Future of state estate taxes hangs on U.S. "fiscal cliff"

Wed Dec 26, 2012 2:51pm EST

(Reuters) - Falling off the "fiscal cliff" is a bad thing, right?

Not necessarily for some state governments that could begin collecting more in estate taxes on wealth left to heirs if the United States goes over the "cliff," allowing sharp tax increases and federal spending cuts to take effect in January.

In an example of federal and state tax law interaction that gets little notice on Capitol Hill, 30 states next year could collect $3 billion more in estate taxes if Congress and President Barack Obama do not act soon, estimated the Urban-Brookings Tax Policy Center, a Washington think tank.

The reason? The federal estate tax would return with a vengeance and so would a federal credit system that shares a portion of it with the 30 states. They had been getting their cut of this tax revenue stream until the early 2000s. That was when the credit system for payment of state estate tax went away due to tax cuts enacted under former President George W. Bush.

With the return of the credit system next year as part of the "cliff," states such as Florida, Colorado and Texas - which have not collected estate tax since 2004 - could resume doing so. California Governor Jerry Brown has already begun to add the anticipated estate tax revenue into his plans, including $45 million of it in his 2012-2013 revised budget.

Brown may or may not be jumping the gun.


The outlook on the "fiscal cliff" coming up at year-end is uncertain. Democratic President Barack Obama has said he hopes for a last-minute deal to avert it. That would need to get done soon, with Congress just now coming back from its holiday break.

Chances of an agreement became more remote last week after Republicans in the U.S. House of Representatives fumbled their own legislative attempt to prevent the fiscal jolt that economists say could trigger a recession.

House Speaker John Boehner abruptly adjourned the chamber for the holidays after failing to gather the votes from within his own party to pass legislation he and other Republicans had drafted, after walking out of negotiations with Obama.

Weeks of inconclusive political drama over the "cliff" have focused largely on individual income tax rates and spending on federal programs such Medicare and Social Security, but many tax issues are also involved, including the estate tax.

At the moment, under laws signed a decade ago by Bush, the estate tax is applied to inherited assets at a rate of 35 percent after a $5 million exemption. That means a deceased person can pass on an inheritance of up to $5 million before any tax applies. Inherited wealth passed to a spouse or a federally recognized charity is generally not taxed.

Obama wants to raise the rate to 45 percent after a $3.5 million exemption. Republicans have called for complete repeal of the estate tax, which they call the "death tax," though Boehner earlier this month called for freezing the estate tax at its present level. It was difficult to determine what the Republicans want after last week's events in the House.


If Congress and Obama do not act by December 31, numerous Bush-era tax laws will expire, including the one on estate taxes. That would mean the estate tax rate will shoot up next year to the pre-Bush levels of 55 percent after a $1 million exemption.

It would also mean that for the first time in years, a portion of that estate tax would go to the states, through the return of the credit system.

Under that old law, estates paying the tax could get a credit against their federal tax bill for state estate tax payments of up to 16 percent of the estate's value.

If the fiscal cliff were allowed to take hold unaltered by Washington, 30 states would again automatically begin getting their share of federal estate taxes. The state laws are generally written so the state estate tax amounts are calculated under a formula based on the amount of the federal credit.

This would help states that have struggled with lower tax revenues since the 2007-2009 financial crisis and resulting recession, according to research by the Pew Center on the States, though painful federal spending cut backs would also hurt the states.

(Editing by Kevin Drawbaugh and Cynthia Osterman)

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Comments (3)
SnoopyUSA wrote:
Anyone with an estate worth over $3.5 million who doesn’t have their assets protected using a trust or similar structure deserves to be taxed. A decent tax and estate attorney could completely avoid this tax quite easily.

Dec 26, 2012 5:08pm EST  --  Report as abuse
hapibeli wrote:
The Republican spin on the “death tax” was always bogus. Just more greed from the High Party of Greed as opposed to the Low Party of Greed ( The Dems). Both sel centered, yet one, the Dems, at least offer something for the working classes. Forget that Middle class crap. There is only a working class, a merchant class, and the financial class as in “rich”.
The fiscal cliff sounds like a winner, even if I am a progressive!

Dec 27, 2012 1:42am EST  --  Report as abuse
AdamSmith wrote:
This morning Dec. 27, 2012 in America a newborn baby of a wealthy family will be enrolled in a ‘legal’ trust by which he will receive for his entire life income from one thousand apartment units.

Another 99 babies born this morning to working class families who are often behind on their rent, will struggle his/her entire adult life, to pay rent and interest to the wealthy baby, by then grown up.

This is how it is. The 1% is supported by the labor of the 99%, the tribute being extracted through rent and interest over an entire lifetime.

But the saddest part is that the 1% babies, when they have grown up with every advantage, begin to criticize the poor, saying such things as, ‘the poor just need to work harder, they need a better attitude, they are such mooches’.

THIS, the last paragraph, the utterly disdainful hubris of the children of the rich when they reach adulthood, is why America needs to bring back the estate tax.

A 90% estate tax for the 1% would probably make our culture a better one, and help reduce the wealthy criminal class’s ability to corrupt congress.

Dec 27, 2012 2:43am EST  --  Report as abuse
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