Planning for State Estate Taxes

Michael Foltz for the Wall St Journal writes: In the last 30 years, advisers have looked at federal estate taxes much more closely than they have state estate taxes. But now that the federal estate tax exemption is $5.25 million and the exemption between spouses is portable, most people don't end up paying federal estate taxes.

Therefore, when looking for ways to lower estate taxes for clients, advisers need to start paying attention to tax laws in individual states and seriously consider taking advantage of techniques to mitigate any state estate taxes. 

There are 19 tax jurisdictions, 18 states and Washington, D.C., that levy their own estate taxes, which can be as much as 16%. Also each state has different estate tax exemptions: New York has a $1 million exemption whereas New Jersey's exemption is only $675,000. So there's a lot to pay attention to. And, since the federal estate tax is no longer such a material consideration for most people we have to think about not only state estate taxes, which include inheritance and gift tax, but also state income tax.

Where a client retires is a very relevant question. Some clients may be willing to relocate to states that have beneficial tax laws. However, for those who don't want to move, one way to mitigate state estate taxes is to adopt estate-planning strategies in a jurisdiction where there is no tax. This can be done even if you don't live there. 

For example, often a husband and wife will have a revocable living trust that provides for a credit shelter trust upon death. It's becoming more popular to put estate tax planning vehicles like these in place during a client's lifetime. We can put assets in that credit shelter trust, and you don't necessarily have to create the trust in the state that the client resides. If you're an Illinois resident, for example, you can create this lifetime credit shelter trust in South Dakota--a state that does not tax trust income--and thereby escape the 5% Illinois state income tax.
To determine how to help clients, especially those willing to move, advisers should not only take a look at each state's estate taxes, but also how each state taxes wage income, capital gains, interest dividend, pension income, Social Security income and sales tax.

We ran an internal study that examines income taxes, state inheritance and gift taxes, real estate tax, and the sales tax. We found that Wyoming, Alaska, South Dakota, Florida, Nevada, New Hampshire, Texas and Washington represent some of the best jurisdictions to consider retiring. 

Tax laws have changed a lot over the last couple of years, and it's important that advisers talk to clients about the current tax laws, and also remind them that especially federal taxes could change in the near future. We need to adequately account for state taxes and make sure we are considering and implementing proper techniques during a client's lifetime.