As you’ve peered into the future in preparing your estate plan, you might have decided that the estate tax isn’t something you’ll have to worry about. After all, you’ve probably reasoned, the federal estate tax doesn’t even kick in until your estate value approaches $13 million, and you’re nowhere near that level. You should be in the clear, right?

Not so fast, says this recent article from the Wall Street Journal.  In this eye-opening piece, reporter Ashlea Ebeling alerts us all to a reality that many overlook. Yes, she writes, you can be comfortably in the “safe zone” when it comes to federal estate taxes – but depending on where you live or own property, the officials in your state may have other plans for your money when you’re gone, and your estate – or your heirs – can find themselves on the hook for a hefty tax bill.

Seventeen states (plus the District of Columbia) charge an estate tax, and another half dozen charge an inheritance tax which can come directly out of the pocket of your heirs. How do you plan ahead and prepare? Let’s see what Ebeling’s Wall Street Journal article suggests.

State Estate Tax Levels Hit Modest-Sized Estates

Ebeling begins her article with a real-life example – the Yee family from Massachusetts. “Karl Yee was about to pay a nearly $112,000 Massachusetts tax bill for his late mother’s estate,” she writes, “when he got a reprieve from the governor. A retroactive change to the state’s estate-tax law had dropped the estate’s bill to $12,000.”  Yee’s response: “Hallelujah!”

But the Yee family’s predicament is actually quite common. “While the federal estate tax hits only the wealthiest Americans, the thresholds for state estate and inheritance taxes are generally much lower,” the Wall Street Journal reports. “These taxes can cost heirs tens of thousands of dollars they aren’t expecting to pay, along with the grief of figuring out how to pay the bill when the bulk of an estate’s value is tied up in a house or business.”

Ebeling adds that the problem of unanticipated estate taxes is getting more acute because of what she terms “recent meteoric rise in real-estate values.” Families inheriting appreciated property may find themselves hit with a major tax bite.

Estate Tax Rules are Complex, Changeable

The problem is compounded because estate tax rules at the state level are volatile. “As families like the Yees often learn too late, the state tax rules are complicated and subject to change,” the Wall Street Journal reports.

As Ebeling explains, seventeen states and the District of Columbia have an estate tax, an inheritance tax or both. “Generally, your estate will be subject to these taxes if you consider one of these places your permanent home or you have property there,” she writes.

The two types of taxes are slightly different. “Estate taxes get levied at rates of up to 20 percent on estates over a certain threshold, known as the exemption amount,” says the article. “Estate-tax exemption amounts vary from $1 million to $12.92 million.” By contrast, inheritance taxes “aren’t levied on the estate, but the heirs. The much lower exemption amounts and tax rates depend on the heir’s relationship to the deceased.”

One important point to emphasize: if you leave your assets to a spouse who is a U.S. citizen, neither estate nor inheritance taxes are levied. The passing of assets between spouses is generally free from those types of levies.

Estate Taxes Bring In Serious Money for States, Uncle Sam

A glance at the revenue figures helps explain why states love these taxes. “Estates paid $6.7 billion in death and gift taxes at the state and local level in 2021, according to the Urban-Brookings Tax Policy Center,” the Wall Street Journal writes. Pennsylvania alone saw revenues of $1.5 billion from 50,000 estates in the 2022 fiscal year, state revenue officials report. That’s an average of $30,000 per estate. (Pennsylvania has a 15 percent inheritance tax.)

By contrast, the federal estate tax is a far greater revenue generator. The threshold for an individual is $12.92 million, rising to $13.61 million for 2024, the Wall Street Journal reports. Even at those levels, in 2021, 2,584 estates paid more than $18.4 billion in federal estate taxes.

The Wall Street Journal article includes a table showing which states charge estate tax or inheritance tax and at what rate. The table also lists exemption levels. Those of us living in the Pacific Northwest, home to AgingOptions and Life Point Law, face some of the highest estate tax rates and lowest exemption levels in the U.S.  The State of Washington levies an estate tax of 20 percent, tied with Hawaii for the nation’s highest, and exempts the first $2.19 million. Oregon’s tax rate is lower at 16 percent, but everything over $1 million is considered taxable.

