Another state drops death tax as federal inheritance tax looms

A sign of the political divide on death taxes, Iowa is repealing its inheritance tax, with a gradual reduction in the tax bite retroactive to January 1 and a full repeal on January 1, 2025. The abolition of the death tax state estates was a key priority for Republican Gov. Kim Reynolds; it was part of a larger tax cut package that accelerates the income tax cuts signed earlier this summer.

The repeal of Iowa’s estate tax comes as proposed federal death tax changes could mean many more estates will be subject to federal taxes at much lower wealth levels.

The Iowa decision will leave five states with an estate tax, and 11 states and the District of Columbia with an estate tax (see Where Not to Die in 2021 for the full list). Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania are the other estate tax states. Maryland has the dubious distinction of having both an inheritance tax and an inheritance tax. The repeal of Iowa makes Nebraska “an outlier geography,” notes Sarah Curry, director of policy at the Platte Institute.

If you live in one of these states, it is essential that you review your estate plan to avoid surprises for your heirs, not just taxes owed, but administrative hassle. In New Jersey, for example, leaving a bequest of $ 2,500 to a sibling in your will triggers the requirement to file a 22-page inheritance tax return, even if no tax is owed. Leave $ 727,000 for a niece or nephew and the New Jersey estate tax is $ 109,240.

This unfair treatment between heirs – the tax rate is based on the relationship between the deceased and the heir – is perhaps the biggest flaw in inheritance tax. Take Nebraska, for example. Nebraska taxes children and grandchildren at a rate of 1%, nephews and nieces at a rate of 13%, and unrelated persons at a rate of 18%. In a report calling for an end to inheritance tax in Nebraska, Curry notes that a long-time domestic partner is not recognized as a legal spouse by the state, which means their gift from the deceased is taxed at the rate The highest.

It’s not just the rich who need to be careful. A study by the Iowa Department of Revenue found that 92.5% of inheritance tax was imposed on households with adjusted gross income of $ 80,000 or less.

How much will the repeal of Iowa’s inheritance tax cost the state? The Iowa change cuts the tax rate by 20% per year over four years, then eliminates tax entirely on or after January 1, 2025 (for deaths that occur on or after that date). Once the repeal is fully effective, it will reduce state revenues by more than $ 100 million per year, according to a tax impact analysis from the Revenue Ministry.

According to a report by the Center on Budget and Policy Priorities (State Taxes On Inherited Wealth, Table 1), state death taxes generate revenues of around $ 5 billion annually in total. The authors, Elizabeth McNichol and Samantha Waxman, argue that in order to combat the extreme concentration of wealth and to “build more widely shared prosperity” that states with these taxes should maintain them, and states without them should consider enacting them. or consider taxing inheritances as income.

Meanwhile, a bigger death tax battle is brewing at the federal level. Federal death tax is separate from state taxes. While Trump’s tax cuts temporarily doubled the federal estate tax exemption to $ 11 million per person, virtually eliminating federal estate tax for all but the richest, two proposals could be used as a revenue stream for Democrats’ $ 3.5 trillion soft infrastructure spending program. under discussion in Congress.

First, the level of exemption from federal inheritance tax could be reduced to $ 3.5 million per person. It should come back to $ 5 million, indexed to inflation, in 2026 anyway. And second, a proposal to end the “grossed-up base” (with a $ 1 million exemption) would mean that your heirs would have to pay 43.4% income tax on unrealized capital gains to your company. death. The Senate’s 50 Republicans recently wrote a letter to President Joe Biden to oppose this “new backdoor death tax.” They warned of “colossal implementation problems” and a significant tax increase that would hit family businesses, farms and ranches, citing a study by the Texas A&M Agricultural and Food Policy Center which found that 98% farms in its 30-state database would be affected, with additional tax liabilities averaging $ 726,000 per farm.

Further reading:

State death tax is changing the loom: where not to die in 2021


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