Stateline Story

Estate Taxes Bite the Dust in 34 States

Congress' decision to phase out the federal estate tax has created a new class of haves and have-nots -- states that have estate taxes and those that don't.

Starting this year, all but 16 states will stop collecting taxes on inherited wealth, creating a patchwork of estate tax liability that some say could spur the rich to start shopping for where to die.

"Some wealthy people might well decide to move out of a state with an estate tax," said Leonard Burman, co-director of the Urban-Brookings Tax Policy Center, which opposes full repeal of the estate tax.

In 34 states, taxpayers in 2005 will be hit with one tax bill -- from the federal government -- on estates of more than $1.5 million. In the 16 states that preserved their own estate tax, heirs still will be subject to the federal estate tax but also will pay a separate state tax bill.

Since Congress voted in 2001 to temporarily repeal the so-called death tax, more inherited wealth is being exempted from federal taxation each year: $675,000 was exempted in 2001 with the exemption growing annually until the federal estate tax phases out completely in 2010.

The federal move automatically caused a decline in state revenue because all 50 states had collected estate taxes at least in part by piggybacking on the federal law. Starting this year, states no longer will collect estate taxes that are tied to the federal tax until 2011. So only the 16 states that have chosen to levy separate estate taxes will collect taxes on inherited wealth.

The disparity among states will grow even sharper if Congress votes to permanently repeal the federal tax after 2010, as President Bush proposes. Then the only places the government will impose a surcharge after death would be in those 16 states: Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Vermont, Virginia and Wisconsin.

The reason some states have chosen to keep their death taxes -- and that more are considering joining the group -- is that billions of dollars in state revenue are at stake.

Estate taxes will generate an estimated $2.3 billion this year for the 16 states that impose them, according to the Center on Budget and Policy Priorities. The 34 states that will stop collecting the tax will lose $4 billion to $5 billion in 2005, according to the Federation of Tax Administrators.

Washington is on the verge of becoming the 17th state with its own estate tax after the Legislature voted April 22 to reinstate a narrower version of the tax that was struck down by the state Supreme Court in February. Gov. Christine Gregoire (D) has said she will sign the measure, which could raise $135 million over two years.

Elsewhere, proposals in North Carolina and Maine would extend those states' temporary estate taxes. A bill to impose an estate tax in Arkansas, garnering $18 million in 2006 and $20 million in 2007, faltered in committee.

In an unsuccessful effort to defect from the group of 16, Nebraska this session defeated a proposal to repeal its state estate tax, which raises an estimated $20 million a year.

The 2005 tax year is the first in which the federal estate-tax phase-out will be fully felt by state treasuries. President Bush's 2001 tax relief package, which included the gradual repeal of the federal estate tax, had allowed all 50 states to continue to capture a portion of the estate tax revenue that taxpayers owed the federal government through a credit from 2001 to 2004. But the sharing ended last year.

Estate taxes are not a primary source of state revenue, representing less than 2 percent of states' general revenues before Congress began reducing the tax. But the loss of estate tax dollars was felt acutely in some states because it coincided with the drop in other revenues caused by the nation's economic downturn in 2001, said Harley Duncan, executive director of the Federation of Tax Administrators.

Besides prompting competition among states, expiration of the federal estate tax may make it difficult for states that still want to collect estate taxes because states rely on federal assessments of an estate's value to determine the tax liability, said Liz McNichol, a senior fellow at the Center on Budget and Policy Priorities, which opposes permanent repeal of the tax.

Although Congress voted in 2001 to phase out the estate tax by 2010, it must vote again to make the repeal permanent or the tax will come back in full force in 2011. The U.S. House of Representatives on April 13 voted for a permanent repeal. The proposal now goes to the U.S. Senate. Bush has pegged making the 2001 tax cuts permanent as a top priority of his second term.

Advocates who want to bring back the estate tax, also dubbed the "Paris Hilton tax" by those who support estate taxes on the ultra-wealthy such as the Hilton hotel chain heiress, argue that it encourages charitable giving and only affects the largest 1 percent to 2 percent of estates. But opponents of the tax say it is amounts to unfair double taxation and particularly hurts small businesses that families want to pass to loved ones.

"When people work their entire lives, they should be able to pass on the fruits of their labor to their children and not have the government coming around digging the gold fillings out of their teeth," said Chris Butler, a spokesman for Americans for Tax Reform, which opposes estate taxes.