and inheritance tax regimes. A number of states subjected estates to a state estate tax, even if such estates were not subject to the federal estate tax. In some cases, state estate tax rates exceeded the federal credit for estate taxes, and certain states did not recognize the unlimited marital deduction for inheritance tax purposes.

∙ ERTA

Among the most significant changes made by ERTA to the federal estate tax were the following:

1. Increase of the federal exemption from $175,625 to $600,000 (phased in over five years);

2. Introduction of the unlimited marital deduction; and

3. Creation of Qualified Terminable Interest Property (QTIP) subject to the marital deduction.

In the wake of these changes, most states limited their estate tax to the maximum federal state death tax credit under § 2011. As a result, most states recognized the unlimited marital deduction, adopted QTIP, and conformed their exemptions to the federal exemption. This concept was commonly referred to as the “pick up tax” or “soak up tax”, as the individual states would simply absorb the maximum state death tax credit available through § 2011. In fact, in the years leading up to the 2001 tax act, only 13 states retained an independent estate or inheritance tax.i

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D. The Economic Growth Tax Relief Reconciliation Act of 2001 (“EGTRRA”)

1. Among the changes that were made to the federal estate tax with the passage of EGTRRA were the following:

i. Phase-in of the increase in federal exemption amounts beginning in 2002 and ending in 2009 ($1 million for decedents dying in 2002-2003, $1.5 million for decedents dying in 2004-2005, $2 million for decedents dying in 2006-2008, and $3.5 million for decedents dying in 2009) with no estate tax for decedents dying in 2010 and a sunset of the federal estate tax in 2011 with a $1 million exemption;

ii. Reduction of the top marginal tax rate for estates from 55% to 45%

(50% in 2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006 and 45% in 2009); and

iii. Phase-out of the top rate of the state death tax credit from 16% to elimination (12% in 2002, 8% in 2003, 4% in 2004, elimination in 2005) with credit to return in 2011 with limits equal to those in place in 2001. Congress replaced the credit with a deduction for state estate taxes paid beginning January 1, 2005.

2. As a result of EGTRRA, Congress adopted what ultimately became codified as § 2011(b)(2), which provides that in the case of estates of decedents dying after December 31, 2001, the credit was reduced by 25% for decedents dying in 2002. The credit was further reduced by 50% for decedents dying in 2003, and by 75% for decedents dying in 2004. For decedents dying after December 31, 2004, the state credit for death taxes paid was eliminated.

3. In reaction to phase-out and elimination of § 2011, states that had enacted estate tax regimes that conformed to the federal estate tax were in a position of losing significant tax revenue as a direct result of this new legislation. As a result, some states took action to modify existing estate tax laws, while other states enacted their own regimes independent of the federal estate tax. Still other states took no action as a result of EGTRRA.

i These states included Connecticut, Indiana, Iowa, Kentucky, Louisiana, Maryland, Nebraska, New Hampshire, Ohio, Oklahoma, Pennsylvania and Tennessee.

STATE ESTATE TAX RECENT DEVELOPMENTS1

Tye J. Klooster Partner

Katten Muchin Rosenman LLP Chicago, Illinois


OCTOBER 21, 2011

1 The statements contained in this Outline are the author’s alone and should not be attributed to any other person

and/or Katten Muchin Rosenman LLP unless otherwise indicated. The statements contained in this Outline should not be relied upon without separate and independent verification of their accuracy, appropriateness given the particular facts presented and/or potential tax consequences. The author hereby disclaim any warranty as to the accuracy of the statements contained in this Outline.

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STATE ESTATE TAX RECENT DEVELOPMENTS

I. Summary of State Estate Tax Laws.

A. Introduction. Prior to the repeal of the state death tax credit, little if any planning was required for state death taxes because for the most part the states simply received estate tax revenue from the federal government through the 2011 credit. This revenue sharing device was eliminated as a result of the phase out of the 2011 credit in 2005. A number of states amended their revenue laws in an attempt to recoup this lost revenue, others have not. The result is a convoluted mix of state estate tax laws which has made estate tax planning more complicated and costly. In short, we have complete and utter chaos in regards to state estate tax laws. This environment is dangerous for estate planners. It is difficult to master your own state’s estate tax laws and impossible to master the state estate tax laws of all 50 sates and the District of Columbia. If your clients have property in other states or change their residency to a different state, engaging local counsel is all the more necessary if that state has a state estate tax.

B. McGuire Woods LLP Chart. See attached chart titled “2011 State Death Tax Chart”, which is a chart maintained by Skip Fox of McGuire Woods LLP and has been attached hereto with Skip’s permission. The chart was most recently updated September 22, 2011. The chart does a very nice job of summarizing the current state of the estate and inheritance tax laws of the various states.

C. Summary of Existing State Estate Tax Laws.

1. Chart. See attached chart titled “Summary of Existing Estate Tax Laws”. In this chart I have grouped the states into the various types of state estate tax regimes or lack thereof. I have attempted to group the states in a manner consistent with the status of their state estate tax laws and provide other helpful information, including the estate tax exemption, top tax rate and whether a separate state QTIP election is authorized. Please be aware that a lot of conflicting information exists regarding the status of the various state estate taxes and I can assure you that the attached chart is not accurate in each and every respect. Accordingly, I cannot stress enough that this chart should not be a substitute for your own independent verification of the current status of a particular state’s estate tax laws.

2. Outright Repeal. My understanding is that 5 states have completely eliminated their state estate tax (Arizona, Kansas, Nebraska, Oklahoma and Virginia).

3. Pick Up Only States. My understanding is that 29 states are “pick up only” states and as a result of the repeal of the Section 2011 credit currently have no state death tax. These states have either failed to act in response to the phase out of the 2011 credit or are prohibited from doing so. Florida, for example, is prohibited from imposing a separate state estate tax on its citizens and residents which exceeds the amount allowed to be credited upon or deducted from any similar tax levied by the United States or any state. Florida Constitution, Article VII, Section 5; FL Statutes § 198.02.

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4. Modified Pick Up States. My understanding is that 12 states and the District of Columbia (total of 13) have decoupled and are modified pick up states imposing a state estate tax based on the Section 2011 credit as it would have been in effect with certain assumptions (e.g., as the 2011 credit was in effect on December 31, 2001, but assuming a $2 million exclusion amount).

5. Stand Alone State Estate Taxes. My understanding is that 4 states currently have a stand alone state estate tax. Kansas and Oklahoma phased out their separate state estate taxes as of January 1, 2010.

6. Inheritance Taxes. My understanding is that 8 states impose an inheritance tax. A number of states, however, only impose an inheritance tax on collateral heirs (e.g., unrelated individuals, cousins, aunts and uncles) and not on lineal heirs (spouse, children, grandchildren, parents). There is a lot of variation in state inheritance tax laws.

7. States With Both Estate and Inheritance Taxes. My understanding is that 2 states (Maryland and New Jersey) impose both an estate tax and an inheritance tax. However, my understanding is that in both states the estate tax is reduced by the amount of inheritance tax paid to eliminate the double taxation.

