By Lowell L. Kalapa
One of the silent issues waiting in the wings is whether or not lawmakers will do something about Hawaii’s estate or “death” tax given the fact that the federal law will terminate that tax automatically within the next few years.
As a result of the Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA), the federal estate tax will be repealed as of the year 2010. In the meantime, the exemption grows from the $675,000 allowed before the passage of the Act to $3.5 million before the tax is repealed in 2010. Another element of the EGTRRA phases out the tax credit for state death taxes.
This tax credit for state death taxes formed the basis for the amount that some states impose as their state estate or death tax. This mechanism is known as the “pick-up” tax as states merely took advantage of a provision of the federal law which acknowledged that states might also impose a tax on estates. Hawaii adopted this mechanism in 1983.
While the federal estate tax was imposed as early as 1916, the pick-up tax was not created until 1924 when Congress elected to recognize that states might also impose taxes on a decedent’s estate and therefore adopted the credit to allow the states to “pick-up” some of the federal tax without increasing the total liability of the estate. Thus, when a state chooses to eliminate its death taxes in favor of the “pick-up” tax, it is eliminating any additional state liability for the estate and tying its tax revenues directly to the federal Code.
The “pick-up” tax was adopted with the idea of minimizing the compliance on the part of the taxpayer’s representative upon death of the individual. Prior to the adoption of the “pick-up” tax, Hawaii imposed an inheritance tax which focused on the recipient of the wealth passed on by the deceased taxpayer. This is different from the federal estate tax which looks to the total amount of the estate of the deceased taxpayer. Thus, the personal representative had to determine who was going to get what amount of the estate and then determine what the recipient’s relationship was to the decedent.
At the time, lawmakers reasoned that since the federal law allowed for a tax credit for state taxes that might be imposed, why not just take advantage of the amount of the credit and eliminate all of the hassle of making additional calculations based on who received the bequest. Because the federal law granted the identical amount as a credit against federal estate taxes owed, there was no appreciable increase in the amount of taxes owed. So, if the state didn’t impose a death tax, then the decedent’s estate ended up paying the full tab of federal estate taxes, but if there were state death taxes, that amount reduced the amount owed the federal government.
Nearly three dozen states “piggyback” on the federal estate tax credit for state death taxes by using the “pick-up” tax approach. As a result, many states, like Hawaii, will now be faced with the dilemma of the federal tax credit provision disappearing in a matter of three years. On a relative scale, the state inheritance and estate tax contributes only about $16 million annually whereas the general excise tax is responsible for generating more than $1.6 billion each year.
While the state death tax does not produce a lot of money on a comparative basis, it is no less a source of financing for state expenditures. However, given the fact that federal lawmakers have chosen to eliminate the federal tax on estates, at least for the moment, state lawmakers may find it difficult to reinstate the state tax. Further, if other states do not impose a replacement for the “pick-up” tax and instead choose to eliminate any state tax on estates, it may be one more reason the elderly might consider moving their place of residency to a state which has no death taxes.
Although the federal changes were adopted last year, lawmakers failed to discuss the issue in the 2002 session. The state death tax credit will be reduced to 75% of what it was prior to the federal changes for this year, then another 25% for each of the next two years until it is finally repealed in 2005. So the clock is running on what lawmakers will do with the state death tax. If they do nothing, then taxpayers can expect that by 2005 there will be no tax on estates in Hawaii.
On the other hand, if lawmakers choose to enact a whole new tax on estates, they may face resistance from taxpayers awaiting the repeal of the federal tax.