Topic:
TAX CREDITS; STATISTICAL INFORMATION; TAXATION (GENERAL); GIFT TAX; ESTATE TAX;
Location:
TAXES - ESTATE;

OLR Research Report


June 29, 2005

 

2005-R-0535

NEW STATE ESTATE/GIFT TRANSFER TAX

By: Judith Lohman, Chief Analyst

You asked for an explanation of (1) changes in the federal estate tax affecting Connecticut's estate tax; (2) the succession, estate, and gift taxes in effect in Connecticut during 2004; and (3) the recently enacted state estate and gift taxes that affect deaths and gifts on or after January 1, 2005.

SUMMARY

PA 05-251 includes a new uniform estate and gift tax that replaces Connecticut's former estate, succession, and gift taxes. The new tax takes effect with deaths occurring and gifts made on or after January 1, 2005. The new tax applies to taxable estates, aggregate taxable gifts over a donor's life starting January 1, 2005, or any combination of the two that exceed $2 million. Tax rates are set at levels equivalent to the federal estate tax credit for state inheritance taxes that applied in 2001, before Congress enacted P.L. 107-134, the Economic Growth and Tax Relief Recovery Act of 2001 (EGTRRA).

That law, among other things, revamped the federal estate tax starting with deaths on or after January 1, 2002 and phased out the federal credits for state taxes, which was the basis of Connecticut's estate tax. The phase-out of the federal credit starting in 2002 effectively eliminated Connecticut's former estate tax as of January 1, 2005.

In addition to the estate tax, Connecticut also had a temporary higher estate tax that applied in lieu of the regular estate tax for the last six months of 2004. Like the former estate tax, the temporary tax was based on the federal estate tax credit but was set at 130% of the 2001 credit. The temporary tax applied to estates over $1 million. It expired on December 31, 2004.

PA 05-251 eliminated the Connecticut succession tax, which applied to estates over a certain threshold based on the relationship of the heirs to the decedent, and the old gift tax, which applied to federally taxable gifts over $25,000. Both taxes were in the process of being phased out but would have remained in effect for several more years under prior law.

The taxes under the 2001 Connecticut estate tax and under the newly enacted estate tax are roughly the same. Thus, a $3.56 million taxable estate would have owed $242,960 in Connecticut estate taxes in 2001 and would owe $234,960 under PA 05-251.

FEDERAL ESTATE TAX

Federal Estate Tax Prior to 2002

For many years, the federal government has imposed a tax on transfers of estates worth more than a specified threshold. In addition, the federal government allowed a credit against federal estate taxes for state estate taxes that an estate subject to the federal tax had to pay. The credit amount depended on the size of the “adjusted taxable estate,” which is the federally taxable estate minus $60,000 (IRC 2011(a)).

Many states, including Connecticut, had state estate taxes that equaled the amount of the federal estate tax credit. Such taxes are called “pick-up” or “sponge” taxes because they allowed states to share in the revenue from the federal tax without increasing the total tax liability on estates. Connecticut's estate tax applied only to estates subject to the federal tax. Thus, in addition to being linked to the federal credit, Connecticut's tax was also linked to the federal tax thresholds for determining which estates were subject to the state estate tax.

Table 1 shows the federal estate tax credits, and thus Connecticut's estate tax rates, for 2001. The threshold for a taxable estate for 2001 under both federal and state law was $675,000. The threshold was scheduled to rise to $700,000 in 2002, $850,000 for 2004, $850,000 for 2005 and $1 million in 2006 through 2009. Though the tax applied only to estates over those thresholds, as Table 1 shows, the credit was calculated based on the taxable estate's first dollar.

For example, as Table 1 shows, the Connecticut estate tax in 2001 on a $3.5 million adjusted taxable estate was $242,960.

Table 1: Connecticut Estate Tax — Deaths Before December 31, 2001

(100% Federal Credit for State Taxes)

ADJUSTED

TAXABLE ESTATE

TAX

Col. A:

Over

Col. B:

But

not over

Col. C:

Tax on

Col. A

Col. D:

Tax Rate on

excess over

Col. A

0

$40,000

No Tax

$40,000

90,000

0

0.8%

90,000

140,000

$400

1.6%

140,000

240,000

1,200

2.4%

240,000

440,000

3,600

3.2%

440,000

640,000

10,000

4.0%

640,000

840,000

18,000

4.8%

840,000

1,040,000

27,600

5.6%

1,040,000

1,540,000

38,800

6.4%

1,540,000

2,040,000

70,800

7.2%

2,040,000

2,540,000

106,800

8.0%

2,540,000

3,040,000

146,800

8.8%

3,040,000

3,540,000

190,800

9.6%

3,540,000

4,040,000

238,800

10.4%

4,040,000

5,040,000

290,800

11.2%

5,040,000

6,040,000

402,800

12.0%

6,040,000

7,040,000

522,800

12.8%

7,040,000

8,040,000

650,800

13.6%

8,040,000

9,040,000

786,800

14.4%

9,040,000

10,040,000

930,800

15.2%

Over $10,040,000

$1,082,800 plus 16.0%

of the excess over $10,100,000

Internal Revenue Code 2011 (b)(1)

