Does Your State Have an Estate or Inheritance Tax?

There is a lot of focus recently on the federal estate and gift tax and the potential for changes due, and rightly so.  The tax rate is 40% of amounts gifted and left at your death above the exemption amount, which is likely to go down.  But, what a lot of people don’t consider is that some states have their own estate taxes, and in a few cases, inheritance tax.  Texas has neither, but I thought a blog on state estate and inheritance taxes would be a good follow-up to my recent blog on issues to consider when moving to a new state.  See that here:  https://www.galliganmanning.com/should-you-update-your-estate-plan-if-you-move-to-a-new-state/

Although it has fallen out of favor recently, many states still have either an estate tax, inheritance tax or some combination.  According to The Tax Foundation’s recent article entitled “Does Your State Have an Estate or Inheritance Tax?”  17 states and the District of Columbia all apply some or both of these taxes.  Hawaii and the State of Washington have the highest estate tax rates in the nation at 20%, and there are 8 states and DC that are next that apply a top rate of 16%. Massachusetts and Oregon have the lowest exemption levels at $1 million, and Connecticut has the highest exemption level at $7.1 million.    For the New York readers, the estate tax exemption is at nearly $6 million and applies rates from about 3% up to 16% depending on how far you exceed the exemption.

6 states have inheritance taxes.  Inheritance taxes, unlike estate taxes, apply a tax rate based relationship of the decedent to the beneficiary, meaning it applies even if the estate is relatively small.  Nebraska has the highest top rate at 18%, and Maryland has the lowest top rate at 10%. All 6 of these states exempt spouses, and some fully or partially exempt immediate relatives.  For you Pennsylvania readers, this could be anywhere from 0% to spouse and 15% to individuals who aren’t close family members.

Estate taxes are paid by the decedent’s estate, prior to asset distribution to the heirs. The tax is imposed on the overall value of the estate less the exemption applicable to that state. Inheritance taxes may be due from either the estate or the recipient of a bequest and are based on the amount distributed to each beneficiary.

As I mentioned earlier, most states have been steering away from estate or inheritance taxes or have upped their exemption levels because estate taxes without the federal exemption hurt a state’s competitiveness. Delaware repealed its estate tax at the start of 2018, and New Jersey finished its phase out of its estate tax at the same time, though it still applies its inheritance tax.

Connecticut still is phasing in an increase to its estate exemption. They plan to mirror the federal exemption by 2023. However, as the exemption increases, the minimum tax rate also increases. In 2020, rates started at 10%, while the lowest rate in 2021 is 10.8%. Connecticut’s estate tax will have a flat rate of 12% by 2023.

In Vermont, they’re still phasing in an estate exemption increase. They are upping the exemption to $5 million on January 1, compared to $4.5 million in 2020.

DC has gone in the opposite direction. The District has dropped its estate tax exemption from $5.8 million to $4 million in 2021, but at the same time decreased its bottom rate from 12% to 11.2%.

So, it is of course a good idea to consider reviewing your estate plan when relocating, but especially if you move to states that have estate or inheritance tax.  Talk to an experienced estate planning attorney about how estate and inheritance taxes affect you in your new state.

Reference: The Tax Foundation (Feb. 24, 2021) “Does Your State Have an Estate or Inheritance Tax?”

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What’s the Best Way to Go with Loans to Family?

Loans to family must be treated like real, enforceable loans to third parties if you don’t want to run afoul of gift and estate tax.

Loans are a terrific way for parents to foster a child’s independence, encourage responsibility and signal their confidence that their child can succeed on their own.  They also don’t use any of your lifetime gift tax exemption ($11.58 million per person).  But, loans to family highlight some important tax and family concerns you should be aware of.

Kiplinger’s recent article entitled “Gifts vs. Loans: Don’t Be Generous to a Fault” tells the story of Mary Bolles. The case illustrates that parents’ actions and expectations as to repayment of the loan can recharacterize the “loan” to a taxable “gift.” That can mean unintended gift tax consequences. Mary was the mother of five who made numerous loans to each of her children. She kept copious records of each loan and any repayments. Between 1985 and 2007, she loaned her son Peter about $1.06 million to support his business ventures — despite the fact that it soon was clear he wouldn’t be able to make any more payments on the loans. None of the loans to Peter was ever formally documented, and Mary never tried to enforce the collection of any of the loans.

In late 1989, Mary created a revocable living trust, which specifically excluded Peter from any distribution of her estate when she died. While she later amended her trust to no longer exclude him, she included a formula to account for the “loans” he received in making distributions to her children. After her death, the IRS said that the entire amount of the loans, plus accrued interest, was part of her estate. They assessed the estate with a tax deficiency of $1.15 million.  The estate said the entire amount was a gift.

At trial, the court considered the factors to be weighed in deciding whether the advances were loans or gifts. Noting that the determination depends not only on how the loan was structured and documented, the court also explained that in the case of a loan to family, a major factor is whether there was an actual expectation of repayment and intent to enforce the debt.

The court compromised and held that any advances prior to 1990 were loans (about $425,000), since the evidence suggested that Mary reasonably expected that Peter would repay the loans, until he was disinherited from her trust in late 1989. The court said that the money given to Peter after he was disinherited — from 1990 onward — were gifts.

