Trust & Estates

CONNECTICUT ENACTS UNIFIED ESTATE AND GIFT TAX; REPEALS SUCCESSION TAX

What is the impact of these changes?

By: Richard J. Di Marco

Connecticut has enacted a new estate tax, changed its gift tax, and repealed the succession tax, all effective January 1, 2005.

A summary of this new law is contained below. Depending upon your personal situation, changes to your estate plan or gift program may be in order. (See "Planning Considerations" below.)

Overview of the Key Changes

• The Connecticut succession tax has been repealed effective January 1, 2005.
• The current version of the Connecticut gift tax has been repealed effective January 1, 2005.
• The state has adopted a unified estate and gift tax system, effective for gifts made after January 1, 2005 and estates of decedents dying after January 1, 2005.
• There is a $2 million exemption for aggregate lifetime gifts and estates.
• There is a "cliff" in the tax rate schedule. The tax due on a taxable estate of $2,000,000 is zero; the tax due on an estate of $2,000,001 is over $101,000.
• The tax rates begin at 5% for estates over $2 million and rise to 16% for estates over $10 million.
• All estates of Connecticut residents, regardless of their size, are required to file a Connecticut estate tax return.

Background

As part of the changes to federal estate and gift tax laws that took place in 2001, Congress repealed a provision known as the credit for state death taxes. This is a credit allowed against federal estate tax liability for state inheritance taxes paid. Many states, including Connecticut, imposed a state estate tax exactly equal to the credit allowed against the federal estate tax, in essence taking a portion of the total tax and shifting it to the state. When Congress repealed the federal credit for state death taxes, the tax revenues to the states whose estate taxes were based upon the federal credit evaporated, and those states were left to find another source of revenue. This recent legislation by Connecticut is an attempt to reclaim some of the lost revenue.

Repeal of Succession and Gift Taxes

The succession tax, which imposed different rates of tax based upon the family relationship of the beneficiaries to the decedent, is completely repealed, effective January 1, 2005. The succession tax was repealed by legislation passed in 1997, but the phase out was to take place over a period of years, and the phase out was delayed several times. At the time of the most recent legislation, the succession tax still applied to transfers to siblings, nieces, nephews, and more distant relatives, as well as unrelated parties, at rates that could exceed 20%. The Connecticut gift tax, in its old form, applied to taxable gifts in excess of $25,000 in any year, at progressive rates that reached 6% for aggregate gifts in excess of $675,000. The tax was imposed on an annual basis, without reference to gifts made in other years.

New Estate and Gift Tax

The new estate tax applies to estates of decedents who die after January 1, 2005. Connecticut residents are subject to the estate tax on all their property wherever located. If they have real or tangible personal property located in another state, their estates will be allowed a credit for taxes paid to the other state (not to exceed the amount of Connecticut tax attributable to such property). Estates of nonresidents are subject to Connecticut estate tax on real property and tangible personal property located in the state of Connecticut.

Connecticut residents are subject to gift tax on all transfers of property except gifts of real estate or tangible personal property located outside the state. Nonresidents of Connecticut are subject to gift tax only on gifts or real estate and tangible personal property located in the state of Connecticut.

The Connecticut estate and gift taxes are unified. Thus, similar to the federal estate tax, the Connecticut estate tax will be based upon the sum of the aggregate of lifetime Connecticut gifts and the Connecticut taxable estate, with a credit against the estate tax for any gift taxes (on gifts made in 2005 and thereafter) that have been paid.

Rate Brackets

The rate brackets are based upon the rates contained in the now-repealed federal death tax credit, but with no tax on estates or aggregate gifts of $2 million or less. The rates are graduated starting at the 5% rate and increasing to 16% for taxable estates over $10,100,000. However, there is a "cliff" in the tax rate schedule. A taxable estate of $2,000,000 will pay zero tax. A taxable estate of $2,000,001 will pay a tax of $101,600.10!!

Definition of Taxable Gifts

Taxable gifts have the same meaning as under federal law. Therefore, annual exclusion gifts ($11,000 per donee) and payments of tuition or medical expenses directly to providers are not considered taxable gifts for Connecticut purposes either.

Tax Returns

Planning Considerations

1. The former Connecticut gift tax applied to taxable gifts in excess of $25,000. The new gift tax will not apply until total taxable gifts exceed $2 million. This allows much larger gifts of interests in the family business or real estate to next generation family members without any transfer tax cost. (But remember, while Connecticut will not tax gifts under $2 million, the federal gift tax exemption is still only $1 million.)
2. Those clients who divide their time between Connecticut and a state that does not impose any estate tax may want to reevaluate their choice of domicile, if a significant tax savings may be achieved.
3. In January 2006, the federal estate and gift tax exemption will also rise to $2 million. For married couples with estates in excess of that amount, dividing the assets evenly and employing traditional estate planning techniques such as "credit shelter" trusts will allow a couple to shield up to $4 million of property from estate taxes.
4. Since gifts of out-of-state property by a Connecticut resident are not subject to Connecticut gift tax, but will be subject to Connecticut estate tax, Connecticut residents should consider lifetime gifts of their out-of-state property, if that state does not impose any gift tax. Persons who permanently reside in another state who own Connecticut real property may find that giving away the Connecticut property during their lifetimes may result in a savings of Connecticut estate tax. Another alternative would be to hold that real estate in an entity, thereby converting an interest in real property (which is taxable) to an interest in intangible personal property (which is not taxable). They should also consider moving valuable tangible personal property (paintings, etc.) to their other home.

This bulletin is intended to provide an overview of Connecticut's new estate and gift tax system. Depending upon your own particular personal situation, some changes to your estate plan or documents may (or may not) be necessary.