Planning for State Estate Taxes

ParkBridge Wealth Management Fall Webinar Series

Speaker: Bruce Steiner, Kleinberg Kaplan ((BSteiner@KKWC.com)

Host: Jonathan Shenkman, ParkBridge Wealth Management (Jonathan@ParkBridgeWealth.com)

Introduction

Jonathan Shenkman: Good morning, and welcome to the ParkBridge Wealth Management Fall Webinar Series. Today's program is entitled Planning for State Estate Taxes. As always, my name is Jonathan Shenkman, and I'm the President and Chief Investment Officer of ParkBridge Wealth Management. In that role, I serve in a fiduciary capacity to help my clients achieve their financial objectives. The goal of my programs is to bring professionals together to help them better serve their clients. This is done by educating attendees on the latest topics in wealth planning and by encouraging collaboration among a client's attorney, CPA, and financial advisor where appropriate. I focus on working with high-net-worth families, businesses, and not-for-profits. I manage individual investment portfolios, trust accounts, corporate retirement plans, and endowments to help my clients achieve their financial goals.

In addition to the 20 or so events I run every year, I also do a fair amount of writing on investing and financial planning. You can read my work in a variety of periodicals, including Barron's, CNBC, Forbes, Kiplinger, The Wall Street Journal, and Trusts & Estates magazine, to name just a few. In particular, you can see my latest piece, "How to Keep Your Estate Plan from Tearing Your Family Apart," published this week in The Wall Street Journal. If you'd like a link to that article, feel free to email me after the program and I'll send you a copy. You can also see my work on my website at parkbridgewealth.com/articles or by following me on social media at Jonathan on Money. Additionally, you can check out my weekly podcast, also called Jonathan on Money, on Apple, Spotify, or wherever you get your podcasts.

Today we're privileged to hear from Bruce Steiner of Kleinberg Kaplan, based in New York City. By way of background, Bruce brings more than 40 years of experience in taxation, estate planning, business succession planning, and estate and trust administration. He's a frequent lecturer for bar associations, CPAs, and other professional groups, and is the co-author of CCH's Roth IRA Answer Book. Bruce serves as a commentator for Leimberg Information Services and sits on the Editorial Advisory Board of Trusts & Estates, where he chairs the Retirement Benefits Committee. He's also a member of the Executive Committee of the New York State Bar Association Trusts and Estates Law Section, and Vice Chair of its Life Insurance and Employee Benefits Committee. Bruce has written extensively for leading professional journals and is regularly quoted in major national publications. He has served on advisory boards for several charitable organizations and has been recognized by Super Lawyers and Best Lawyers for his work in trusts and estates. Today, Bruce is going to be speaking on planning for state estate taxes. With that introduction, I'll now turn the floor over to Bruce.

Presentation

Bruce Steiner: Thanks, Jonathan, and thanks for having me back once again. As Jonathan said, we're going to talk about state estate taxes, which is the flip side of a topic I've covered many times: state income taxes. We rarely see or hear anything about state estate taxes, and yet 12 states and the District of Columbia have them, and 5 states have inheritance taxes.

Federal Background

By way of background, we all know the federal estate tax has a $15 million exempt amount, called the exclusion amount, and it's indexed for inflation, so it will continue to go up unless Congress does something about it. There's portability for the federal estate tax exempt amount. So if I have $15 million and my spouse has $15 million, and I leave everything to her, and she files an estate tax return for me, she inherits my exempt amount, and now she has a $30 million exempt amount.

There's also a GST exemption of $15 million, and there's no portability for the GST exemption. So if I'm worth $15 million and she's worth $15 million, I'm going to leave my $15 million in trust for her, so that we get the benefit of both my GST exemption and hers.

QTIP elections: we're now allowed to make QTIP elections even if they're not necessary to reduce or eliminate the federal estate tax, because people might want a second basis step-up in the spouse's estate.

State Estate Taxes: An Overview

Now let's turn to the state estate taxes. As I mentioned, 12 states and DC have them. Except for Connecticut, the exempt amount is less than $15 million, so you've got to do your planning with a different exempt amount. If I'm in a state where the exempt amount is less than $15 million, which is the other 11 states and DC, and I leave $15 million to a credit shelter trust, I'm going to be paying state estate tax, possibly a million or two dollars of it.