8. Gifts In Contemplation of Death. By my count 10 states have laws which in some manner seek to prevent deathbed gifts as a planning tool to avoid state estate or inheritance taxes (Indiana, Iowa, Kentucky, Maine, Maryland, Nebraska, New Jersey, Ohio, Pennsylvania and Tennessee). Most of these states are states which impose an inheritance tax. For states which have decoupled and do not impose a gift tax or have laws regarding gifts in contemplation of death, deathbed gifts are a planning tool to consider.

9. Gift Taxes. To my knowledge only 2 states (Connecticut and Tennessee) impose state gift taxes.

10. Exemptions and Rates. In modified pick up states, simple references to state estate tax exemption amounts and rates are not always accurate. For example, it is often stated Illinois has a $2 million state estate tax exemption amount. Illinois, however, does not technically authorize a $2 million state estate tax exemption amount; rather, Illinois imposes a state estate tax equal to the “state tax credit”, which is defined as an amount of tax equal to the full credit calculable under Section 2011 of the Code as the credit would have been computed and allowed as the Code was in effect on December 31, 2001 (without the reduction of the state death tax credit) but recognizing a $2 million applicable exclusion amount. For example, a 2011 Illinois decedent who had an estate of only $500,000 but who made $4,500,000 of adjusted taxable gifts would owe an Illinois state estate tax of $9,690. Illinois’ “exemption” is not really an exemption, but a threshold amount.

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In modified pick up states it is also not technically accurate to simply state that state estate tax rates are based on the credit rates provided for the 2011 credit (which range from 0% to 16%). An important exception to this general rule exists for an estate with a taxable value just above the equivalent state exemption amount. In this case the tax rate can be much higher. For example, a 2011 Illinois decedent who had an estate of $2,500,000 (Illinois has a $2,000,000 estate tax threshold) and made no lifetime gifts would owe $128,518 of Illinois estate taxes, which translates into a tax rate of 25.70% for the amount by which the estate value exceeds the exclusion amount ($128,518 / $500,000). This result occurs as a result of the computation of the 2011 credit amount, which is the lesser of (a) 2011 credit amount (lower rates), or (b) the amount of the Federal estate tax (higher rates). Basically, the (b) computation results in higher marginal rates until the (a) computation becomes larger. Since the Federal estate tax rates are much higher, higher marginal rates apply to estate values just over the exemption amount. This is counterintuitive and difficult to wrap your head around, but is something that you should keep in mind when discussing applicable state estate tax rates.

D. Emerging Issues in State Estate Tax Planning.

1. Federal Deduction for State Death Taxes. In a number of modified pick up states which impose a state estate tax by reference to the 2011 credit, the deduction for state estate taxes under Section 2058 has potentially caused an interrelated state estate tax calculation. Basically, the Section 2058 deduction reduces the value of the Federal taxable estate, which reduces state estate taxes, which in turn reduces the 2058 deduction, etc. The Illinois Attorney General, for example, provides a state estate tax calculator which provides ten trials before deriving the appropriate state estate tax figure. Some states (e.g., Connecticut, Delaware, Maine, Maryland and North Carolina) have enacted legislation which provides that the Section 2058 deduction for state death taxes is not taken into consideration in calculating the state estate tax, resulting in greater state estate tax in these states.

2. Availability of State QTIP. In situations where the available state estate tax exemption is less than the available federal estate tax exemption, it is beneficial if the state authorizes a separate state QTIP election. By my count 10 states with an estate tax currently authorize a separate state QTIP election in some form or another. 7 states that impose an estate tax do not offer a separate state QTIP election.

Illinois is an example of a state that has enacted separate state QTIP legislation designed to eliminate state estate taxes at the first spouse’s death. Illinois law allows a state QTIP election to be made even if a corresponding Federal QTIP election is not made. Illinois currently has a $2 million estate tax exemption and the Federal exemption is currently $5 million. Assume a client dies with an estate of $10 million (and made no prior taxable gifts). In Illinois this would allow the funding of the following trusts: (a) credit shelter trust with $2 million, consuming part of the Federal exemption and the full Illinois exemption; (b) QTIP Trust #1 with $3 million, which is the difference between the Federal and state exemptions, over which an Illinois state-only QTIP election is made, thereby consuming the remaining $3 million of Federal exemption but delaying any state estate tax until the survivor’s death; and (c) QTIP Trust #2 with $5 million, for

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which Federal and state QTIP elections are made. In essence, because Illinois allows a separate state-only QTIP election, taxpayers may make full use of their Federal and Illinois exemptions amount at death and avoid a state estate tax on the first spouse’s death.

Other states are more restrictive in their authorization of a state QTIP election, only allowing a QTIP election to the extent a Federal QTIP election is made or to the extent no Federal estate tax return is required to be filed. In these states an executor may be forced to decide whether to pay some state estate tax at the first spouse’s in order to fully consume the decedent’s Federal estate tax exemption. A number of interesting issues have developed in these states.

What if a Federal estate tax return is filed solely to “put” the predeceased spouse’s unused estate tax exemption to the surviving spouse under the new Federal portability rules? Does this mean that in these states a state QTIP election is not available? New York issued a technical memorandum dated July 29, 2011 which provided that even if a Federal estate tax return is filed solely for the purpose of electing portability, the same QTIP election reflected on the Federal estate tax return must be made for New York estate tax purposes. If a QTIP election is not made on the Federal estate tax return it cannot be made for purposes of the New York estate tax return. The technical memorandum provides a specific example of a 2011 decedent whose estate is below $5 million but for which a Federal estate tax return is filed solely to make a portability election. In that case no QTIP election is available for purposes of the New York estate tax return. Note that a Federal QTIP election is not available in this case even if desired (see discussion below regarding PLR 201131011). In the situation where the estate value is less than the Federal filing threshold but there is a surviving spouse with significant assets, an executor may be forced to decide to pay some state estate tax in order to take advantage of the portability of the Federal exemption (a decision that will need to be made with the knowledge that portability of the Federal exemption, under current law, is only valid in 2011 and 2012). One potential solution to this mess is for the Federal government to provide a different mechanism for making a portability election other than filing a Federal estate tax return. For example, the Federal portability election could be changed such that it is made on a separate form that is not the Federal estate tax return.

What of 2010 decedents who have opted out of the Federal estate tax regime? The issue is that the Federal opt out does not eliminate otherwise applicable state estate taxes. New York’s Office of Tax Policy Analysis issued TSB-M-10(1)M dated March 16, 2010 permitting a separate state QTIP election when no Federal estate tax return is required to be filed, such as for 2010 decedents for which an election is made out of the estate tax regime or when the size of the estate is such that there is no requirement to file a Federal estate tax return. New York’s Office of Tax Policy Analysis issued Technical Memorandum TSB-M-11(9)M dated July 29, 2011 which confirmed (and clarified) the March 26, 2010 technical memorandum.