Estate tax rates state by state range from 12 percent to 20 percent, with exemption levels averaging between 3 percent and 5 percent. The six states levying an inheritance tax on heirs charge between 6 percent and 16 percent. “Inheritance tax exemptions are highly variable,” says the Wall Street Journal, “typically depending on how the heir is related to the decedent.”

Ordinary Family Hit With Estate Tax Surprise

Writing in the Wall Street Journal, Ebeling returns to the Yee family. “Unlike the federal tax, a big share of state estate- and inheritance-tax revenue doesn’t come just from the wealthiest families, but from the large number of smaller estates subject to the levy,” she writes. For that reason, “The state estate tax wasn’t on the Yee family’s radar.”

Karl Yee’s mother, Suy Kue Yee, had worked as a union seamstress. His father, Bake Yee, was a cook at a Chinese restaurant who had immigrated from China as an infant.

“When his mother died in January, at age 93, she was living in the two-family home the couple bought for $43,000 in 1970,” Ebeling relates. “The house, now appraised at $2.08 million, plus her bank account balances, put her estate in Massachusetts estate-tax territory.”

Yee Family Catches a Break When Estate Tax Rules Change

In the case of the Yee family, a change in state law came at just the right time. “Massachusetts became the latest state to soften its estate-tax bite, doubling the exemption from $1 million to $2 million,” says the Wall Street Journal, softening the tax blow. “That leaves Oregon as the only state with a $1 million threshold.”

Oregon is currently examining its laws to exempt family farms and certain other types of estates. Iowa is phasing out its inheritance tax at the end of 2024, the article reports, and Nebraska reduced its top inheritance-tax rate to 15 percent from 18 percent, effective January 1, 2023. Nebraska voters may be asked in 2024 whether they want to ditch the tax altogether.

Some Suggested Ways to Plan for Estate Taxes

As with everything retirement-related, advance planning is key. “If you live in a state with an estate tax or expect to inherit from someone who does,” Ebeling writes, “here’s what to know:”

Watch out for the estate-tax cliff. As the Wall Street Journal warns, the rules in some states create a “cliff” for those barely exceeding exemption amounts. Ebeling cites an example from New York. “For an estate that is valued at $6.9 million, 5 percent above the $6.58 million New York exemption amount, the estate tax would be $626,000,” she writes, “a 9 percent effective tax rate but a 190 percent marginal rate on the excess.” 

(By contrast, the estate tax in Washington State is incremental, starting at 10 percent for the first $1 million of estate value and topping out at 20 percent for taxable amounts over $9 million.)

The article suggests avoiding the cliff by giving away assets to reduce the value of their estates before death. One planner also suggests that holders of high-value estates can add a clause in their will that directs any amount in excess of the exemption amount be given to a charity.

Check for inflation adjustments. “Some states, like Rhode Island which has a $1,733,264 exemption, increase the threshold each year in line with inflation,” the Wall Street Journal reports. “That helps keep more estates below the new thresholds, even as the value of the assets grows.”

Nonresidents can owe estate taxes. Ebeling warns us that those who live in a state with no estate or inheritance tax but who own property in a state that has one can still be on the hook for taxes. One planner she spoke with had just completed an Oregon estate-tax return for a Nevada transplant. He had kept his Oregon investments properties in a limited liability company, but not the home he had retained in Bend, Oregon. “The son, who was the executor, was surprised that he had to pay Oregon estate taxes of about $65,000 on the $640,000 home, which wasn’t put in the LLC,” this planner told the Wall Street Journal.

Revisit your estate plan. “In cases where real estate is a big part of the estate, and the heirs will want to hold on to it, think through how they will pay the tax,” Ebeling advises. This is where advice from a qualified financial planner and an attorney skilled in estate planning is essential.

Move out of state. “The ultimate move to avoid state death duties is to move,” says the Wall Street Journal. “Jeff Bezos recently said he was relocating from Seattle to Miami, a step that could shield his heirs from Washington state’s estate tax.” For those of us here in the Puget Sound area, that’s quite the local twist!

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(originally reported at www.wsj.com)