By Lowell L. Kalapa
| One of the measures that failed to gain approval in this year’s legislature was a bill that would have extended the application of Hawaii’s estate tax law beyond the changes made to the federal death tax.
Because Hawaii’s estate tax law is tied to what is known as the state death tax credit, the fortunes of the tax are dependent on what happens to the federal death tax. As many know, a few years ago Congress decided to get rid of the federal estate tax law — but they weren’t quite sure that it was the right thing to do so they provided that it would be reinstated a year after its repeal in 2010.
However, the provision of the federal law that recognizes that states also levy a tax on estates by providing a federal tax credit was phased-out over four years. It is that credit to which Hawaii’s estate tax is tied. Called a pick-up tax, the amount of the state death tax is the amount granted under the federal tax credit depending on the size of the estate as determined under the federal law.
This approach to state death taxes is also employed by more than two dozen other states. Adopted in Hawaii in the early 1980’s, the pick-up tax was seen as a way to minimize administrative and compliance costs as well as disputes over what is or is not subject to the tax as those questions are resolved by federal officials. If the estate is not taxable for federal purposes, then it is not taxable for state purposes.
All well and good until Congress decided to get rid of the federal estate tax and the tax credit for state death taxes. If the legislature does nothing about decoupling or separating from the federal changes, then Hawaii’s estate tax law will disappear in two years. To better understand what is happening and how the state tax interacts with what is going on at the federal level, one has to look at how the federal law is changing, but always with a mindful eye that everything could revert back to the way it was prior to the changes made by Congress in 2001.
Although the federal tax credit for state death taxes paid is being phased-out over these four years, one has to remember that the exemption, or threshold before the federal estate tax is imposed, is beginning to rise or grow. As a result, smaller estates of any consequence are escaping the federal tax and as noted before if no federal taxes are due, then no state taxes are due.
The exemption from the estate tax has risen from $675,00 to $1 million this year and will continue to rise to $1.5 million in 2004 and to $3.5 million by the time the estate tax is repealed in 2010. As a result, even if the tax credit for state taxes was not phased out, the number of Hawaii estates that would have to pay state death taxes would continue to dwindle because the basic exemption at the federal level has risen.
So for policy makers and administration officials the question is whether or not they want to let go of the state death tax. Some may see hanging on to the state death tax credit as a tax increase because under current circumstances the tax would disappear altogether by the year 2005. On the other hand, if the understanding is that with the rising federal exemption most estates in Hawaii will not be subject to the federal estate tax and thus pay no state taxes, then one has to ask if Hawaii is missing out on tax revenues that could help the state budget but would be paid only by the very well to do.
For taxpayers, constant review of their estate plan and how it would interact with the changing federal and state estate tax laws will be crucial. The unknown of what will happen after the year 2010 when the tax disappears for a year and then returns begs for constant review of one’s own estate planning situation.
Even the last Tax Review Commission recommended that policy makers and administration officials take a long hard look at what is happening to the federal estate tax law. If policy makers believe that the state death tax should be retained, then they need to examine how these changes forced on the state by the federal changes affect their constituents. What they will find is that retention of the state death tax credit while the federal exemption grows will mean that only very few large estates will continue to pay the state death tax. On the whole the changes made by the federal law will spare smaller estates which represent the bulk of their constituency.
However, the real dilemma will be for our congressional delegation as the year 2010 draws near. Will federal lawmakers let the estate tax become history or will they preserve it in its current form?