Another interesting issue that has arisen for 2010 decedents who elect out of the Federal estate tax regime and into the carryover basis regime is the potential for double taxation. As an example, New York state estate tax would still be due on the excess over

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the available state exemption amount. In addition, the income tax basis of the heirs in the property received is the Federal income tax basis, which is the basis in the hands of the decedent (subject to the increased basis allocation rules). The result is the estate would pay New York state estate tax and the heirs would have no relief from the additional income tax that results from the carryover basis rules. Legislation was introduced in New York to address this potential for double taxation, but the legislation did not pass.

What if the decedent’s estate is $2 million and the decedent dies when the Federal exemption is $5 million and in a state with a $1 million state estate tax exemption and which authorizes a state QTIP election only to the extent allowed for Federal estate tax purposes? Assume the decedent’s estate plan directs $1 million to a QTIPable marital trust and $1 million to a credit shelter trust and further assume the decedent’s surviving spouse has little to no property. Can the executor of the decedent’s estate file a Form 706 and make a QTIP election on the $1 million QTIPable marital trust in order to eliminate state estate taxes upon the decedent’s death? In PLR 201131011 the Service held that under Rev. Proc. 2001-38 a QTIP election will be treated as null and void where the election was not necessary to reduce Federal estate tax liability to zero. The result in this case is that state death taxes will be due upon the first spouse’s death.

3. Portability of State Exemption. The 2010 Tax Act included provisions which make the unused Federal exemption of a predeceased spouse portable to the surviving spouse, assuming a Form 706 is filed by the estate of the predeceased spouse. The portability of the Federal exemption is available for estates of persons dying in 2011 and 2012. One of the issues with relying on portability of the Federal exemption is that no state to my knowledge authorizes portability of the state exemption. New York’s Office of Tax Policy Analysis issued Technical Memorandum TSB-M-11(9)M dated July 29, 2011 which expressly provides that there is no portability of the New York state estate tax exemption.

4. Same Sex Marriage / Civil Unions. Same sex couples may now marry in six states: Connecticut, Iowa, Massachusetts, New Hampshire, New York and Vermont. Washington, D.C. also permits same sex marriages. Maryland and New Mexico (per an attorney general ruling) recognize same-sex marriages but do not grant marriage licenses to same-sex couples. Civil unions and domestic partnerships are authorized by a number of states, including most recently Illinois, Rhode Island, Hawaii and Delaware. Other states, such as California, have domestic partnership laws.

Under Defense of Marriage Act (“DOMA”) the Federal government does not recognize these same sex unions and other states are not obligated to follow them. Some states which authorize same sex unions impose a state estate tax which is calculated based on the Federal estate tax and the question that has arisen is whether these states will authorize a state only marital deduction for property passing to the same sex spouse when such a deduction is not authorized on the Federal estate tax return.

New York, for example, currently imposes an estate tax on estates exceeding $1 million and, as discussed above in regards to the state QTIP election, generally New York decedents may only make a QTIP election to the extent a QTIP election is made on a

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Federal estate tax return (or to the extent no return is filed). New York addressed this issue with the release of TSB-M-11(8)M on July 29, 2011. This technical memorandum provides that for New York state estate tax purposes, the term “spouse” includes different sex spouses and same sex spouses and as a result the same deductions and elections allowed for different sex couples are available to same sex couples – regardless of whether a Federal estate tax return is filed.

Illinois now authorizes civil unions and therefore presents a similar issue. The Illinois estate tax is equal to the state tax credit under Section 2011 as the credit would have been allowed as of December 31, 2001 but recognizing a $2 million estate tax exemption. Illinois’ estate tax law piggybacks off the Federal estate tax law. Therefore in order to confer a marital deduction for transfers at death to the other party of a civil union the text of Illinois’ estate tax law seems to require that Federal law also recognize the deduction. Illinois’ civil union law, however, requires that the act be construed liberally to promote its underlying purposes. At some point the Illinois legislature, Illinois Attorney General or an Illinois court will likely have to address this issue.

5. Thirst for Additional Revenue.

a. Retaliatory State Estate Tax - Florida. Various bills have been filed in Florida over the last couple of years which seek to impose a retaliatory state estate tax. The most recent bills were HB 183 and SB 1006. Both bills have been indefinitely postponed and withdrawn from consideration. However, it is probably not the last we are going to see of these types of bills in Florida and therefore a discussion of the most recent bills is merited.

Currently, Florida imposes no estate tax on residents or nonresidents of Florida. Florida’s constitution prohibits the imposition of a separate state estate tax; however, the constitution only applies to residents of Florida. Accordingly, imposing an estate tax on nonresidents is not prohibited. Florida legislators have proposed legislation to exploit this distinction.

The most recent Florida bills seek to impose a Florida estate tax on nonresidents of Florida who transfer property located in Florida (prior bills listed specific types of property, but the most recent bills were more general in the description of the property subject to tax). There is, however, an important qualification to the imposition of the estate tax - the estate tax is only imposed to the extent the state in which the taxpayer is a resident imposes an estate tax on the estate of a person who is a nonresident of that state on property located in that state.

By way of example, if the nonresident resides in a state with a pick up only estate tax and thus has no current estate tax, then Florida would not impose a tax. However, residents of states that have decoupled may be hit with a Florida estate tax. For example, Illinois imposes a tax on real property and tangible personal property of a nonresident located in Illinois (a proportion of Illinois’ $2 million estate tax exemption is available to the nonresident). Therefore, a client

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who resides in Illinois and has Florida real estate would owe a Florida estate tax under these bills.

The amount of the tax would be equal to the tax that a nonresident of the taxpayer’s state of domicile would have to pay if he or she were a resident of Florida and the Florida property was located in the taxpayer’s state of domicile and the nonresident’s property located in the state of domicile were located in Florida. The tax and estate tax return would be due on or before the last day prescribed by the laws of the nonresident’s state of domicile for the payment of tax or the filing of returns. The bills would have been effective July 1, 2011.

b. Attempt to Broaden Scope of Inheritance Tax – Pennsylvania. A draft policy statement was recently prepared by the Pennsylvania Department of Revenue which would seek to expand the Pennsylvania inheritance tax to the receipt of property upon the termination of an irrevocable trust (Draft Policy Statement § 94.3). The Policy Statement would be effective as of January 1, 2012 and seeks to impose an inheritance tax on property terminated by consent of the necessary parties pursuant to 20 Pa.C.S. § 7740.1 (which I understand to be similar to UTC § 411). If such an irrevocable trust is terminated pursuant to 20 Pa.C.S. § 7740.1 without court approval or notice to the Department of Revenue, then the person responsible for filing the inheritance tax return and the Trustee of the irrevocable trust would have joint and several liability for the tax due. The Department of Revenue requested comments from Nina Stryker, Chairman of the Probate Section of the Philadelphia Bar Association. Nina’s responded to the Department of Revenue and indicated that the section (1) does not believe the proposed policy would be enforceable because it does not appear to be a legitimate extension of current law (current law apparently only applies tax to the termination of certain trusts at the surviving spouse’s death and Pennsylvania does not impose a gift tax), and (2) the proposed policy’s attempt to impose liability on a Trustee for which the Trustee no longer holds trust assets would impose an undue and unfair burden not supported under current law.