The rules that govern QTIP elections and alternate valuation elections also vary among the states. There's no one way they all do it. It's not like the pre-2002 state estate tax, where every state had a state estate tax, and in every state the tax was equal to the state death tax credit against the federal estate tax. Once the state death tax credit went away, the states went in all different directions. 38 states got rid of their estate tax, either immediately or subsequently, and the other 12 states have made changes to theirs, so they work differently. We're going to talk about some of the differences.

We only have a half hour, so we're not going to take a deep dive into all the nuances of every state, but we hope you'll get enough that it will allow you to think about and look in the right places when you have an estate that might be subject to estate tax in some state.

New York

We'll start with New York, because it's the largest state that has a state estate tax, and it's a wealthy state. In New York, the exclusion amount is $7,350,000. But that exclusion amount is phased out between that level and 105% of that level, which is $7,717,500. So at $7,717,500, you get no exclusion amount, and you pay a state estate tax of $734,780.

The marginal tax rate in that phase-out range is about 200%. So if my estate goes from $7,350,000 to $7,450,000, if it goes up by $100,000, it's going to cost me about $200,000 of state estate tax. If burning money were deductible and I had that estate, I would take $100,000 and burn it, or I would direct my executor to burn $100,000, and it would save $200,000 of tax. There's no portability for the New York estate tax.

The QTIP and alternate valuation elections or non-elections that you make federally are controlling for New York, except that if you're not required to file a federal return, and you don't file one for portability, you can make a separate New York QTIP or alternate valuation election.

So what are some of the planning techniques for the New York tax? In New York, gifts made more than 3 years before death don't count. That's unlike the federal system, where gifts are not in the estate, but they're adjusted taxable gifts, and so they are taken into account in determining your estate tax. In New York, gifts within 3 years of death are included in the estate, but once 3 years have gone by, they're not included. So if you think you're going to live for more than 3 years, you can make lots of gifts and get money out of your estate for New York estate tax purposes, at the cost of giving up the new basis at death.

New York looks through a single-member LLC. Most states do not for estate tax purposes; they treat the LLC interest as an intangible. New York looks through it to the underlying assets. So for an out-of-state person who owns a building in New York and puts it into a single-member LLC, it's still a New York asset for estate tax purposes. A New York person who buys a building in some other state and puts it into a single-member LLC, it's still not a New York asset. So you can buy real estate outside New York, and it's not a New York asset. You can buy gold coins or gold bars; you just have to make sure you store them outside New York. Obviously, you've got the market risk of what the price of gold will be tomorrow, which, if I knew, I wouldn't be getting up early in the morning to speak about state estate taxes. You can buy artwork and keep it outside the state, although then you have higher transaction costs, and storage and insurance costs.

What can married people do about the New York estate tax? Typically, you limit the credit shelter trust to the New York exclusion amount. So instead of having a will that says I leave $15 million to my credit shelter trust, I might say I leave $7,350,000 to my credit shelter trust. Obviously, I would do it by formula to take into account whatever other adjustments there are, whatever other assets pass in some other way, the inflation adjustments, and so on. Then I can elect portability for the federal estate tax, if my federal exemption is higher than my New York exemption. And I can leave the marital share in a marital trust and make a reverse QTIP election to fill up my GST exemption amount and get the benefit of two GST exemptions.

There's some interesting IRA planning you can do for the New York estate tax, and to some degree this works in other states as well. You can leave the IRA to the spouse and get the rollover. Or, if you need it to fill up the state exclusion amount, you can leave it in trust for the children, or to the credit shelter trust. You can leave IRA benefits to a charitable remainder trust for the children, and that replicates the stretch. I wrote an article about it. If you just Google my name and "charitable remainder trust replicate the stretch," it'll pop up. You can leave it to a conduit trust for the spouse, and under SECURE 2.0, the spouse can elect to be treated as if the spouse were the owner for purposes of the RMDs, and that slows down the RMDs. The RMDs are leakage if you're trying to shelter the IRA from the estate. But the RMDs may not be that much, because it uses the Uniform Lifetime Table and is recalculated each year, and maybe that's okay. That's another possibility to think about. Sometimes it will work.

