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Tax cut has complicated estate planning for wealthy families

Mark Reutter, Business & Law Editor


CHAMPAIGN, Ill. — The old saw about death and taxes has taken on new meaning as state governments grapple with the confusion spawned by the 2001 federal tax cut.

A little-noticed aspect of the $1.35 trillion tax cut package championed by President George W. Bush was the phase-out of state estate-tax credits, which had been tied to the federal tax code for nearly a century.

The change had the effect of ending state-level taxes on inherited assets on Dec. 31, 2005, even though the federal tax on inherited property remains in effect through 2009, Kevin M. Bohl writes in the Elder Law Journal, published by the University of Illinois College of Law.

State legislatures have responded to the phase-out in different ways. “Some states revised their local estate taxes to compensate for the loss of tax credits, others absorbed the increased financial burden, and a few states chose a cautious course and revised their laws for temporary periods,” wrote Bohl, the editor-in-chief of the journal.

The net effect is “much more complexity and uncertainty” in the planning of a wealthy family’s financial affairs.

Illinois, for example, has decoupled from the federal code and imposed its own tax on estates worth $2 million or more. (Estates under $2 million are not subject to any Illinois tax.)

The tax on estates of people dying in 2010 is eliminated in both Illinois and on the federal level, but only for one year. Starting on Jan. 1, 2011, the Illinois and federal estate taxes are scheduled to return with just a $1 million exemption.

The time periods are not the only complexity arising from the 2001 law. Heirs with family property located in several states run the risk of getting caught in the “death tax trap.” Bohl cited the example of a person with a $20 million estate who lives in Florida, but has $2 million worth of property in New York. Under New York law, the entire state tax credit will be taken by New York and then reduced by the amount of tax paid to other states.

But because Florida has not decoupled from the federal code, the estate tax paid to Florida is equal to zero dollars. Therefore, New York will collect all of the state taxes owed. “The end result is that the Florida resident ends up paying the equivalent of a New York resident estate tax on the entire estate,” Bohl noted.

There are political reasons behind the confusion. In order to pass the tax bill, Congress “sunsetted” the law, which brings the old tax rules back in force in 2011.

This week President Bush called on Congress to make the tax cuts permanent and to repeal the estate tax altogether. The Bush proposal is certain to spark a fight. Proponents for keeping the tax say that it covers only a small number of superrich families, and repeal of the tax would cost the federal government at least $50 billion a year.

Of the 2.4 million Americans who are expected to die this year, only about 6,500 of their estates would be subject to the federal estate tax.

Bohl urged state governments to help bring “predictability” to estate planning by either decoupling from the federal tax code or eliminating state estate taxes altogether.

His article is titled, “The Resurrection of the Death Tax: Decoupling and the Economic Growth and Tax Relief Reconciliation Act of 2001.”