II. Update on State Estate Tax Legislation and Administrative Rulings.

A. Connecticut. In 2009 Connecticut increased its estate tax exemption to $3,500,000 effective as of January 1, 2010 and reduced state estate tax rates (7.2% to 12% top rate). However, in May of 2011, the estate tax exemption was lowered to $2,000,000 as part of a budget bill, retroactive to January 1, 2011 (top rate is still 12%). Note that Connecticut estate tax is due six months after date of death and not nine months. CT Statutes § 12-391.

B. Delaware. For estates of decedents dying until July 1, 2013, Delaware’s state estate tax is calculated based on the 2011 credit as in effect on January 1, 2001 and other provisions of the federal estate tax laws with respect to the duty to file a return and the calculation of the taxable estate in effect on the earlier of the date of the decedent's death or the date immediately preceding the effective date of the repeal of the federal estate tax. DE Statutes 30 §§ 1502(c)(2). It is not clear whether Delaware’s filing threshold is $3,500,000 or $5,000,000.

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C. Hawaii. HB 2866 was enacted by the Hawaii legislature on April 29, 2010 after overriding a veto of Governor Lingle. The new Hawaii estate tax law applies to estates of decedents dying after April 30, 2010 and imposes an estate tax equal to the 2011 credit assuming an estate tax exemption of $3,500,000 (the state estate tax, however, apparently is not imposed until the taxable estate is at least $3,600,000). The Hawaii exemption available to non-resident, non-U.S. citizens is $60,000. Initially many believed that the new legislation imposed an estate tax only on nonresident, non-U.S. citizens with property in Hawaii.

D. Illinois. Governor Quinn signed into law Illinois PA 096-1496 on January 13, 2011 which imposes a state estate tax for estates of decedents dying after December 31, 2010 equal to the 2011 credit amount assuming a $2,000,000 exemption.

E. Indiana. HB 1563 was introduced on January 20, 2011 and SB 148 was introduced on January 5, 2011. Both bills would phase out Indiana’s inheritance tax between 2013 and 2018 (no inheritance tax after June 30, 2018), phase out payments of the inheritance tax replacement amount to counties between 2013 and 2018 and provide that the estate tax and generation skipping transfer tax do not apply after June 30, 2018. Both bills are still in committee and the last action taken was on SB 148 when Senator Randolph was added as a co-author of the bill on February 14, 2011.

F. Iowa. Senate File 2380 was signed into law by Governor Culver and reinstates Iowa’s pick up tax for estates of decedents dying after December 31, 2010. IA Code § 451.2. Therefore, if the Federal estate tax law sunsets on December 31, 2012 and the 2011 credit is restored Iowa will again receive estate tax revenue.

G. Maine. Maine currently imposes a state estate tax equal to the 2011 credit amount in effect on December 31, 2000 assuming a $1,000,000 estate tax exemption. Maine’s Revenue Services department issued a Tax Alert (Vol. 20, No. 6) in May 2010 which provided that a 2010 decedent was presumed, for Maine estate tax purposes, to have died in 2009 and that Maine’s state-only QTIP election was limited $2,500,000 or the difference between the Federal exemption of $3,500,000 and the Maine exemption of $1,000,000 in 2009. It is not clear if there is a limit on the state-only QTIP election now that the Federal exemption is $5,000,000. Maine’s governor signed into law Public Law Chapter 380 on June 20, 2011. The new law increases the Maine estate tax exemption to $2,000,000 in 2013 and changes the estate tax rates as follows: (a) $2,000,000 - $5,000,000 – 8%; (b) $5,000,000 - $8,000,000 – 10%; (c) $8,000,000 and over – 12%.

H. Minnesota. Various bills have been introduced over the last couple of years which seek to impose a Minnesota gift tax and to tax pass through entities (e.g., LLCs) owned by nonresidents which own Minnesota sitused real estate. These bills were not enacted. However, one significant change was passed as part of the budget fix this summer. The new Minnesota law grants an additional $4 million exemption (in addition to the $1 million state estate tax exemption otherwise authorized) to farmland if the land includes the homestead of the decedent or his or her spouse. The new increased exemption amount also applies to small business owners with annual gross sales under $10 million. However, there is a recapture provision if the property is sold by the family within three years of death.

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I. Ohio. Ohio currently imposes an estate tax (top rate of 7%) on estates which have a value exceeded $338,333 (low exemption, but also a low rate). However, the Ohio state tax now only applies to decedents dying before December 31, 2012. On June 30, 2011, HB 153 was signed into law and repealed the Ohio state estate tax as of January 1, 2013.

J. Oregon. HB 2541 was signed into law on June 28, 2011 and replaces Oregon’s pick up tax (with an assumed $1,000,000 estate tax exemption) with a separate and stand alone state estate tax effective as of January 1, 2012. The exemption amount will be $1 million and tax rates will range from 10-16%.

K. Rhode Island. On June 30, 2009, HB 5983 was signed into law and increased the state estate tax exemption from $675,000 to $850,000. The new law calls for annual adjustments beginning January 1, 2011 based on the percentage increase of the CPI (rounded up to the nearest $5 increment). The Rhode Island state estate tax exemption currently stands at $859,350. The inflation adjustment may prove to be extremely beneficial to estates if (when) we enter a high inflationary environment in the years to come.

L. Vermont. Vermont’s estate tax exemption amount was increased from $2,000,000 to $2,750,000 in 2010. As of January 1, 2012 Vermont’s estate tax exemption is pegged to the Federal estate tax exemption, but the Vermont estate tax exemption cannot be less than $2,000,000 and no more than $3,500,000. VT Statutes 32 § 7442a.

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SUMMARY OF EXISTING ESTATE TAX LAWS

No State Estate Tax Pick Up Only – Currently No Estate Tax Arizona Alabama Michigan Texas Kansas Alaska Mississippi Utah Nebraska Arkansas Missouri West Virginia Oklahoma California Montana Wisconsin Virginia Colorado Nevada Wyoming Florida New Hampshire Georgia New Mexico Idaho North Dakota Indiana Pennsylvania Iowa South Carolina Kentucky South Dakota Louisiana Tennessee Modified Pick Up States Exemption Separate QTIP Top Rate Delaware $3,500,000 or 5,000,0001 No 16% District of Columbia $1,000,000 No 16% Hawaii $3,500,0002 Yes3 16% Illinois $2,000,000 Yes 16% Maine $1,000,000 Yes 16% Maryland $1,000,000 Yes 16% Massachusetts $1,000,000 Yes 16% Minnesota $1,000,000 No 16% New Jersey $675,000 No 16% New York $1,000,000 Yes4 16% North Carolina $5,000,000 No 16% Rhode Island $859,350 Yes 16% Vermont $2,750,000 No 16% Stand Alone Tax Exemption Separate QTIP Top Rate Connecticut $2,000,000 No 12% Ohio $338,333 Yes 7% Oregon $1,000,000 Yes 16% Washington $2,000,000 Yes 19% Inheritance Taxes L / C Exemption5 Separate QTIP L / C Top Rate5 Indiana $100,000 / $100 Yes 10% / 20% Iowa Unlimited / $25,000 Yes N/A / 15% Kentucky Unlimited / $500 Yes N/A / 16% Maryland Unlimited / $1,000 Yes N/A / 10% Nebraska $40,000 / $10,000 No6 1% / 18% New Jersey Unlimited / $500 No N/A / 16% Pennsylvania $3,500 / $0 Yes7 4.5% / 15% Tennessee $1,000,000 / $1,000,000 Yes 9.5%