Federal Estate Tax Changes for 2002 and After

In June 2001, the President signed the Economic Growth and Tax Relief Recovery Act of 2001 (EGTRRA - P.L. 107-134), which made major changes in the federal estate tax. It eliminates the federal tax over eight years, from 2002 through 2010, but the elimination is only temporary. (The tax returns to its 2001 level in 2011.) It accomplishes the phase-out by reducing the top tax rate and gradually raising the threshold for estates subject to the federal tax. To offset the federal revenue loss from the tax phase-out, the EGTRRA phased out the federal credit for state taxes paid, reducing the credit by 25% per year over three years.

Between 2002 and 2004, EGTRRA reduced Connecticut's pick up estate tax in two ways. First, it reduced the amount of the federal credit and therefore Connecticut's tax rates by 25% per year and second, it raised the threshold on estates subject to Connecticut's tax from $675,000 in 2001 to $1 million in 2002 and 2003 and $1.5 million in 2004. Finally, upon completion of the federal credit phase-out, the EGTRRA effectively eliminated Connecticut's pick-up estate tax as of January 1, 2005.

CONNECTICUT'S 2004 ESTATE, GIFT AND SUCCESSION TAXES

Temporary Estate Tax

In 2003, Connecticut responded to the estate tax revenue loss resulting from the EGTRRA by enacting a temporary estate tax that applied to deaths occurring on and after July 1, 2004 and before January 1, 2005 (PA 03-1, June 30 Special Session). The tax was to take effect only if, by July 1, 2004, the Office of Policy and Management secretary did not certify that the state would receive at least an extra $110 million in federal assistance for FY 05. Because the extra federal assistance did not materialize, the temporary estate tax became law.

The temporary tax applied to estates valued at $1 million or more (instead of the $1.5 million threshold that applied under the federal law and Connecticut law for deaths between January 1 and June 30, 2004). The tax rate on these estates was 130% of the federal credit, excluding the 75% reduction for 2004. That is, the tax was based on the federal credit that would have applied to the estate in 2001 (see Table 1 above). Thus, for estates subject to it, the temporary tax represented an increase not only over the taxes payable in the first part of 2004 but also over the taxes they would have paid in 2001.

Succession Tax

For deaths before January 1, 2005, Connecticut also imposed a succession tax on certain estates. Whether the tax applied and at what tax rate depended not only on the estate's value but also on the relationship of the heirs to the decedent. For purposes of the succession tax, state heirs were divided into classes based on the closeness of their relationship to the decedent. The classes are: surviving spouse (Class AA); lineal parents and descendents such as grandparents, parents, children, and grandchildren (Class A); collateral relatives, such as siblings, nieces, and nephews (Class B); and more remote relatives and unrelated heirs (Class C).

Prior law was phasing out the succession tax. The succession tax on estates passing to Class AA heirs was eliminated with deaths on or after July 1, 1988. The tax on Class A heirs was phased out over three years from 1997 through 2000, with no tax on estates passing to such heirs for deaths on or after January 1, 2001. The tax was to be fully phased out for Class B heirs with deaths on or after January 1, 2006 and for Class C heirs starting with deaths on or after January 1, 2008.

Tables 2 and 3 show the succession tax rates since 2001 and the rates that would have been in effect for 2005 if the new estate tax law had not eliminated the tax. As the tables show, a $3.5 million taxable estate passing to a nephew in 2004 owed succession tax of $404,300. In 2005, under prior law, the tax would have been reduced to $228,800. The same estate left to a friend owed $639,925 in tax in 2004 and would have owed $609,180 in 2005. Succession taxes actually paid were credited against Connecticut estate tax liability under both the regular and the 2004 temporary estate taxes.

