You asked for (1) a history of the Connecticut estate tax and (2) a summary of estate tax changes proposed in the 2010 regular General Assembly session.

SUMMARY

On and before December 31, 2001, Connecticut had two taxes on the value of the property a person bequeaths to his or her heirs and one on property a person transfers by gift during his or her life. The two inheritance taxes were the succession tax, originally enacted in 1929, and the estate tax, originally enacted in 1931. The Connecticut gift tax was enacted in 1991. It imposed a state tax, payable by the donor, on gifts subject to the federal gift tax.

Before 2005, the Connecticut estate tax was closely tied to the federal estate tax. Until 2001, federal law gave taxpayers a dollar-for-dollar credit against the federal tax for state inheritance taxes paid. As a result, Connecticut, like many other states, set its estate tax to equal the maximum federal credit on a federally taxable estate. This so-called “pick-up” or “sponge” tax allowed Connecticut and the other states with similar taxes to share the revenue from taxable estates with the federal government without increasing the estate's total tax liability.

A federal tax reduction law enacted in 2001 began to phase out both the federal estate tax itself and the federal credit for state estate taxes paid. Under the 2001 law, the federal estate tax phase-out period was 10 years, but the phase-out period for the state credit was three years. Because Connecticut's state law was tied to the federal estate tax credit, the new federal law had the effect of gradually eliminating the state tax.

In 2005, Connecticut revamped its taxes on inheritances and gifts. It repealed the succession tax, which it was already phasing out, and it combined the state estate and gift taxes into one transfer tax with the same rates. The pre-2005 gift tax was being phased out for gifts under $1 million and the state's pick-up estate tax had been phased out by the operation of the 2001 federal law. The new state estate and gift tax law applied to estates and gifts over $2 million. The tax rates were generally the same as the federal estate tax credit rates prior to January 1, 2002. But because the federal credit had been phased out, the state tax payment no longer counted as a dollar-for-dollar reduction in federal estate tax liability. Thus, the state tax on taxable estates was no longer subsumed by the federal tax.

In 2009, as part of the state's biennial budget act, the General Assembly reduced the state estate tax by (1) increasing the threshold for a taxable estate or gift to $3.5 million and (2) cutting tax rates by 25%. These changes took effect for deaths and gifts on or after January 1, 2010. In December 2009 and during the 2010 regular legislative session, the General Assembly made three attempts to delay these estate tax reductions for two years, but none of the proposals became law.

CONNECTICUT'S ESTATE TAX BEFORE 2005

Connecticut Estate Tax in 2001

Before January 1, 2002, Connecticut's estate tax law was closely tied to, and heavily dependent on, the federal estate tax law.

For deaths on or before December 31, 2001, the federal estate tax law allowed a dollar-for-dollar 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)).

As a result, many states, including Connecticut, set their state estate taxes at an amount that equaled the maximum federal estate tax credit for the estate. 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 maximum 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 from 2006 through 2009.

Table 1: Connecticut Estate Tax — Deaths on or before December 31, 2001

(100% of the Federal Credit for State Taxes)

2001 Federal Tax Changes

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 eliminated the federal tax over eight years, from 2002 through 2010, but the elimination is only temporary. (The tax returns in 2011.) It accomplished 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, the 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.

Temporary Connecticut Estate Tax: 2004

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). 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.

CONNECTICUT SUCCESSION TAX BEFORE JANUARY 1, 2005

For deaths before January 1, 2005, Connecticut also imposed a succession tax on certain inheritances. Whether the tax applied and at what tax rate depended not only on the value of the inheritance 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 were: 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).

The pre-January 1, 2005 law was already phasing out the succession tax. The succession tax on inheritances by Class AA heirs was eliminated with deaths on or after July 1, 1988. The tax on inheritances by Class A heirs was phased out over three years from 1997 through 2000, with no tax on inheritance by 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 from 2001 through 2004 and the rates that would have been in effect for 2005 if a new estate tax law (see below) had not eliminated the tax. As the tables show, a nephew inheriting $3.5 million in 2004 owed succession tax of $404,300. In 2005, under the pre-January 1, 2005 law, the tax would have been reduced to $228,800. The same inheritance 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

Table 3: For Deaths During 2005 Under the Pre-2005 Law

GIFT TAX BEFORE JANUARY 1, 2005

Connecticut's pre-January 1, 2005 gift tax applied to gifts of tangible or intangible personal and real property located in Connecticut that were subject to the federal gift tax. Donors whose gifts were includable in their gross estates received a credit against succession tax liability for gift taxes paid.

Under both the federal and state gift tax in effect in 2004, only gifts to a single recipient valued at more than $11,000 counted as “gifts” for gift tax purposes. In addition, under the state gift tax law, once a gift exceeded the $11,000 trigger, the first $25,000 of the gift ($50,000 for a gift made by a couple) was exempt. For example, under the pre-2005 state gift tax, two gifts of $10,000 each to two people were not taxed because they did not reach the federal gift tax trigger and a $20,000 gift to a single person was not taxed because it was below the $25,000 state gift tax exemption threshold.

