Federal Estate Tax vs. Tennessee Estate Tax

If you own a home and some life insurance and are entitled to retirement plan benefits from work, your gross estate may already exceed the threshold at which estate tax liability begins. Since the top estate tax rate is 50% (in 2002, with the top rate being phased down to 45% by 2009), planning to make the best use of your exemption is essential.

In 2004 and 2005, the first $1.5 million of your taxable estate is exempt from federal estate tax. (Technically, the law provides for this exemption by allowing a credit of $555,800, which is the amount of tax on the first $1.5 million of a taxable estate, calculated under the estate tax rate schedule.) If married, your spouse is also entitled to an exemption of $1.5 million. In 2006, 2007 and 2008 the exemption equivalent for estate tax purposes is $2 million, and in 2009 it is $3.5 million. The federal estate tax is scheduled to expire on January 1, 2010, but it is scheduled to be restored (with only a $1 million exemption) on January 1, 2011.

If the value of all assets owned by you and your spouse exceeds the exemption amount described above, an estate plan that results in the surviving spouse receiving all the assets will result in estate tax liability at the death of the second spouse. This, in turn, reduces the amount available for your children or other beneficiaries.
A married couple can escape federal estate tax on assets of up to two times the exemption amount ($3 million in 2004 or 2005, $4 million in 2006, 2007, or 2008, or $7 million in 2009) if the couple’s living trust or wills are drafted to take full advantage of each spouse’s own credit. The living trust or wills should provide that, when the first spouse dies, the amount protected from estate tax by the available credit passes to a trust (the “credit shelter trust”) from which the surviving spouse can benefit during his or her remaining lifetime but which will not be included in the surviving spouse’s estate at death.

However, for Tennessee residents, the law is somewhat different. Tennessee’s exemption amount is not the same as the federal exemption amount. For example, for 2004 the federal exemption amount is $1.5 million but the Tennessee exemption amount is $850,000. This discrepancy can create an unplanned and unnecessary Tennessee death tax at the death of the first spouse. For years, attorneys have used formula provisions in client’s trusts and wills to ensure the proper utilization of the exemption amount. Unfortunately, under the new federal law and the current law in Tennessee, the use of such formula provisions can result in a Tennessee death tax. The table below illustrates the amount of Tennessee death tax due on the first death if the credit shelter trust is fully funded with the then federal exemption amount.

 

Federal and Tennessee Exclusion Amounts

Year In Which Death Occurs

Tennessee Death Tax Exemption

Completely Funded Credit Shelter – Amount That Can Be Transferred Free of Federal Estate Tax
(The “Applicable Exclusion Amount”)

Completely Funded
Credit Shelter – Tennessee Death Tax

2001

$675,000

$675,000

$0

2002

$700,000

$1,000,000

$19,700

2003

$700,000

$1,000,000

$19,700

2004

$850,000

$1,500,000

$50,150

2005

$950,000

$1,500,000

$40,650

2006

$1,000,000

$2,000,000

$83,400

2007

$1,000,000

$2,000,000

$83,400

2008

$1,000,000

$2,000,000

$83,400

2009

$1,000,000

$3,500,000

$225,900

2010

$1,000,000

Federal estate tax and generation- skipping transfer tax fully repealed.

N/A

2011

$1,000,000

$1,000,000 (Law reverts to law prior to the Tax Relief Act.)

$0

 

There are ways to minimize and/or avoid the Tennessee death tax while still sheltering assets from the federal estate tax. Some available planning options include disclaimer based planning and the use of a “Clayton” QTIP. If you have not done estate planning or if your plan has not been reviewed recently, you should consider meeting with an estate planning attorney to review your current estate plan design.