State Death Tax Changes May Hurt Family Landowners

Published January 5, 2015

In the United States, more than a third of all forest land is owned by families. Studies tell us half of these family forests are owned by people over the age of 65. In the not-too-distant future, those lands will go through the estate transfer process and possibly be subject to taxation.

In 2010, when the federal estate tax was reduced, landowners rejoiced, and it was hard not to be happy for them. 

Additional changes to the federal tax code made in 2013 reduced or eliminated the federal estate tax for more taxpayers. However, lurking in the background, without much attention from the forestry community, are state estate tax laws and state death taxes.

As many taxpayers have become aware of the federal estate tax changes, owners have shifted from planning for tax minimization, to planning for succession. In some states, this failure to plan for tax minimization could result in the need to cut timber or sell off parts of a family’s land.

‘Doing Nothing’

Historically, the federal income tax code has included a credit for taxes paid to the state upon a taxpayer’s death. On January 1, 2005, however, this credit was phased out, replaced with a deduction for state death taxes. If legislators had not come to an agreement regarding the 2001 changes in 2013, estate tax law would have reverted to the one passed in 2001, bringing back the the credit for state taxes as well. 

States responded to the 2013 federal tax changes in two different ways.

Twenty-three states did nothing. This lack of action effectively killed the state death tax, because those states had directly matched the state death tax rate to the federal death tax credit, so that they offset one another.

When the federal credit was eliminated, the state no longer collected state estate taxes, because they had tied the state’s tax rate to the federal government’s tax credit, cancelling out one another. However, should federal estate tax changes include a credit for state death taxes, these states would start collecting death tax revenue.

Another way states responded was through the creation of a standalone estate tax. As of August 2014, fourteen states and the District of Columbia have a state death tax separated from the federal government’s estate tax credit. In the states with estate taxes, private forest land constitutes between 34 and 94 percent of the states’ total forested areas.

Tied to Earlier Laws

Other states, such as Minnesota tied their state death tax exemption to the federal exemption at a specific point in time. Minnesota uses the federal estate tax law as it was on December 31, 2000.

On that date, the federal law included an exemption for estates with less than $675,000 in assets. Minnesota’s exemption was set up to increase, in steps, to a $1 million exemption.

Because the state’s estate tax is tied to the pre-2001 federal law, an estate in 201when the federal law allowed a $5 million dollar exemption—would pay state taxes at the rate of 41 percent on the first $93,000, over the $1 million exemption.

In March 2014, Gov. Mark Dayton (D) signed legislation increasing the exemption to $1.2 million for 2014, with step increases in later years. The exemption will continue to increase until 2018, when it reaches $2 million. 

Triggering the Tax

In Minnesota, 44 percent of forest land is owned privately. As land values increase over time, it isn’t hard to see how a modest amount of forest land in an estate can trigger a state estate tax liability.

The resulting tax may exceed the liquid assets in the estate, requiring either a sale of timber before the forest has matured, or a partial property sale.

In the past few months, a couple of states have made efforts to increase the exemption and in at least one case to expedite the phasing out of the state death tax.

Additionally, there are federal proposals on the table to change both the death tax rate and exemption levels. Should the federal tax credit for state death taxes return, landowners in 23 states will have to plan for estate taxes in their state.

Many forest landowners have been under the belief that very few of them will have to worry about the estate tax. In reality, many states with state death taxes have a lot of private forestland.

Although much work has been done on federal estate tax reform, state death taxes still represent a hidden threat to continuing stewardship of the land within the family.

Tamara Cushing ([email protected]) is the Starker Assistant Professor of Private & Family Forestry at Oregon State University.