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Important Information About State Inheritances

| By Amanda Blount

We often talk about federal estate tax when discussing estate planning options. This was a hot topic last summer and fall when there was a proposed bill making its way through Congress that would reduce the lifetime exclusion amount.

When speaking about state inheritance or estate tax, let’s put aside the federal estate tax business and instead look at what’s going on at the state level. First, it’s important to distinguish between inheritance tax and estate tax.  

The beneficiary—or the person who inherits the money—must pay inheritance tax when they receive the inheritance. Estate tax is taken directly from the estate when someone dies. Pennsylvania has inheritance tax, not estate tax. Sure, oftentimes the inheritance tax is paid from the estate for the sake of convenience, but it is still inheritance tax.  

One common misconception we hear when talking to clients is that adding a beneficiary will prevent inheritance tax from being owed. That isn’t necessarily true. Inheritance tax is ruled by the state you live in and is assessed on everything in your name, even IRAs or accounts with specific named beneficiaries.

Not All States Have It

Actually, there are 17 states—plus D.C.—that have some form of inheritance or estate tax. Most states in the southern and western U.S. give their residents a pass on this type of tax. Florida, Ohio, Virginia, West Virginia, North and South Carolina and Georgia don’t have inheritance or estate taxes.  So, let’s look at some examples of states that do have this type of tax and we’ll start with Pennsylvania.  

Pennsylvania says if you are leaving assets to someone other than your spouse, then your beneficiaries will owe inheritance tax. The amount is dependent on the relationship. 

  • If the beneficiary is a lineal heir, like a child, grandchild or a parent, it is 4.5% 
  • If you’re leaving money to a sibling, it is 12%  
  • If you leave money to a cousin, a nephew or a friend, it is 15%  

Pennsylvania doesn’t care about the federal government’s exclusion amount of $11.7 million per person. They’re going to levy that tax on everything in your name if you’re a resident and filing your taxes here. 

Iowa, Kentucky, Nebraska and New Jersey are similar to Pennsylvania in that regard. If they have exclusion amounts, it’s usually a small amount between $500 and $25,000. The rest of the assets are subject to inheritance tax if you’re leaving to someone other than a spouse.  

The rates are slightly different for each state. For example, New Jersey and Kentucky goes up to 16%, and Nebraska tops out at 18%.

Not Just Estate Tax

Other states have estate tax that includes an exemption amount. New York State exempts just under $6 million and levies estate tax of up to 16% on assets above that. Washington State exempts almost $2.2 million with the overage taxed at up to 20%.  

Meanwhile, Massachusetts and Oregon exempt $1 million and then tax the rest up to 16%. Vermont and Maryland have similar rates, but exempt $3 million.  

A side note here—if you live in or plan to live in one of these states, be careful when considering the exclusion amount. Several states caveat their exclusion when they say, 

“If your estate exceeds a certain amount then, you don’t get to enjoy the exclusion at all.”

Now, just because you reside in a state, doesn’t necessarily mean it is your domicile. A domicile is important when deciding what state’s laws you fall under for estate and inheritance tax purposes. Most people assume if you spend 6 months and 1 day in a residence then it is your home state. For better or for worse, that may not necessarily be true.  

Other considerations are (1) what state your drivers license is from, (2) if you have two homes, is there a big discrepancy in size and price between the two of them, (3) where your business and family ties are, and (4) where near and dear items are kept.  

The Teddy Bear Test

The Teddy Bear Test is “Where do you keep those things most important to you?” Here’s a little story. Back in 2009, Gregory Blatt was asked to take over as CEO of Match.com. He loved summering in the Hamptons and had just renovated his West Village apartment in New York. But the job offer required him to be in Dallas. He worked out a deal that he’d work in New York part of the time and travel to Dallas when necessary.  

Blatt rented a Dallas apartment, joined a gym, and started to build a social life in his new city. He filed his 2009 and 2010 return in Texas, a state without income tax. New York started asking questions and notified Blatt in 2013 that he owed over $430,000 in taxes.  

Their argument was that he owned property and lived and worked in New York for a good deal of each year. It went to court and Blatt won because in November of 2009 he moved his elderly dog to Dallas. Yes, you read this right. At the time, he told a friend that the dog was the final step to finally moving to Dallas. 
So in this case, Blatt’s dog was the teddy bear.  The judge ruled that the dog’s arrival in Dallas in November 2009 was when he officially moved to Texas and she canceled his New York tax bill. The important takeaway is that you should be aware of the tax laws for the state you consider your domicile – the state in which you file your taxes – especially if you have multiple residences.  Make sure you have a complete and clear picture because state taxes can have a large impact – not only on your income taxes, but also on estate and inheritance taxes once you’re gone.

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