Estate Planning: State Estate Taxes

How to reduce the state estate and inheritance taxation of your estate.

By Financial Advisor Peter Egolf

Once you understand your federal estate tax burden (read this article first if you haven’t already), the next step is to consider whether you will face state estate and inheritance taxes.

State Estate and Inheritance Tax

Will I pay state tax on my estate?

Even if you don’t think Federal estate tax will apply, you may still be exposed to state estate or inheritance taxes. Each state has specific rules around estate and inheritance taxes. We work with many clients in Vermont and Pennsylvania, so we will explain those rules below. Note that each state is different, and some states do not have estate or inheritance taxes!

How can you avoid Vermont estate tax?

Vermont has an estate tax.¹ If your estate is worth less than $5 million, it is not subject to estate tax. If your estate is more than $5 million, any amount over $5 million is subject to a 16% estate tax. Unlike Federal estate tax, each spouse has a separate $5 million exemption, and an unused portion cannot be ported between spouses. The martial deduction is unlimited between spouses. However, if your estate does or will exceed $5 million and you have other non-spousal beneficiaries (e.g., children, charities), it could be wise to consider gifting assets as you are able or have an estate plan that uses up the first decedent spouse’s exclusion amount to avoid leaving a taxable estate greater than $5 million after the second spouse passes.

How can you avoid Pennsylvania inheritance tax?

Pennsylvania, on the other hand, does not have an estate tax but instead imposes an inheritance tax. Thus, the tax is on the beneficiary’s right to receive the property. Spouses receive an unlimited martial transfer exemption (0%), as do parents to minor children (under age 21). The Pennsylvania inheritance tax is 4.5% to direct descendants (lineal heirs), 12% for transfers to siblings, and 15% for transfers to other heirs.² If we compare Pennsylvania to Vermont, we see that even a Pennsylvania small estate left to children, siblings, or other heirs exposes the beneficiaries to taxation on the assets received. In contrast, a small estate (anything less than $5 million) would avoid estate taxes in Vermont.

As you design your estate plan, it’s essential to consider which state is your primary residence as it directly informs the potential taxation of your assets upon your death and that of the surviving spouse. In the cases above, it is not uncommon to see retirees establishing residency in low-state-income and estate tax jurisdictions to maximize their wealth while alive and that of their beneficiaries. For example, Florida has no state income tax, does not tax social security or retirement distributions, and has no estate or inheritance tax. It’s more than just good weather!

Like all tax codes, estate taxation is ever-changing at the federal and state level. It’s essential to have an estate plan that minimizes your taxation and ensures it is still doing what you intended, including incorporating any changes to the tax code.

1. Estate Tax - Vermont
2. Inheritance Tax - Pennsylvania