SUCCESSION TAX RATES

Table 2: For Deaths During 2001-2004

CLASS B HEIRS

Estate Value

Tax

Over

But Not Over

0

$600,000

None

$600,000

1,000,000

11.7%

Over $1,000,000

14.3%

CLASS C HEIRS

Estate Value

Tax

Over

But Not Over

0

$200,000

None

$200,000

250,000

14.3%

250,000

400,000

15.73%

400,000

600,000

17.16%

600,000

1,000,000

18.59%

Over $1,000,000

20.02%

Table 3: For Deaths During 2005 Under Prior Law

CLASS B HEIRS

Estate Value

Tax

Over

But Not Over

0

$1,500,000

None

Over $1,500,000

11.44%

CLASS C HEIRS

Estate Value

Tax

Over

But Not Over

0

$400,000

None

$400,000

600,000

17.16%

600,000

1,000,000

18.59%

Over $1,000,000

20.02%

Gift Tax

Connecticut's former gift tax applied to federally taxable gifts (i.e., gifts to a single recipient worth more than $11,000) of tangible or intangible personal and real property located in Connecticut. The first $25,000 of any gift was exempt. Gifts made jointly by married couples were considered as being made 50% by each, thus making the exemption $50,000 for each couple. Donors whose gifts were includable in their gross estates received a credit against succession tax liability for gift taxes paid.

Under prior law, the tax was being phased out for gifts of $1 million or less. Such gifts were scheduled to be exempt starting with calendar year 2010. Table 4 shows the rates that applied to gifts made during 2003 and 2004 and that, under prior law, would also have applied to gifts in 2005. Thus, a person who gave away $1 million of property to one of his children in 2004 would owe a Connecticut gift tax of $50,750.

Table 4: Connecticut Gift Tax

(Rates in effect during Calendar Years 2003 and 2004 and, under prior law, through 2005)

VALUE OF GIFT

TAX

Col. A:

Over

Col. B:

But not over

Col. C:

Tax on

Col. A

Col. D:

Tax Rate on excess over Col. A

0

$25,000

0

No Tax

$25,000

50,000

$250

2.0%

50,000

75,000

750

3.0%

75,000

100,000

1,500

4.0%

100,000

675,000

2,500

5.0%

Over $675,000

$31,250 plus 6.0% of the amount over $675,000

NEW ESTATE AND GIFT TAXES

PA 05-251 eliminates the succession tax and the former gift tax as of January 1, 2005 instead of phasing them out over several more years. As already described, the state's pick-up estate tax was effectively eliminated by the federal law starting with deaths on or after January 1, 2005 and the state's temporary estate tax also expired on that date.

The new act replaces all these taxes with a uniform tax on transfers of Connecticut taxable gifts and estates that exceed a combined lifetime total of $2 million. It applies to:

1. estates of people who die on or after January 1, 2005 if (a) the estate's taxable value exceeds $2 million and (b) the person was either a Connecticut resident when he died or owned Connecticut real or personal property;

2. gifts above the federal gift tax threshold (currently $11,000 per year, per recipient) made on or after January 1, 2005 that, in the aggregate over the donor's life, exceed $2 million; and

3. a person's estate, if the combined value of all the Connecticut taxable gifts he made after January 1, 2005 and his taxable estate exceeds $2 million.

A Connecticut taxable estate is (1) a person's gross estate minus all federally allowable deductions except the one for state death taxes paid plus (2) the aggregate value of all Connecticut taxable gifts the decedent made during his life starting on January 1, 2005. For state tax purposes, a person may take advantage of the optional deduction for the value of a qualifying life income interest in property passing to a surviving spouse, even if he does not do so for the federal estate tax. But the act requires the gross estate to include any such qualifying life income interest that the decedent held.

A Connecticut taxable gift is (1) any federally taxable gift made by a Connecticut resident, excluding real estate or tangible personal property located outside the state, and (2) any federally taxable gift made by a nonresident of real estate or tangible personal property located in Connecticut. Any gift taxes paid on gifts made on or after January 1, 2005 are credited against total estate and gift tax liability.

Table 5 shows the tax rates on taxable gifts made, and taxable estates of those who die, on or after January 1, 2005. These rates are equivalent to the federal credit tax rates that served as Connecticut's estate tax rates in 2001 (see Table 1).

Table 5: Tax Rates on Connecticut Taxable Gifts and Estates Under

PA 05-251

VALUE OF GIFT OR ESTATE

TAX

Col. A:

Over

Col. B:

But not over

Col. C:

Tax on

Col. A

Col. D:

Tax Rate on excess over Col. A

0

$2,000,000

No Tax

$2,000,000

2,100,000

5.085% of the excess over 0

2,100,000

2,600,000

$106,800

8.0%

2,600,000

3,100,000

146,800

8.8%

3,100,000

3,600,000

190,800

9.6%

3,600,000

4,100,000

238,800

10.4%

4,100,000

5,100,000

290,800

11.2%

5,100,000

6,100,000

402,800

12.0%

6,100,000

7,100,000

522,800

12.8%

7,100,000

8,100,000

650,800

13.6%

8,100,000

9,100,000

786,800

14.4%

9,100,000

10,100,000

930,800

15.2%

Over $10,100,000

$1,082,800 plus 16%

of the excess over $10,100,000

JL:ro