Estate Tax Planning in Washington State: Concepts and Background
Although estate tax planning sounds like a complex topic, the underlying concepts and rules at play are relatively straightforward. Comprehensive estate tax planning can help an individual achieve peace of mind that his/her assets will pass smoothly to the appropriate beneficiaries.
What is an estate tax?An estate tax is a specific type of tax that is sometimes levied by the government on the assets that someone owns when he/she dies. An estate tax is different from an "inheritance tax" which is another form of what is known as a "death tax." While an estate tax must be paid by the estate of the deceased person, an inheritance tax must be paid by the person inheriting property. Both Washington and the federal tax system levy an estate tax, rather than an inheritance tax.
What is an individual's estate?The broadest definition of an individual's estate is simply all the assets that an individual owns when he/she dies. There are several more specific definitions of an individual's estate, however, including the concept of a "taxable estate" and a "probate estate."
An individual's "probate estate" is simply all the assets that individual owned at death that must be passed to beneficiaries through the court probate system.
An individual's taxable estate" is the collection of assets owned by a deceased individual that the government takes into account for estate tax calculation purposes. We will discuss later some of the rules that the government uses for calculating an individual's taxable estate. An important concept to remember is that an individual's "estate" is not always the same collection of assets as an individual's "taxable estate."
What percent is the estate tax?The federal estate tax brackets range from 18-40%, while the Washington State estate tax brackets range from 10-19%. As a reminder, these percentages are calculated from the amount that the taxable estate exceeds the applicable "exclusion amount, rather than from the total value of the decedent's estate, which is a concept that will be discussed later in this guide.
Who is affected by the Washington State estate tax? Who is affected by the federal estate tax?Much like there is a federal income tax and, in states like Oregon, also a state-level income tax, so too are there two estate tax systems: the Washington State estate tax and the federal estate tax.
One major difference between the federal and Washington state estate tax systems is who they affect. The federal estate tax affects only 2% of the U.S. population, while the Washington estate tax has the potential to affect a larger portion of the State's population.
Both estate tax systems use what is called an "exclusion amount" to determine who will be affected by an estate tax. The "exclusion amount" is the amount of assets that someone can die owning before being affected by an estate tax. If, for example, an exclusion amount was set at $100 dollars, then an individual who died with $105 in his taxable estate would pay estate tax only on $5 (the amount that exceeds the exclusion amount).
For federal purposes, the 2017 exclusion amount is 5.49 million dollars per individual. For Washington State estate tax purposes, the exclusion amount is 2.129 million dollars per individual. As these numbers show, the lower Washington State exclusion amount means that Washington's estate tax has the potential to affect a much greater portion of the population than the federal estate tax affects.
The Key to Washington Estate Tax Planning for Married CouplesThere is another crucial difference between the federal and Washington estate tax systems: a difference that greatly impacts how estate tax affects married couples.
For both the Washington and federal estate taxes, married couples enjoy a major tax benefit. Namely, when a spouse dies and leaves assets to the surviving spouse, that surviving spouse receives an "unlimited marital deduction" that eliminates any estate tax on the assets that the spouse receives. If, for example, Bill Gates were to die and leave billions of dollars in assets to Melinda Gates, there would be no estate tax owed at the time Bill Gates died (but there would be an estate tax when Melinda Gates dies if she still wealthy at her death).
While both estate tax systems give spouse the "unlimited marital deduction," these systems could not be more different in how they treat the ability for one spouse to give to the other his/her exclusion amount, a concept known as "portability."
Under the federal estate tax system, when one spouse dies, that spouse can transfer his/her exclusion amount to the other surviving spouse, to create a combined 10.98 million dollar exclusion amount per married couple. Washington State, however, does not allow "portability" between spouses. This seemingly innocuous statement is incredibly important for tax planning and bears close examination.
Because Washington State does not allow portability, the first spouse to die cannot simply pass his/her 2.129 exclusion amount to the surviving spouse without some kind of special tax planning. The effect of this lack of portability can be costly. Take, for example, the married couple that owns $4 million dollars of combined assets.
Let's say that the husband dies first, leaving his half of the marital property (2 million dollars) to his wife. First, we must apply the concept of the unlimited marital deduction to understand that the surviving spouse pays no estate tax at husband's death. Because the 2 million dollars passing from husband to wife is shielded by the unlimited marital deduction, however, husband 's 2.129 million exclusion amount simply vanishes, as it is unneeded at his death. With no portability available to husband, the exclusion amount simply evaporates into thin air!
But what is the problem here? Wife has just received the 2 million dollars free of any estate tax, so why worry? The answer is simple. Assuming that wife does not gift away or otherwise reduce her estate that is now worth 4 million dollars (the 2 million dollars she owned combined with the 2 million dollars received from husband), she will die with 4 million dollars in her estate, yet she will have an exclusion amount worth only 2.129 million. Wife, therefore, could potentially pay estate tax on the 1.871 million dollars that exceeds her exclusion amount (resulting in a tax liability of approximately $221,940).
This difference in portability is the key concept to understand. While the specific estate planning tax strategies are beyond the scope of this guide, it is important to note that the proper estate tax planning techniques can work to "capture" the decedent spouse's exclusion amount at his/her death.