If you have an unmarried client, Paul Forster and Larry Kaiser wrote an article proposing a "Santa Clause." It says that if I would have more money left after tax by leaving some money to charity, I leave to charity the largest amount that will save more in taxes than the charity gets. So, in my classic example, the estate is $7,717,500. If I cut it back to $7,350,000 and give charity a little over $350,000, I've saved a little over $700,000 in taxes. Surely anybody would be thrilled to give money to charity if the government more than matches it, so to speak, and I'm better off. It would be like this: if, on my income tax return, I could take a $2 credit for every dollar I gave to charity, I would give as much to charity as the government would give me that credit for.

Roth Conversions

Roth conversions. Roth conversions are huge, and this applies in any state that has a state estate tax. A conversion removes the income tax on the conversion from the estate. That's crucial if I'm in that 200% estate tax bracket, but it will shift the numbers in any state with a state estate tax, making a Roth conversion much more attractive than it might otherwise be. The income tax is out of the estate. And unlike the federal estate tax, which is deductible against the income tax under Section 691(c), the 691(c) deduction is not available for state estate taxes.

We had a $4 million Roth conversion. We had a client who was very elderly, with an estate in the $8 million range, and we did a $4 million conversion that brought her estate down to about $6 million, because we paid the income tax, which would have gotten paid anyway. It saves at least $700,000, and probably closer to $1 million, of New York estate tax. So give some thought to Roth conversions in any state that has a state estate tax.

Connecticut

Connecticut has a $15 million exemption. The rate is 12%, but the maximum estate tax is capped at $15 million. It's sort of backwards, like the Social Security tax, which is also capped. So if you're a billionaire, you only pay $15 million of Connecticut estate tax. It's sort of backwards, but I guess they thought it would keep billionaires in Connecticut. $15 million of tax is better than no tax if they move to Florida. Taxable gifts are taken into account, and Connecticut is the one state that still has a gift tax. It has the same rates and the same exempt amount, and it functions the way the federal gift tax does.

In Connecticut, federal QTIP elections are controlling. If there's no federal QTIP election, you can make a Connecticut QTIP election. This was more important when the Connecticut exemption was lower. The federal alternate valuation election or non-election is controlling.

District of Columbia

In DC, the exemption is $4,988,400. I don't know why they came up with such a strange number. The taxable estate is the same as the federal, so all your federal elections or non-elections control for DC.

Hawaii

In Hawaii, it's $5,490,000. They must have frozen it at whatever the federal amount was at the time. Gifts are taken into account. The federal elections control, but if there's no federal return, you can make separate Hawaii elections. Hawaii and Maryland are the only two states that have portability for the state estate tax, so that can change your planning.

Illinois

Illinois, in some ways, is like New York. It's got a $4 million exemption, and taxable gifts count against the exemption, but the $4 million exclusion amount is phased out between $4 million and about $5.36 million, with a marginal rate of 28 4/7%. I don't know where they come up with these numbers. We just had an estate in that range; it was a client's mother. If you're in that range of $4 million to a little over $5 million, you've got a 28-plus percent marginal Illinois estate tax rate, and that made a Roth conversion of her entire IRA worthwhile. And while taxable gifts count, annual exclusion gifts don't, so we had her make annual exclusion gifts to all of her grandchildren. A separate QTIP election is permitted, which is nice.

Maine

Maine has a $7,160,000 exempt amount, and gifts within one year of death are counted. So it's even more favorable than New York: you can end-run the tax by making lots of gifts, if you promise to live for a year.

The UK has something similar. The UK has no gift tax. If you make the gift in trust, you're going to pay a 20% tax, but if you make it outright, you don't, and it's back in your estate if you die within 7 years. I believe the Queen Mother, Queen Elizabeth's mother, who was also Queen Elizabeth, made huge gifts when she was in her early 90s, and she lived to be 101, and avoided their estate tax, which they call an inheritance tax, but it works more like an estate tax. So Maine has one year, and New York has 3 years.

