Focus Shifts to State Estate-Tax Planning

Arden Dale for the Wall St Journal writes: The federal government won't tax an individual's estate if it's worth less than $5.25 million.  But many states will tax estates worth far less. For example, New Jersey's estate tax kicks in at $675,000--the lowest threshold in the nation.

Surprisingly, many people don't know how much their estate might owe in state estate taxes at their death, or even what their state considers a taxable estate. In contrast, those who will owe federal estate taxes generally know it, and have planned for it with their financial advisers.

"They may think, 'I don't need an estate plan, I'm not worth that much,'" said Katherine Dean, managing director of wealth planning at Wells Fargo Private Bank in San Francisco, which manages $170 billion.

That has started to change, according to some advisers, who are now ramping up plans to reduce their clients' state estate taxes.

Indeed, these plans are "taking on the more prominent role in the 20 or so states with an estate or inheritance tax," said Michael C. Foltz, a wealth manager at Balasa Dinverno Foltz LLC, an advisory firm in Itasca, Ill., with about $2.1 billion under management.

For some of his clients, Mr. Foltz has recommended a credit shelter trust, which are often set up so that when the first spouse dies, assets in it go to beneficiaries--usually the couple's children. The living spouse keeps the right to the assets, however, as well as income it earns over the rest of the person's life. The trust ultimately benefits heirs because both spouses can use their estate-tax exemptions.

Mr. Foltz is currently working with an Illinois couple that owns a manufacturing company who will use the trust to get full use of both spouses' $4 million state estate-tax exemption. In other words, $8 million of their estate would be tax-free.

Joseph F. McDonald, a partner at McDonald & Kanyuk in Concord, N.H., noted that without a credit shelter trust, an estate "may unnecessarily pay an estate tax on the second death."

For advisers with clients in different states, keeping on top of state estate-tax rules can be daunting.

Until 2001, every state had an estate tax linked to the federal tax with a credit that essentially gave each state the right to collect around 20% of whatever the taxpayer owed the federal government. The credit was phased out completely by 2005. Congress did not relink federal and state estate taxes as some had expected when it set the federal exemption at $5.25 million earlier this year.

Some states enacted separate estate taxes after the credit was phased out, and others didn't. Also, some states also have an inheritance tax, which is levied on the bequest to an individual heir, rather than on a full estate.

Today, 15 states and the District of Columbia collect estate taxes, according to the Tax Policy Center. Maryland and New Jersey collect both estate and inheritance taxes, and five other states collect inheritance but not estate taxes.

In addition, 25 states explicitly refer to the defunct federal estate-tax credit in their tax laws. But since that credit no longer applies, those states no longer impose estate taxes.