In Part I of this series on taxes, we discussed federal taxes. For Part II, we will discuss state taxes.
State Taxes: Income Taxes
The first type of state tax that affects estate planning is individual income tax. Like federal income tax, state income tax can apply to individuals, married couples, and entities, including trusts. Income tax is a tax on direct income such as earned income (wages and tips) and unearned income (social security, pensions, annuities, distributions of income from a trust, interest, and dividends). As individuals in California, we file a 540 Income Tax Return, and estates and irrevocable trusts file a 541 Income Tax Return. There are eight states that do not have any personal income tax:
- South Dakota
State Taxes: Capital Gains
The second type of state tax that commonly affects estate planning is capital gains. Capital gains are most prevalent when it comes to selling a property or selling securities. A simple explanation would be that you are taxed on the profit, and your profit is the amount you sell an asset for minus the amount you purchased it for (typically called your tax basis). A tax preparer or accountant will tell you it’s more complicated than that, because it is. There are capital improvements and depreciation to take into account for real estate, and steps up in basis based on inheritance.
State Taxes: Estate Taxes
Here in California, there is no state-specific estate tax. However, 17 states have estate tax:
- Connecticut: Estate tax of 11.6 percent to 12 percent on estates above $9.1 million
- District of Columbia: Estate tax of 11.2 percent to 16 percent on estates above $4.3 million
- Hawaii: Estate tax of 10 percent to 20 percent on estates above $5.5 million
- Illinois: Estate tax of 0.8 percent to 16 percent on estates above $4 million
- Iowa: Inheritance tax of up to 9 percent
- Kentucky: Inheritance tax of up to 16 percent
- Maine: Estate tax of 8 percent to 12 percent on estates above $5.8 million
- Maryland: Estate tax of 0.8 percent to 16 percent on estates above $5 million; inheritance tax of up to 10 percent
- Massachusetts: 0.8 percent to 16 percent on estates above $1 million
- Minnesota: 13 percent to 16 percent on estates above $3 million
- Nebraska: Inheritance tax of up to 18 percent
- New Jersey: Inheritance tax of up to 16 percent
- New York: Estate tax of 3.06 percent to 16 percent for estates above $6.1 million
- Oregon: Estate tax of 10 percent to 16 percent on estates above $1 million
- Pennsylvania: Inheritance tax of up to 15 percent
- Rhode Island: Estate tax of 0.8 percent to 16 percent on estates above $1.7 million
- Vermont: Estate tax of 16 percent on estates above $5 million
- Washington: Estate tax of 10 percent to 20 percent on estates above $2.2 million
These are all items to consider if you move to another state for retirement purposes or if you own any property in that state. Just because you may live in another state, you can still be subject to taxes in other states by virtue of owning property in those states.
State Taxes: Inheritance Taxes
Inheritance taxes are more common in European countries and Canada. While there is no inheritance tax levied by the State of California, six states do have an inheritance tax:
- Iowa: Inheritance tax rate of 4-12%
- Kentucky: Inheritance tax rate of 4-16%
- Maryland: Inheritance tax rate of 10%
- Nebraska: Inheritance tax rate of 1-18%
- New Jersey: Inheritance tax rate of 11-16%
- Pennsylvania: Inheritance tax rate of 4.5-15%
We have discussed estate tax, a tax on a decedent’s estate that is paid before distributions are made to beneficiaries. Now we are discussing inheritance tax, a tax that a beneficiary must pay on the inheritance they are receiving. Inheritance tax usually applies if the decedent lived in one of these states or if the inherited property is located in one of these states. It does not mean that if a beneficiary lives in that state, they are automatically taxed. In addition, the tax rate depends on how closely related an heir was to the decedent and the value of the inheritance. Typically, the closer the relation, the lower the tax rate.
State Taxes: Gift Taxes
A gift tax is a tax paid by a person who makes a gift of something of value to another person during their lifetime. As of 2022, Connecticut is the only state with a gift tax, so if you live in Connecticut, please consult your tax advisor.
Look for Part III next month, where we discuss taxes imposed at the local county level. In addition, please reach out to your estate planning attorney or certified public accountant if you need to know how taxes affect your specific situation.
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