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1. Given the interaction of the 2010 Tax Act and Delaware law, it is unclear whether the state estate tax exemption is $3,500,000 or $5,000,000. This issue will need to be clarified by statute or Division of Revenue action.

2. The exemption is $3,500,000 but no tax is due until the estate is at least $3,600,000. 3. Hawaii Tax Information Release No. 2010-09 (October 6, 2010). 4. State QTIP election is only available when the value of the gross estate is too low to require

the filing of a Federal estate tax return. 5. L = lineal heirs and C = collateral heirs. States differ on what constitutes a lineal or collateral

heir, but typically lineal heirs include a spouse, children, grandchildren and parents and collateral heirs include unrelated persons, cousins, aunts and uncles.

6. Nebraska has no statute which authorizes a state QTIP or similar election; rather, the

determination is left to the County Attorney of the county in which the decedent resided. It is my understanding that the County Attorneys in Nebraska’s two largest counties (covering Omaha and Lincoln) have not objected to QTIP claims.

7. Pennsylvania law authorizes an election to defer tax until the surviving spouse’s death if the

trust qualifies as a “sole use trust”.

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STATE ESTATE TAX

CONSIDERATIONS FOR MULTISTATE BUSINESSES1

Hugh F. Drake Partner

Brown, Hay & Stephens LLP Springfield, Illinois


OCTOBER 21, 2011

1 The statements contained in this Outline are the author’s alone and should not be attributed to any other person

and/or Brown, Hay & Stephens, LLP, unless otherwise indicated. The statements contained in this Outline should not be relied upon without separate and independent verification of their accuracy, appropriateness given the particular facts presented and/or potential tax consequences. The author hereby disclaims any warranty as to the accuracy of the statements contained in this Outline. Additionally, the author thanks William Forsberg for the use of his material entitled “The State Estate Tax Conundrum” presented at the ABA Joint Tax/RPTE Meeting, 2005.

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Business succession planning could be profoundly affected by state estate tax regimes. The current state estate tax system constitutes patchwork that has unfortunately concentrated a significant amount of enforcement in state tax departments. When dealing with business succession planning for clients and their businesses operating in multiple states, we must be prepared to deal with a variety of issues and uncertainty in legislation and enforcement at the state level. I. Location, Location, Location. A. Introduction

1. Location of the decedent (domicile) and location of the asset for tax purposes (tax situs) is key to the way the state estate tax is calculated. The tax situs is a product of either the client’s residence in the case of intangibles, or the physical location of the client’s real and personal tangible property. Questions of domicile are similarly much more complicated than they might appear at first glance. A decedent who owns real and tangible personal property in multiple states will need additional estate tax planning.

2. The state income tax calculation and apportionment rules for

nonresidents, both for individual income taxpayers and corporate income taxpayers, differ from state estate tax apportionment rules. In general, an individual income taxpayer will be required to pay state income tax in a nonresident state if the individual earns income in that state. A corporate income taxpayer will generally pay income tax in a particular state if the corporation has some connection to a state.

3. By contrast, state estate tax apportionment rules only tax certain

types of property (i.e. real estate and tangible personal property) located in a non-domiciliary state at death.

4. Even though a corporation is required to pay state income tax in a

particular state (i.e. because the corporation owns property, has sales, or pays wages in that state) it will not cause the corporation’s shareholders to pay state estate tax in that state because stock owned in a corporation is considered to be intangible personal property for estate tax purposes in all states. As an intangible it is subject to estate taxes in the state where the shareholder is domiciled at death, not where the corporation or entity does business. Similarly, the payment of state income tax by a nonresident individual taxpayer during his or her life will not cause the individual taxpayer’s estate to pay state estate tax in that state at death.

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5. In those states that were pick up states, coupled with EGTRRA, (and did not legislate a new estate tax, such as Florida) there will be no state estate tax to pay if all of the decedent’s real and tangible personal property is located in his state of domicile at death. If, however, the decedent owned some real or tangible personal property in a state in which he was not domiciled at death and that state decoupled with EGTRRA and had a modified pick up tax (or had standalone estate or inheritance tax) then there may be state estate tax to pay in the non-domiciliary state based on the date of death values of the non-domiciliary state property to the date of death values of the decedent’s entire gross estate.

6. By contrast, if a decedent was domiciled at death in a modified pick

up state that decoupled (or enacted a new estate or inheritance tax) but owned real or tangible personal property in a pick up state that remained coupled with EGTRRA, (and did not legislate a new estate or inheritance tax) then the state estate tax liability may be lower.

B. Domicile.

1. Change of domicile to a nontax state as an estate tax control

measure has become very popular. The same result tax-wise may be achieved by an estate plan that zeros out the death tax in the first estate of married couples, followed by the surviving spouse individually changing domicile to a state with no estate tax. Changes of domicile may, however, be difficult for reasons of personal convenience, family business or family ties and come with significant legal challenges.

2. Clearly you can move entirely and change your domicile to a state,

such as Florida, that has no estate tax. But, if you commute between two states throughout the year—and sometimes if you simply continue to own property where you used to live—your state of origination could argue that you failed to change domicile.

3. The case for making a permanent home in a new state is as strong

as the ties you establish and what you’ve left behind. In addition to living there for most of the year and paying taxes, you should change your driver’s license and vote there (and avoid doing those things in your old state).

4. Any change in domicile must be undertaken in a manner that will

be respected by the state of the current domicile of the client. Since a taxpayer can have only one domicile there is a presumption against a change in domicile. State taxing authorities have become more aggressive in addressing the issue of domicile, particularly with taxpayers who own residences in multiple states.

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5. In the case of an individual having multistate contacts, including residences in more than one state, planning for that individual should take into account the possibility of more than one state finding that the individual is domiciled there for tax purposes.

C. Tax Situs.

1. The tax situs of a decedent’s property effects estate taxation under

state tax laws. The tax situs is borne of either the client’s residence in the case of intangibles, or the physical location of the client’s real and tangible personal property.

2. Equitable conversion is a legal doctrine wherein a purchaser of real

property becomes the equitable owner of title to the property at the time that they sign a contract binding them to purchase the land at a later date. The seller’s interest at that point becomes intangible (a right to the payment of money, rather than a right to the property).

