Imagine a mangy, old grey wolf with matted fur, missing teeth and ribs poking through its sides. This fearsome warrior has fought countless battles over the years, winning some and losing others.
That wolf is an apt metaphor for the federal estate tax system. Born in 1916, the federal estate tax has been a mighty hunter for decades, generating many billions for the U.S. Treasury.
But those on whom it preys have learned its tricks and fortified their defenses. Only 4,000 estates pay federal taxes each year, less than 1% of the total number of estates, according to the Tax Foundation.
Feeling safer? Don’t. There is another predator stalking you. In fact, it’s likely lurking in your neighborhood: the coyote of state estate taxes.
While taxpayers are usually alert to the threat of the wolf, they often ignore the coyote. States such as Illinois tax estates with assets of more than $4 million. While this seems like a generous exemption, there are some instances in which unsuspecting heirs will see their inheritances reduced by a sizeable bite from a coyote state.
Consider this example: a Florida widower has a $20 million estate and a well-crafted plan to distribute assets swiftly and with minimal interference from the taxman to his children after he dies. After his death, his estate gets hit with a sizeable tax bill from the state of Illinois.
Why? Though a longtime resident of Florida, a no-estate tax state, he still owned a $2 million home in Illinois. By keeping this home, the widower effectively handed his heirs a hefty bill of about $250,000 payable to the state of Illinois.
Like others, the widower likely thought he would be protected from the coyote’s bite if he declared residency in Florida. But the Illinois coyote prowls a wide territory. And because he wasn’t a resident of Illinois, his estate couldn’t claim the Illinois estate-tax exemption of $4 million, either.
Illinois isn’t the only state with a voracious tax authority. Among the others are Washington, Minnesota, Maine, Massachusetts, New York, Hawaii, Maryland, Oregon, Rhode Island, Vermont and Connecticut. Washington, D.C. is also a hungry coyote.
Those who hope to protect their hard-earned assets know they need to do more than merely avoid the old grey wolf, the federal estate tax. With their trusted advisors, they should also take defensive action to protect their heirs against the bite of the coyote.
Estates require continued safeguarding even after wills and trusts are crafted, especially if you are acquiring properties in high-tax states. As your estate grows in assets and complexity, be sure to consult your lawyer to make sure it will be protected.