Maine has a complicated way of dealing with QTIP elections. You can make a separate QTIP election for the difference between the Maine exempt amount and the federal exempt amount, and that actually makes a lot of sense. You can put the state exempt amount in a credit shelter trust, and then take the difference between the state and federal exempt amounts, which we usually call a gap trust, and put it in a trust that's in QTIP format. You don't have to elect QTIP federally, although with portability you might, but you can elect QTIP for state purposes. It's an interesting solution, though no longer as important as it once was.

Maryland

Maryland has a $5 million exempt amount, a separate QTIP election, and portability. So, much like the federal system, if you don't need two GST exemptions, you can just leave everything to your spouse and elect portability, both federal and state. It gives you another planning choice that you might not otherwise have.

Massachusetts

Massachusetts used to be a mess. The exempt amount used to be $1 million, and it worked the way Connecticut used to with its $2 million: once you went over, you lost your exemption and had to pay tax on everything. In Massachusetts now, you get a credit equal to the tax on the first $2 million. So colloquially, we say the exemption is $2 million. It really just means that above $2 million, you're paying tax at the rates in the brackets above $2 million, but that's not a major issue. The $2 million is an obstacle in Massachusetts, because lots of people there have lots of money, and it only gives you $4 million for a couple, or $2 million for a single person. They allow separate QTIP elections and separate alternate valuation elections. The states that begin with M are generally more flexible about allowing state-only elections.

Minnesota

Minnesota has a $3 million exemption. Gifts within 3 years of death count, so again, you want to live for 3 years after you make your gift. We all know that rule from the federal system for life insurance, but in some of the states, that's how it works for everything. They allow separate QTIP elections, and the taxable estate is the same as the federal, with a few adjustments. As for alternate valuation, if you're not required to file a federal return, it's not available; you have to elect it federally.

Oregon

Oregon now wins the prize for the lowest exempt amount. It had been New Jersey, at $675,000, but New Jersey repealed its estate tax about 7 or 8 years ago and made up the revenue by increasing the gasoline tax by 23 cents a gallon, thus shifting the burden of the tax to different taxpayers. The people who pay the gasoline tax are different from the people who pay the estate tax, though obviously there's some overlap.

After New Jersey, it was Oregon and Massachusetts at $1 million. Massachusetts went up to $2 million; Oregon is still at $1 million. Oregon also has a high income tax, about 9 or 10%, but Oregon has no sales tax, joining the ranks of, I think, Montana and… oh, gosh, New Hampshire, which doesn't have much in the way of taxes. There are a few others that don't have a sales tax, such as Delaware.

Anyway, Oregon has the lowest exempt amount, and it allows a separate Oregon QTIP election and a separate Oregon alternate valuation election. So Oregon is not a tax-friendly state, although a lot of people love Oregon. Obviously, there are lots of people who love each of the 50 states.

Rhode Island

Rhode Island has an exempt amount of $1,838,056. I don't know where they come up with these numbers. Its tax is based on the old state death tax credit rates. All the states started off with those rates, and over time some of them increased their rates, some decreased them, some did all kinds of things with their rates, and many of them just kept the old rates.

Rhode Island allows a separate QTIP election. It allows alternate valuation if no federal return is required or filed, but if you file one, even just for portability, that knocks you out of the box, and you can't do it.

Vermont

Vermont has a flat 16% rate with a $5 million exemption, which is kind of interesting. The federal elections control.

Washington

Did I skip Washington State? Oh my goodness, I'm so sorry, I didn't put Washington State on the outline. Washington has about a $3 million exempt amount, but the rate goes up to, I think, 35%, so it's a real nightmare of a tax. They have no income tax, except they have a capital gains tax, I think on people with over a million dollars of income or gains. As you might expect, without an income tax, Washington State is constrained for revenue.

State Inheritance Taxes

Five states have inheritance taxes: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Maryland also has an estate tax, which makes it interesting.

Kentucky

In Kentucky, the rates range from 4% to 16%, and they exempt spouses, parents, children, stepchildren, grandchildren, and siblings. At one time, inheritance taxes were common in lots of states.

I remember when New Jersey taxed everybody; even spouses paid inheritance tax. Over time, the states either repealed their inheritance taxes or repealed them for closer relatives.

Maryland

In Maryland, the rate is 10%, but they exempt issue, spouses of issue (that's an interesting one), parents, grandchildren, stepchildren, and stepparents, and they now exempt siblings in Maryland. So different states have different exemptions.