3. Equitable conversion is a constructive alteration in the nature of

property whereby, in equity, real estate is for certain purposes considered as personalty, (or personalty regarded as real estate), and the interest is transferrable in its new form.

4. The point of equitable conversion in the state estate tax context is

that the actual location of land or tangible personal property may be different than the tax situs of ownership interests. Whether an equitable conversion has occurred depends upon the law of the situs of the land or tangible personal property; if conversion is deemed to take place, the interests are treated thereafter as intangible personalty subject to the law of the owner’s domicile. Intangible interests may control real property or tangible personal property located in a state other than the owner’s domicile without subjecting that property to state estate tax where it is physically located.

5. Equitable conversation of land and tangible property may occur by

placing property in a business entity that will result in only intangible shares or units. This planning should be undertaken with care due to the issues and uncertainties surrounding this are of the law. It is possible that property could be considered as having a tax situs in more than one state with twice the taxation.

6. Partnership interests are intangibles that have a situs in the state of

residence of the owner. However, the planner needs to determine if the partnership must continue after death in order to make the situs the state of residence of the partnership interest holder for state estate tax purposes.

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7. Another concern is whether property transferred to an FLP or FLLC that is brought back into the taxable estate of the decedent through IRC § 2036 should be considered as having a state tax situs in the state of residence of the decedent or in the state in which such property is located.

8. Planners need to consider whether the formation of a given

business entity has a bona fide business purpose or is for tax avoidance purposes only which could be important to determining the tax situs of property held by the entity. This issue has been extensively litigated in federal estate tax cases involving FLPs and FLLCs and provide fertile ground for state estate taxing authorities who have become more aggressive in recent years. Planners should take the same precautions to assure the integrity of the business entity as would be taken for federal estate tax purposes.

9. Planners also need to consider whether an entity can maintain its

organizational characteristics, if doing business in a state that does not provide for the formation of that entity. Is property owned by an entity in such a state the property of the entity or of the owners of the entity for state estate tax situs purposes, and does the determination hinge on limited liability protection being afforded by the state of property situs? As the rate of state estate taxes increases, these issues become much more important.

10. Another issue that crosses both income and estate tax lines is the

tax treatment of a single member LLCs.

a. An LLC is disregarded as an entity separate from its owner if it has a single member. As such, all income and deductions of the LLC are reported and taxed to the single member as if he or she operated the LLC as a sole proprietorship. All income and deductions of the LLC would therefore be reported on the individual member’s individual income tax return, Form 1040, Schedule C or Schedule E.

b. The question comes then whether or not the default

classification of a single member LLC for income tax purposes as a non-entity carries over for purposes of state estate tax, where the LLC owns property in a state other than the state of the LLC member’s domicile at death. Whether a decedent has an interest in property that is included his or her gross estate for federal and state estate tax purposes is determined by reference to state property laws.

c. Most states adopt federal estate tax law as their own state

estate tax law. Unless a state has legislation that defines an interest in a single member LLC to be other than intangible personal property, or looks through the single member LLC to the underlying property owned by the LLC, to define “property” for state estate tax purposes, then an interest in the LLC, whether single member or multiple member, should not be subject to state estate tax apportionment because it will be considered

http://www.westlaw.com/Link/Document/FullText?findType=L&pubNum=1012823&cite=26USCAS2036&originatingDoc=I6bab407436d911db908682b25f9bd094&refType=LQ&originationContext=document&vr=3.0&rs=cblt1.0&transitionType=DocumentItem&contextData=(sc.Default)

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intangible personal property and be taxed in the state where the LLC member is domiciled at death. It is important to note though that states are becoming more aggressive in assessing “business purpose” of entities to make the interests subject to state estate tax.

11. Other issues to consider include whether a transfer may require the

consent of a third party owning an interest in the property or having a lien on the property. The transfer could cause underlying debt to be accelerated, the ad valorem tax base of real property taxation may change or the transfer may itself cause a tax. Also, some property may not be permitted to be transferred due to condominium bylaw or a purchase option.

D. Situations to Consider.

1. Situation # 1-The taxpayer is a resident of a pick up only state, and

owns real or tangible personal property in a modified pick up state. a. This situation is where the taxpayer is a resident of a pick up

only state at death (e.g. Florida) but owns real and tangible personal property in a modified pick up state (e.g. Illinois).

b. Because Illinois is a modified pick up state, if the real and

tangible personal property were owned individually by the taxpayer at death rather than in an entity (e.g. corporation, LLC or partnership), the real and tangible personal property would be subject to Illinois estate tax.

c. The result would be that the taxpayer’s estate would be

subject to a Illinois estate tax equal to the Illinois estate tax rate times the proportionate date of death value of the Illinois real and tangible personal property to the value of the decedent taxpayer’s entire gross estate.

2. Situation # 2-The taxpayer is domiciled in a pick up state, and owns

real or tangible personal property in a standalone state.

a. This situation is a bit more difficult to provide generalized advice. This situation contemplates a taxpayer who is a resident at death of a pick up only state (e.g. Florida) but owns real and tangible personal property in a state with a standalone estate tax (e.g. Iowa).

b. It should be noted that most stand alone states that have a

separate estate tax or separate inheritance tax still adhere to the intangible personal property-real/tangible personal property situs distinction when calculating their state estate or inheritance tax.

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c. That is, a non-domiciliary decedent is only subject to state estate tax or state inheritance tax on the real and tangible personal property located in such state. Intangible personal property (e.g. stock) for a non-resident decedent is generally not subject to the non-domiciliary state’s estate tax or inheritance tax laws.

d. Therefore, the advice is twofold:

i. First, review such states stand alone estate or

inheritance tax laws to determine what is included in the state estate tax base or is subject to that state’s inheritance tax.

ii. Second, if that state’s laws provide that only real and

tangible personal property owned by the decedent in his or her name individually and located in that state are subject to state estate or inheritance tax then the advice is that same as Scenario # 1-place the real and tangible personal property located in the non-domiciliary state in an entity such as an LLC, corporation, or partnership.

e. If such state’s estate tax or inheritance laws tax the real and

tangible personal property located in the non-domiciliary state, whether owned individually or in an entity, then the tax issue for the taxpayer is neutral, and he or she should be free to own the real and tangible personal property in any form that best fits his or her situation.

3. Situation # 3-The taxpayer is domiciled in a modified pick up state,

and owns real or tangible personal property in a pick up state. a. This situation is the opposite of Situation # 1. b. This is where the taxpayer is domiciled in a modified pick up

state (e.g. Illinois) but owns real and tangible personal property located in the pick up state (e.g. Florida).

c. If the real and tangible personal property located in the pick

up state (e.g. Florida) is owned by an entity (rather than titled in the taxpayer’s individual name) it will be taxed in the modified pick up state-Illinois-at his or her death.

d. However, if the real and tangible personal property is titled

in the taxpayer’s name individually, it will be subject to apportionment and taxed in Florida.

