by Ron Morgan, Esq., and Matt Getty, Esq. Planning for the Vermont Estate Tax Background
It would be an understatement to say that estate planning to minimize potential federal and/or state estate tax liabilities has become considerably more complex in re- cent years. There are two principal reasons for this. First, although we have seen a drop in the top estate/gift tax rate from 55% in 2001 to 35% today, and a dramatic in- crease in the amount of the federal estate/ gift tax exemption—from $1 million in 2001 to $5,120,0001
another level of complexity, made worse by the fact that there are significant ambigui- ties in the application of Vermont estate tax laws to many typically-drafted and existing estate plans.
The purpose of this article is to set forth some of the considerations in drafting a Vermont estate plan designed to minimize both federal and Vermont taxes in an ex- tremely challenging and fluid legal environ- ment.
Key Features of the Vermont Estate Tax today—since 2009 we have
faced the specter of a “sunset” of these in- creasingly favorable provisions and a return to the law as it stood in 2001. The law was originally scheduled to sunset after 2010, but it has now been extended to the end of 2012 as a result of a last-minute legis- lative compromise that was reached in De- cember 2010.
Second, a number of states have made significant changes to their estate tax laws in recent years, principally as a result of the elimination of the federal estate tax cred- it for state death taxes paid. Prior to the elimination of the state death tax cred- it, nearly all states imposed an estate tax that corresponded to the amount of the credit allowed under federal law, and the exemption was the same for both federal and state estate tax purposes. In response to the change in federal law, a number of states, including Vermont, elected to im- pose estate taxes based upon the old state death tax credit, at the same time “de-cou- pling” their estate tax regimes from the federal exemption amount (by generally al- lowing a less generous exemption than that allowed under federal law). The upshot of the changes in federal laws is that persons with assets in excess of $1 million continue to face the unpleasant prospect of having their estates exposed to federal estate taxes of 41%2
or more if
they fail to plan appropriately, without hav- ing the assurance that any expenditure of time and money to carry out such planning will not be rendered superfluous by subse- quent actions of the Congress to maintain or increase the current exemption amount. Moreover, the looming lapse of the $5 mil- lion estate/gift tax exemption at the end of 2012 is driving many to plan on making substantial gifts this year. For married cou- ples in this category, the planning is even more complicated.
As if the fluidity in federal transfer tax laws was not bad enough, taxpayers in “de- coupled” states such as Vermont face yet
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Vermont Estate Tax Rates & Exemption; Phase-out Vermont imposes an estate tax on the transfer of the Vermont estates of dece- dents dying while resident in Vermont or who died owning Vermont situs property.3 The tax rates range from .8% for estates of less than $90,000 to 16% for estates valued at more than $10,040,000. Currently, Vermont law provides for a $2,750,000 exemption from estate tax.4 However, it is very important to recognize that the exemption is determined in an in- direct manner, by first calculating the Ver- mont estate tax liability on the entire tax- able estate as if there were no exemp- tion at all, and then comparing the result with a hypothetical federal estate tax li- ability, calculated by applying federal tax law as it existed in 20115
(with a 35% top
rate), but using an exemption amount of $2,750,000.6
lesser of these two amounts.7
The Vermont estate tax is the For an estate
valued at $2,750,000, there is no Vermont estate tax due because there would be no tax due under the hypothetical federal cal- culation, even though the Vermont estate tax calculation would reflect a liability of $165,280. As taxable estate values exceed $2,750,000, the hypothetical federal estate tax liability continues to be lower than the Vermont estate tax table amount until the size of the estate reaches approximately $3,400,000, at which point the Vermont tax table rates applied to the entire taxable es- tate will be lower than the federal liability, and will thus be used to determine the tax due in those cases. The upshot is that estate assets in excess of $2,750,000 are taxed at a 35% effec- tive marginal rate until the values exceed $3,400,000, at which point the progressive marginal rates of the Vermont estate tax ta- ble will apply to the entire taxable estate. This “cliff” effect, whereby estates valued at or less than $2,750,000 are free from tax entirely, and estates valued at more than
THE VERMONT BAR JOURNAL • SUMMER 2012
$2,750,000 but less than $3,400,000 are subject to a 35% marginal rate, creates sub- stantial incentives for persons with estates in this category to employ planning tech- niques designed to avoid or reduce the im- pact of the Vermont estate tax. For individ- ual estates over $3,400,000, there is no ex- emption available and therefore no “cliff,” although exposure to estate tax at marginal rates up to 16% obviously creates its own incentives for doing appropriate planning. The exemption phase-out has particularly anomalous effects on the estates of married couples, as discussed under “Tax Planning Considerations for Vermont Residents” be- low.
No Vermont Gift Tax, but Taxable Gifts Reduce Exemption Vermont does not impose a gift tax; life- time transfers of assets are free from Ver- mont wealth transfer taxes. However, tax- able gifts in excess of the federal annual ex- clusion amount (currently $13,000 per do- nee, per year) or other federal exclusions will reduce the Vermont exemption avail- able at death. For example, the estate of a decedent who made prior taxable gifts of $1 million would be subject to Vermont estate taxes if the estate at death exceed- ed $1,750,000 in value, because the gifts will have used a portion of the decedent’s $2,750,000 exemption under the “hypo- thetical” federal estate tax calculation, thus increasing the estate tax amount calculat- ed under that method (which would still be less than the calculation of the liability using the Vermont estate tax tables and would therefore be the amount of the Vermont es- tate tax due).
Uncertain Portability of Vermont Exemption for Married Couples Federal law currently provides that a de- cedent’s estate may apply the unused ex- emption of a predeceased spouse against the decedent’s estate tax liability, provid- ed that a timely federal estate tax return was filed for the predeceased spouse and a proper election was made on that return.8 This rule will lapse at the end of 2012 unless Congress acts to extend it. It is unclear at present whether Vermont law provides for “portability” of the $2,750,000 exemption9
.
Because federal exemption portability is not guaranteed beyond 2012, most estate planners continue to use traditional “by- pass” trust plans to maximize exemption utilization for married couples. These types of plans will be discussed below, in the con- text of the federal and Vermont tax consid-
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