Nebraska

Nebraska is 1% for issue, parents, grandparents, and siblings, and others pay 11% to 15%. So they basically pull everybody into the tax system, which adds complexity, even though there's probably a small amount of revenue involved.

New Jersey

New Jersey is complicated. New Jersey now exempts spouses, domestic and civil union partners, issue, ancestors, and stepchildren, but it doesn't exempt step-grandchildren. So to get money to your step-grandchildren, you can leave it to your stepchildren, who can then pass it down.

The rates for other people run between 11% and 16%. But New Jersey has this funky compromise tax. Say you leave money in trust, and you don't know who's going to get it. Maybe I leave money in trust for my children and their spouses, and nobody knows who's going to get it. The tax is not due until the money actually gets paid out of the trust to the beneficiaries. So the state will offer you what's called a compromise tax. They say, "Look, we don't know when the tax comes due, and we don't know if it comes due, because we don't know whether it will go to somebody who's exempt or somebody who's not. So we'll make you a deal. You give us X dollars now, and it's over." And the deal is always favorable. I've never had anybody turn down a deal and say, "We'll wait and see."

So don't provide for your people outright; provide for them in trust. Especially if it's somebody who would attract inheritance tax, provide for them in trust, and the tax will be heavily discounted. That's a common error. If you don't have kids and you're leaving money to your nieces and nephews, don't leave it to them outright. Leave it to them in trust, and you'll get a good deal on the compromise tax. New Jersey has no rule against perpetuities, so when you negotiate the compromise tax, the taxpayer can say, "Look, the money might get paid out never, so give us a really good deal, or we'll leave it open."

There's no New Jersey QTIP election. The interesting thing in New Jersey is that if you paid inheritance tax on a retirement or annuity benefit, like an IRA, the tax paid is treated as previously taxed contributions, and that's essentially deductible against the money that comes out when you draw down the IRA or the annuity. Essentially, you're getting basis. So if you can, you want to leave your IRA in a trust that will attract a teensy bit of inheritance tax, and then you get a basis step-up. I want to thank Kathy Romania in New Jersey for calling my attention to this. It's a wonderful thing that nobody knows about. Similarly, if you have U.S. government interest that you earned in your IRA, it gives you New Jersey basis in your IRA. New Jersey basis is interesting because contributions are never deductible in New Jersey, so you get New Jersey basis against the distributions. This is additional New Jersey basis. I've given you links to the state documents.

Pennsylvania

In Pennsylvania, basically everybody except spouses and minor children pays the inheritance tax. The minimum rate is 4.5%. Gifts within one year of death are included, so you can make gifts. They allow the equivalent of a QTIP election. They exempt life insurance. And joint property is prorated. Joint accounts are usually not a good idea, for lots of reasons, except maybe with a spouse, but they do save you Pennsylvania inheritance tax.

It's exactly 9 o'clock. Thank you very much, Jonathan.

Closing Remarks

Jonathan Shenkman: Great. Thank you so much, Bruce, for that informative talk. If anybody has any questions, new business opportunities, or other issues they'd like to discuss, feel free to reach out directly to Bruce or me, as appropriate. I'll be sure to include his contact information in the follow-up email for this program.

Three quick items before I let you go today. First, my next webinar is on Thursday, October 22nd, at 8:30 a.m., on the topic of Tax Issue Spotting for Non-Tax Lawyers, featuring Matthew Rappaport of Falcon Rappaport & Berkman, based on Long Island, New York. I'll send out the invitation to this program in the coming days. In the meantime, if you have a friend or colleague who would find these webinars of interest, they can subscribe to my webinar distribution list at parkbridgewealth.com/webinars.

Second, you can follow all my work on X and Instagram at Jonathan on Money, or by connecting with me on LinkedIn. You can also listen to my weekly podcast, Jonathan on Money, which is available on Apple, Spotify, or wherever you get your podcasts, and you can watch my practical planning videos, which I post several times a week, by following me on YouTube at Jonathan on Money.

And third, please take 30 seconds to fill out the survey at the end of this program; it helps me bring relevant content to attendees. Thank you in advance. That concludes today's session. Please stay safe and healthy, and have a wonderful day, everybody.