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e. However, because Florida has no state estate tax, the taxpayer’s overall federal and state estate tax burden would be less because Illinois’s tax base for calculation of its state estate tax would be less due to the exclusion of the Florida real estate.

f. Here the advice is the opposite of Situation # 1.

i. It would be better from a strict estate tax perspective

for the taxpayer to own the real and tangible personal property located in the pick up state-Florida-in his or her individual name, rather than in an entity.

ii. Again, this would be especially true if the real and

tangible personal property were encumbered by a large mortgage or other debt.

iii. However, overriding factors, such as income tax and

creditor protection considerations may trump this advice.

4. Situation # 4-The taxpayer is a domiciliary of a modified pick up state, and owns real or tangible personal property in a standalone state.

a. This situation contemplates the taxpayer dying a resident of

a modified pick up state (e.g. Illinois) but owning real and tangible personal property in a state that has a standalone estate or inheritance tax, (e.g. Iowa).

b. Again, the advice is to first review the non-domiciliary state’s

estate tax laws carefully before determining how to operate.

c. In general, if the intangible personal property/real and tangible personal property situs estate tax calculation dichotomy is followed by the non-domiciliary state that has a standalone estate tax or inheritance tax then the advice is the same as in Situation # 2.

d. The real and tangible personal property should be titled in

the taxpayer’s individual name to avoid such state’s estate tax, subject of course, to overriding considerations of creditor protection and added administrative costs.

5. Situation # 5-Resident of a standalone state and owns real or

tangible personal property in either a pick up state or a modified pick up state.

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a. If the taxpayer dies domiciled in a standalone state (e.g. Iowa) owning real or tangible personal property located in a pick up state, title to the pick up state property should be held in the taxpayer’s individual name to avoid the domiciliary state’s standalone death.

b. If, however, the taxpayer’s property is located in a modified

pick up state, then a more complex multi-step analysis is required.

i. Step one: Consider the overall state estate tax exposure in both the domiciliary state and the non-domiciliary decoupled state.

ii. Step two: Calculate the overall state estate tax

exposure assuming the taxpayer’s property located in the non-domiciliary modified pick up state is taxable in the domiciliary state rather than the modified pick up state.

iii. Step three: Compare the overall tax burden from

steps one and two.

c. If the overall tax burden is higher in step one, consider transferring the real and tangible personal property located in the non-domiciliary state to an entity (e.g. an LLC or limited partnership).

d. This will convert it into intangible personal property taxed in

the taxpayer’s domiciliary state.

e. If the step two tax burden is higher, continue to hold the real and tangible personal property in the taxpayer’s individual name so it is taxable in the modified pick up non-domiciliary state.

II. Valuation Issues.

A. Discount Planning.

1. Quite often state estate tax returns require that the gross estate and deductions, or the taxable estate, be taken directly from Page 1 of the Form 706. If discount planning is eliminated at the federal level, as contemplated in recent years, then the results are also eliminated at the state level.

2. Other state estate tax returns develop the gross estate and

deductions from schedules included in the state return; therefore, the gross estate and deductions are independently entered. In this case, it would be possible to take discounts on valuations at the state level.

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B. Special Valuation Provisions.

1. IRC § 2032A allows for a reduction of estate taxes when certain real property is devoted to farming or used in a closely held business. Real estate can be valued under its current use rather than its highest and best use. The reduction though is subject to recapture under certain circumstances and during this recapture when there is a potential liability under the recaptured tax, a special lien is imposed on the property under IRC §6324A. In light of the support of the “family farmer,” several states have provided similar programs either in reference to IRC § 2032A or standing alone.

2. For example, Ohio has legislation patterned after the Federal

Special Use Value. Under the election, farmland is valued under the same “Current Agricultural Use Value” procedure used for Ohio property taxes. The Ohio election has a maximum reduction of value of $500,000. To qualify, the property must be located in Ohio and pass to a member of the decedent’s family. At least 50 percent of the net worth of the decedent’s estate must be in farm real or personal property, and at least 25 percent of the net worth of the decedent’s estate must be in farm real estate, both using fair market values, and the land must have been held in use for agricultural purposes. There is a potential recapture of the tax saved, with interest, if the property ceases to be used for farming purposes or is sold to a person who is not a member of the decedent’s family within four years after the decedent’s death.

3. The Illinois Estate Tax Act works in conjunction with IRC § 2032A

under §10(b) the Illinois Estate Tax Act. There is a lien imposed for additional Illinois estate tax that would be due in the absence of an election under IRC §2032A. 35 ILCS 405/10(b). The Illinois lien remains in place until the liability for the tax with respect to the transferred property is satisfied or becomes unenforceable or other circumstances that the Attorney General is satisfied that no further tax liability may arise under the Illinois Estate Tax Act as it pertains to transferred property. The §10 lien for IRC§2032A property is not valid as it pertains to third-parties until the notice has been filed, and once filed the lien notice is still subject to the same priorities set forth under IRC §6324A(d)(3).

4. Minnesota recently passed legislation that could save families up to

$400,000 in taxes per estate, or $800,000 in taxes if both spouses maximized the provisions. The new Minnesota law exempts estate taxes on up to $4 million worth of farmland actively farmed by family members for three years after the owner’s death, bringing Minnesota in line with federal estate tax exempt on $5 million. To qualify, the farm must include the homestead for the decedent or his or her spouse. Small business owners with annual gross sales under $10 million are also eligible for a similar provision. Should the family members sell the property within three years, the taxes are subject to recapture.

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5. Federal tax provisions have in recent years also allowed for special valuation considerations associated with conservation easements and qualified family owned business, beyond IRC § 2032A. Planners should familiarize themselves with any similar allowances under state estate tax laws.

III. Gift Tax.

A. Lifetime gifts should escape state estate taxation, if the state does not have

a standalone gift tax and does not add adjusted taxable gifts to the state estate tax base. A couple of states do have a standalone gift tax (Connecticut and Tennessee). As state effective marginal tax rates increase through the lowering of the federal estate tax rate, and as a number of the estates taxable at the state level but not taxable at the federal level increases, gifting to eliminate state tax becomes increasing more profitable.

B. IRC §2011 calculates the state estate tax credit based on property included

in the gross estate, but does not apply to adjusted taxable gifts and any state estate tax imposed on adjusted taxable gifts will not qualify for the credit. Accordingly, lifetime gifts are not brought back into the state estate tax base in states referring to the pre-EGTRRA Federal Law. However, some states do require that adjusted taxable gifts be brought back into the state tax base and planners need to be familiar with these nuances of each state. IV. Payment.

A. Extension.

1. Where the IRS grants an extension to file a federal return or to pay federal tax, several states follow suit. The Illinois estate tax act provides that the federal extension also serves as the due date for filing the Illinois return and for paying Illinois estate tax 35 ILCS 405/8 (c)(1). If the extension is granted by the Internal Revenue Service, the tax payer is required to furnish a copy of the approved extension to the Illinois Attorney General.

