Changes to the tax laws in 2009 include a welcome increase in the federal estate tax exemption. Starting January 1, 2009, the amount excluded from federal estate tax will jump from $2,000,000 to $3,500,000. Taking full advantage of the increased federal exemption on the death of a married individual living in a state with a state estate tax, however, could come with an unexpected state estate tax cost. This is a result of marked differences between the applicable federal and state tax exemptions.
Here are the applicable state exemptions for the following states: see table
The increase in the federal estate tax exemption means that Connecticut residents in 2009 will be subject to a federal estate exemption that is higher than the applicable state estate tax exemption, joining residents of many other states, including New York, Massachusetts and New Jersey. Although the higher exemption may result in lower federal estate taxes on the death of the surviving spouse, it can also cause unanticipated state estate tax to be due at the death of the first spouse, when previously no tax would have been due, if your estate plan has not been updated to account for the possibility of differing federal and state estate tax exemptions. For residents of these jurisdictions, if the estate plan is designed to minimize federal estate taxes only, there may be state estate tax of as much as $229,200 at the death of the first spouse.
It is more important than ever for residents of a state with a state estate tax to find out whether your estate planning documents should be updated in light of the possibility that the federal and applicable state estate tax exemptions are different at the time of the death of the first spouse. For a resident of such a state (or a resident of any state who owns real property in such a state) with a traditional estate plan designed to avoid estate tax at the death of the first spouse by maximizing use of the federal estate tax exemption, there will be no federal tax due at the death of the first spouse, but there could be state tax due. For example, a New York resident dying in 2009 with a taxable estate of $3,500,000 (net of all deductions, including the marital and charitable deductions) would owe $229,200 in New York state tax at his death. In many, but not all, cases, it will make sense in the long run to pay the relatively small amount of state tax at the first death to avoid paying substantially more federal tax at the second death. If our New York resident’s wife died later in 2009 with her own taxable estate of $3,500,000, she would have saved over $900,000 in federal taxes in her estate by paying $229,200 in her husband’s estate. Especially in light of the continuing uncertainty about the future of the federal estate tax, you may wish to consider an estate plan that contains the flexibility to react to the federal and state tax laws in effect at the time of your death, instead of trying to predict those laws at the time you sign your documents.
Connecticut and Massachusetts residents or property owners should also be sure that their plans take advantage of the provision of those states’ estate tax laws that permits an estate both to make full use of the federal exemption and avoid state estate tax at the first death.
Now that a new president has been elected, we expect that Congress will make changes to the federal estate tax laws in the next year or so. Various proposals have been made over the last few years, and it is not clear at this early date which of them will eventually be enacted. In all likelihood, however, a federal estate tax will continue to be a reality for some time to come, and estate tax planning will continue to be important for many of our clients. If you have not reviewed your estate planning documents in the last few years (and certainly since 2001, when the last major change to the federal estate tax laws was made), we strongly urge you to contact us for a review of your planning.