All estate planning attorneys know that Congress raised the applicable exclusion to $5.25 million for federal purposes. Years and years ago, the majority of states had “pick-up” taxes. In other words, they only had a tax to the extent of a federal credit for state death taxes. The federal credit was phased out about a decade ago, as part of EGTRRA. Thus, state estate taxes in those states were phased out along with the credit.

However, many states “decoupled” from the federal law and have separate estate taxes. But, what many estate planners do not know is that most of those states that have separate estate taxes do not have a gift tax. Thus, gifting assets can be a very effective deathbed-planning tool in those states. Only two states have a gift tax at the state level, Connecticut and Minnesota. (Minnesota just enacted a gift tax, effective July 1, 2013.)

Thus, the first line of planning to avoid the state estate tax in states (other than CT and MN) is gifting. Of course, when gifting, cash is always the best asset. If the client gifts assets with a built-in gain, then they would lose the step-up, which would be obtained upon the client’s death. If they gift loss assets, the donee receives the asset with a fair market value basis. In other words, the client cannot gift their loss in the asset. So, if the client must utilize the asset with a built-in loss, they should sell the asset, harvest the loss, and then gift the cash.

If the only choice is gifting an asset with built-in gain or not gifting at all, the future capital gain must be weighed against the state gift tax which would be escaped through the gift. Perhaps the client wants the property to be kept in the family. In such a case, the capital gain tax would act as a disincentive to a future sale and this strategy may be palatable. The property might be a residence which might be gifted to a family member as their new residence. In that case, gain might be shielded up to $500,000 due to section 121.

It is important to be mindful of state estate / inheritance taxes and how gifting might be an easy tool to use to avoid these forgotten estate taxes.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com