2. Additionally, the taxpayer can apply directly to the Illinois Attorney

General for an extension of time to file the Illinois return or to pay the Illinois estate tax 35 ILCS 405-/8 (c)(2). The Illinois Attorney General may grant an extension for reasonable cause. If a tax is determined or estimated at the time of filing for an extension, the Illinois estate tax return should be filed to obtain an Illinois Attorney General case number to enter on the check when the payment is made.

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B. Deferral. 1. The Internal Revenue Code provides for various types of deferral or

installment payments for federal estate tax. IRC §6161 (a)(2) allows an extension for reasonable cause for a reasonable period which should not exceed 10 years. Additionally, an estate tax may be paid in installments under IRC § 6161 relating to the inclusion of the value of a closely held business interest in the federal gross estate.

2. Some states, like Illinois, also provide accommodation for the estate

that defers a portion of the federal transfer tax or elects to pay in installments. Under the Illinois Estate Tax Act there is deferral or installment payments in the same manner as is provided under the federal statute, with installments payable at the same time and in the same manner as the payments of the federal transfer tax paid under the code. 35 ILCS 405/6. The Illinois Estate Tax Act provides a fixed rate of 6% interest. The payments are also accelerated under the same circumstance and in the same manner as set forth in the Internal Revenue Code. 35 ILCS 405/6(b).

3. The Illinois estate tax subject to deferral or subject to installment

payments is based upon the proportion to which the gross value of assets having situs in Illinois and giving rise to the deferred or installment payment bears to the gross value of all included assets having a taxable situs in Illinois.

V. State-Only QTIP Considerations.

A. Some states allow a decedent’s estate to QTIP the difference

between the lower state exemption and the higher federal exemption on the first death. The higher federal exemption would continue to fund the family share but there would be a carve out for the difference which would be taxed at the state level only on the death of the second spouse.

B. The QTIP portion of the trust can be created so as to allow for post-

mortem flexibility with a partial QTIP election contemplated. The Credit Shelter Trust can be drafted so as to qualify as a QTIP so that the executor can elect to qualify part of the trust for the marital deduction if it is appropriate post-mortem. If there is no estate QTIP election, the tradeoff remains of state estate tax in the first estate versus loss of federal applicable exclusion, if there is a gap between the state and federal exemptions in the year of the death has occurred.

C. If an estate is large enough for state estate tax, but not federal estate

tax, can we use alternate valuation under IRC § 2032 to establish the federal gross estate on which the state estate tax is based? The Internal Revenue Code says you can only use alternate valuation if an estate tax is owed (presumably federal), but as discussed above many states calculate the size of the state taxable estate using federal law. If alternate valuation is used, does it result in a different step-up in basis of assets for federal and state income tax purposes? The step-up

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in tax basis at death hinges on the estate tax value, but if no federal estate tax return is filed that should be the date of death value, even if alternate valuation was used to determine the state estate tax liability. However, on any single asset, alternate valuation could result in more or less tax.

D. The situation with a state only QTIP election, the question comes as

to whether or not we can still use the administration expenses to reduce the estate for state estate tax purposes and potentially still use those expenses on the fiduciary income tax return, if no federal estate tax return is filed. Quite likely this would still be seen as a double deduction due to the fact that for estate income purposes we calculate taxable income at the federal level which would include a reduction due to estate administrative expenses. Perhaps the safest approach is to add administrative expenses deducted on the estate tax return back on the state fiduciary return to avoid taking an inconsistent position.

FACT PATTERNS

Lisa Rico Gilmore, Rees & Carlson P.C.

Wellesley, MA


OCTOBER 21, 2011

10/5/2011

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Lisa M. Rico, Esq.Gilmore, Rees & Carlson, P.C.

[email protected]

Hugh F. Drake,Esq.

ABA Section of Taxation and Trust & Estate Division of Real Property Trust & Estate Law 2011 Joint Fall Meeting

October 21, 2011

Massachusetts ‐ Transfer Taxes In July 2002, Massachusetts enacted “An Act Enhancing Revenues” which created an estate tax effective for decedents dying on or after January 1, 2003.

The amount of the Massachusetts estate tax equals the amount of the state death tax credit that would have been allowable to a decedent’s estate under IRC § 2011 as in effect on December 31, 2000. M.G.L. ch. 65C, § 2A

The Massachusetts estate tax imposes a tax on the transfer of the estate of a Massachusetts resident and resident of other states owning property in Massachusetts.

Massachusetts does have not have a gift or generation‐skipping transfer tax.

Massachusetts recognizes same‐sex marriages (Goodridge v. Department of Public Health, 440 Mass. 309 (2003)

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Massachusetts ‐ Transfer Taxes

Estate Tax Threshold Amount ‐ $1,000,000

If the value of decedent’s gross estate exceeds the threshold amount, then the Massachusetts estate tax is imposed on entire estate at a graduated tax rate with a maximum rate of 16% (i.e., the federal state death tax credit in effect on December 31, 2000).

Examples: Massachusetts estate tax on a 1,200,000 estate is $45,200, a $1,500,000 estate is $64,400, a $2,000,000 estate is $99,600, a $5,000,000 estate is $391,600, a $7,000,000 estate is $638,000 and a $10,000,000 estate is 1,067,600.

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Massachusetts ‐ Transfer Taxes Threshold amount is reduced by the amount of taxable gifts but taxable

gifts are not added to the taxable estate.

Making taxable gifts can reduce the Massachusetts estate tax, but may not eliminate it because the filing threshold is reduced.

Example: Decedent with $2,000,000 estate gives away $1,000,000 prior to death. Threshold amount is reduced to $0 ($1,000,000 reduced by $1,000,000 taxable gift). Remaining $1,000,000 estate subject to Massachusetts estate tax of $33,200.

Result: $66,400 saved in Massachusetts taxes ($99,600 (amount of Massachusetts tax on $2,000,000) reduced by $33,200 (amount of Massachusetts tax on $1,000,00).

Marital deduction “QTIP” election may be made solely for Massachusetts purposes.

Portability is not allowed.

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Fact PatternFred and Wilma are married with two adult children:

Combined net worth is $10,000,000 comprised of

Primary Residence with a fair market value of $1,000,000

Vacation home with a fair market value of $1,300,000

Closely‐held business with a fair market value (taking into account discounts) $6,000,000

IRAs valued at $700,000

Bank and brokerage accounts valued at $1,000,000

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Fact Pattern1. Assume Fred and Wilma live in a state with a separate

estate tax, should they do any special planning?

2. What happens when Fred dies in 2011?

3. What planning can be done for Wilma to minimize state estate taxes on her death?

4. Assume that the closely‐held business is a farm, can the special use valuation rules of IRC § 2032A be used?

5. Same facts as above, but Fred (Winifred) and Wilma are a same‐sex couple legally married in a state that allows same‐sex marriages.

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state estate tax and business succession planning · state estate tax and business succession...

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