Under the pre-January 1, 2005 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 the old law, would also have applied to gifts in 2005. Thus, a person who gave away $1 million to one of his or her 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 the pre-January 1, 2005 law, through 2005)

2005 ESTATE AND GIFT TAX LAW (PA 05-251)

In the 2005 session, the General Assembly eliminated 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.

Taxable Estates and Gifts

PA 05-251 replaced all of these taxes with a uniform tax on transfers of Connecticut taxable gifts and estates that exceed a combined lifetime total of $2 million. It applied 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 at death or owned Connecticut real or personal property;

2. gifts above the federal gift tax trigger 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 made after January 1, 2005 and the taxable estate exceed $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 or her 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 or she 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 any federally taxable gift made by a (1) Connecticut resident, excluding real estate or tangible personal property located outside the state, and (2) 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.

Tax Rates

Table 5 shows the tax rates on taxable gifts made, and taxable estates of those who died, on or after January 1, 2005 under PA 05-251. 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

Table 5: -Continued-

Tax Cliff

The 2005 law included a large “tax cliff.” Under the 2005 rates, an estate valued at $2 million or less was not taxed while the full value of any estate valued more than $2 million was subject to the tax. This structure produced a so-called “cliff” in which a $1 increase in the value of a taxable estate from $2,000,000 to $2,000,001 increased its tax liability from zero to $101,700.

2009 ESTATE TAX CHANGES

In 2009, the General Assembly made a significant reduction in the Connecticut estate and gift tax affecting the estates of people who die, and gifts made, on or after January 1, 2010. The 2009 law (1) increased the minimum value of an estate or gift subject to the tax from $2 million to $3.5 million, thus making Connecticut's estate tax threshold the same as the 2009 federal estate tax threshold; (2) eliminated the tax “cliff” (see above); and (3) reduced marginal tax rates on taxable estates and gifts by 25% (see Table 6). The legislature also reduced the time an executor has to file an estate tax return from nine to six months after the death; for deaths on or after January 1, 2010, established a credit against estate tax for gift taxes paid between January 1, 2005 and December 31, 2009; and made conforming changes (PA 09-3, June Special Session as amended by PA 09-8, September Special Session).

TABLE 6: OLD AND NEW ESTATE TAX RATES

DECEMBER 2009 SPECIAL SESSION AND 2010 REGULAR SESSION

After passing the 2009 estate tax changes, the General Assembly made three attempts to delay the effective date of the rate reductions and the threshold increase.

PA 09-2, December 2009 Special Session

Before the 2009 estate tax changes were to take effect on January 1, 2010, the General Assembly passed an act to delay the scheduled rate reductions and the increase in the taxable estate and gift threshold for two years, until January 1, 2012. The act did not become law because the governor vetoed it.

The vetoed act delayed until January 1, 2012 (1) the increase, from $2 million to $3.5 million, in the threshold value of an estate or gift subject to the estate and gift tax and (2) the 25% reduction in marginal tax rates on estates and gifts valued at more than $3.5 million. It eliminated the cliff as scheduled, but to offset the resulting revenue loss, it temporarily increased tax rates on taxable estates and gifts to a range of between 8% and 18% from 5.085% to 16%. The higher rates would have affected estates of those who died, and gifts made on or after January 1, 2010

and before January 1, 2012. As of January 1, 2012, rates were to drop back to the post-January 1, 2010 rates established under PA 09-3, June Special Session.

Table 7 shows the higher temporary rates and the post-January 1, 2012 rates under the vetoed act.

Table 7: Estate and Gift Tax Rates Under PA 09-1, December Special Session

(Vetoed)

2010 Regular Session – SB 492 and sSB 478

During the 2010 regular session, two bills were proposed to reverse the estate and gift tax rate reductions enacted in 2009. The first, SB 492, was an emergency certified bill that included various budget reductions for FY 10 and FY 11 along with the proposed estate tax changes. It passed the Senate on March 26, 2010 but died without a vote in the House. The second bill, sSB 478, proposed other revenue increases along with estate tax changes, including a hospital gross receipts tax. It died on the Senate calendar without a vote when the regular session ended on May 5, 2010.

The bills had identical estate and gift tax provisions. They maintained the new higher $3.5 million tax threshold that took effect January 1, 2010 and eliminated the tax cliff. But to compensate for the resulting revenue loss, they increased marginal tax rates on estates and gifts over $3.5 million from between 7.2% and 12% to between 14.8% and 20% for two years. The higher rates would have affected estates of those who died, and gifts made, on or after January 1, 2010 and before January 1, 2012, as shown in Table 8.

Table 8: Estate and Gift Tax Rates Under Two 2010 Proposals

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