Currently 18 states and the District of Columbia impose their own separate estate tax in addition to the federal tax - Connecticut, Delaware, Illinois, Kansas, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Rhode Island, Tennessee, Vermont and Washington. In many of these states there's a "gap" between the federal estate tax exemption and the state estate tax exemption which for married couples can cause a state estate tax to be due when the first spouse dies even though no federal estate tax will be due until after the second spouse's death.
What is the State Estate Tax Exemption Gap?
The state estate tax exemption gap refers to the difference between a state's estate tax exemption and the federal estate tax exemption. For example, while the 2009 federal estate tax exemption is $3,500,000, the 2009 Connecticut exemption is only $2,000,000, which leaves a "gap" of $1,500,000 between the two exemptions. In Tennessee the 2009 estate tax exemption is only $1,000,000, so the gap is $2,500,000.
How Can the State Estate Tax Exemption Gap Affect Your Estate Plan?
If you're married and you live in the District of Columbia or one of the 18 states listed above and your estate plan is more than a few years old, then you may have a state estate tax problem when the first spouse dies. Why? Because the typical estate plan for married couples includes AB Trusts which are designed to maximize the use of both spouses' federal estate tax exemptions. If properly structured, AB Trust planning will allow married couples to pass on $7,000,000 free from federal estate taxes. But the problem for married couples who live in D.C. or one of the 18 states listed above is that AB Trust planning has nothing to do with minimizing state estate taxes.
For example, if the estate plan of a Tennessee couple has been written solely to maximize the use of both spouses' federal estate tax exemptions, then the first $3,500,000 of the estate of the first spouse to die will go into the B Trust. But since the Tennessee estate tax exemption is only $1,000,000, $2,500,000 of the B Trust will be subject to Tennessee estate taxes. This will definitely be a surprise to the surviving spouse who was told years ago when the estate plan was drafted that estate taxes would only be due and payable after both spouses are gone.
What You Should Do
If you're married and you live in the District of Columbia or one of the 18 states listed above and your estate plan is more than a few years old, you should have your estate plan reviewed by a local estate planning attorney. In some of the states that impose a separate state estate tax there are ways to plan for both state and federal estate taxes in such a way that will defer the payment of all estate taxes until after the second spouse's death by using an "ABC" Trust system instead of typical AB Trust planning. But in several of these states this won't be possible and so the choice will have to be made between paying a state estate tax after the first spouse's death or under funding the B Trust so that both state and federal estate taxes will be deferred until after the second death. The key is to work with your estate planning attorney to determine what makes the most sense for you and your family.
