State Inheritance and Estate Taxes: Rates, Economic Implications, and the Return of Interstate Competition

by Jared Walczak, Tax Foundation, July 17, 2017

Key Findings

• Eighteen states and the District of Columbia impose either inheritance or estate taxes, with fourteen states (plus Washington, D.C.) levying estate taxes and six states levying inheritance taxes. Of these, two states (Maryland and New Jersey) impose both taxes, though New Jersey is in the process of repealing its estate tax.
• For decades, the federal government offered a credit against federal estate tax liability for state inheritance and estate taxes paid, which allowed states to impose a “pick-up” estate tax without increasing residents’ overall tax liability. The elimination of this credit in 2005 ushered in a new era of estate and inheritance tax competition among the states.
• Washington State has the highest top marginal estate tax rate at 20 percent, while the 18 percent rate Nebraska imposes on bequests to nonrelated individuals is the nation’s highest inheritance tax rate.
• State inheritance and estate taxes, together with the federal estate tax, reduce investment, discourage business expansion, and can sometimes drive wealthy taxpayers out of state.
• When high net worth individuals leave states with high inheritance and estate taxes, their state of origin loses not only the prospective estate or inheritance tax revenue, but also the revenue from other taxes that might have been collected during their lifetimes.
• Estate planning and tax avoidance strategies create dead-weight losses, reduce economic efficiency, and in some instances break up farms and family-owned businesses. These costs must be taken into account above and beyond actual collections under estate and inheritance tax regimes.
• Since 2005, states have been moving away from estate and inheritance taxes, a trend that is likely to continue.

Introduction

“Pray don’t be uneasy,” shouts the steward in one of Ivan Turgenev’s novellas, his voice carrying across the rising waves to a man in a boat, his little craft darting toward impending doom. “It’s of no consequence! It’s death! Good luck to you!”[1] But human beings have always treated death as a matter of the greatest consequence. They anticipate it, fear it, try to bargain with it, and seek to avoid it.

Not coincidentally, they exhibit much the same set of behaviors when it comes to taxes imposed at death, the estate and inheritance taxes many taxpayers revile about as much as the event itself—levies regarded as cruel as death, and hungry as the grave.[2]

Ben Franklin’s famous aphorism[3] conjoins death and taxes in a shared certitude, but frequently the primary fact of estate taxation is the existence of uncertainty. Death may be certain; its timing is not. Estate planning is complicated by this fundamental uncertainty, along with a constellation of ancillary ones, ranging from the volatility of markets to the liquidity of assets to changes in intended beneficiaries to the tax exposure of heirs. The multiplicity of state inheritance and estate tax regimes further complicates matters, though with competent planning and avoidance techniques, it is frequently possible to largely evade their sting.

State inheritance and estate taxes are a shadow of their former selves, but the shadow they cast—much like death itself—can become a preoccupation. Because they exist, economic opportunities are foregone, inferior investments are made, and capital migrates across state borders. Sometimes people, too.

This paper examines the various characteristics of state inheritance and estate taxes, sets out their current rates and structures, explores the history of estate and inheritance taxation in the United States, and reviews the economic literature on the effects of these taxes on economic activity, migration, and revenue. A thousand doors may lead to death,[4] but each one has different implications for the eighteen states (and the District of Columbia) with estate or inheritance taxes—and for their many peers, eager to exploit a competitive advantage.

Variations in the Structure of State Inheritance and Estate Taxes…

Hawaii

The newest state also conforms to the federal exemption of $5.49 million, though it adopts its own rate structure, with rates ranging from 8.0 to 16.0 percent. The state has a sizable $1 million “zero bracket” in addition to the federal exemption, meaning that in practice, no tax is owed on the first $6.49 million in estate proceeds.[38]

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