The decision shows that if you’re considering taking advantage of the elevated gift tax exemption before it sunsets, review any outstanding family loan transactions. You should see the extent to which those loans may have been transmuted into gifts over the years—which may adversely impact the amount of your remaining available exemption. The safest way to do this would be to consult an experienced estate planning attorney, who can help you safely navigate these complex rules.

When making a gift there are other considerations.  If you will make such a loan, treat it as such.  Have a lawyer prepare a loan agreement.  Create a reasonable expectation that the loan will be repaid and that you’ll enforce it.  This isn’t just for tax reasons, it is to maintain family harmony.  Giving a “loan” to one child may not sit well with the others, so make sure it is honored.  You should also consider the impact this will have on state taxes, income taxes, and long-term care planning if relevant to you.

To be safe, follow these simple steps:

  1. Document the loan transaction between the lender and borrower.
  2. Charge interest based on the government rates (AFR), which are published monthly.
  3. Make sure the borrower will have enough net worth to likely repay the loan.
  4. Get a copy of the borrower’s financial statement.
  5. If the loan sets out periodic payments, make certain these are made on time.
  6. Report the interest income you receive from the borrower on your income tax return.

Make sure that you do any intra-family loans properly to avoid any future issues.

Reference: Kiplinger (Oct. 7, 2020) “Gifts vs. Loans: Don’t Be Generous to a Fault”

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Estate Planning for Non-U.S. Citizens

A non-U.S. citizen owning property in the U.S. needs an estate plan.
There are a number of special estate planning issues a non-U.S. citizen needs to consider.

The United States has experienced a surge in immigration since 1970, and there are now approximately 45 million foreign-born people living in the United States. Some of them have become U.S. citizens, but many non-citizens live in the United States as well. See https://www.dhs.gov/immigration-statistics/special-reports/legal-immigration. Like U.S. citizens, it is essential for non-U.S. citizens to have estate plans in place. But there are also a number of special issues non-U.S. citizens need to consider.

Common law vs. civil law

There are many differences in the law between countries such as the United States and the United Kingdom, which have common law systems, and countries such as Germany, France, or China, which have civil law systems. For example, common law countries recognize trusts, but civil law countries do not.

In addition, common law and civil law countries have different rules regarding which country’s law will apply (e.g., in a common law country, the jurisdiction where real estate is located governs its disposition, but under civil law, the law of the country of the deceased person’s nationality or habitual residence may be the governing law).

These differences (and there are many more not discussed here!) must be taken into account in determining the best options for estate planning involving property located in other countries.

Wills and trusts

In the United States, wills and trusts are some of the instruments most commonly used by individuals to distribute their money and property. However, when a non-citizen owns property in other countries, the law of the country where the property is located may affect how it is distributed. In addition, if the property is located in another country, that country may not accept a United States will as valid. Some foreign countries may recognize it if it satisfies all of their legal formalities. However, other countries never recognize a will drafted in another country or recognize it only in certain special situations.

As a will created in the United States may not be legally valid in other countries, it may be necessary to have multiple wills, each one dealing only with money and property located in that country (and drafted by someone familiar with the local law). In addition, it is important for special care to be taken to make sure that none of the wills unintentionally revoke any previously drafted wills from another jurisdiction.

Tax Considerations for Non-Citizens

Property located abroad taxed in U.S. for U.S. residents

U.S. citizens, and non-citizens who meet the IRS’s definition of a “resident” of the United States, are subject to federal gift and estate taxes on all of their money and property, worldwide. However, U.S. residents can also benefit from the $11.58 million lifetime gift and estate tax exemption and the $15,000 gift tax annual exclusion. In general, a non-citizen is a permanent resident if he or she currently resides in the United States and intends to remain there indefinitely.

Different rules for non-residents

For non-residents, i.e., non-citizens who do not intend to remain in the United States, only money and property “situated” in the United States is subject to estate and gift tax in the United States. However, their estate tax exemption drops from $11.58 million to $60,000, which could result in a very large estate tax bill if the non-resident has a lot of property located in the U.S. Moreover, they may also be subject to estate tax in their country of citizenship, raising the issue of double taxation. The United States has entered into an estate and/or gift tax treaty with a limited number of countries allowing a citizen of one of the treaty countries who owns property to avoid the possibility of both countries taxing the same asset at the time of death.

Special rules for non-citizen spouses

Unlimited marital deduction not available. A U.S. citizen who is married to a non-citizen should keep in mind that the unlimited marital deduction is not available for gifts or bequests to non-citizens, even if the spouse is a permanent resident. If the spouse receiving the assets is not an U.S. citizen, the tax-free amount that can be transferred to a spouse is only $157,000 a year (in 2020).  However, the unlimited marital deduction is available for transfers from a non-citizen spouse to a citizen spouse.

Tip: A non-citizen spouse can inherit from a U.S. citizen spouse free of estate tax if the U.S. citizen creates a special trust called a qualified domestic trust (QDOT). The U.S. citizen can leave property to the trust, instead of directly to the non-citizen spouse, with special rules applying as to who can be Trustee and how distribution may be made.

Estate planning for non-U.S. citizens is very complex. If you are a non-citizen or are married to a non-citizen, an experienced estate planning attorney can help you think through all of the issues that may affect how you plan for the future.

This article references that wills and trusts are commonly used in the United States to transfer assets at death. If you are interested in learning more about Wills and living trusts see https://www.galliganmanning.com/will-vs-living-trust-a-quick-and-simple-reference-guide/

 

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