November 2003

For further information on Corporate Matters, contact David R. White. For more information about other services our firm provides, please call us at 215-893-9300 or email us at lawyers@finemanlawfirm.com.

Recent changes to the Estate tax section of the Internal Revenue Code have prompted a number of states, including Pennsylvania and New Jersey, to make some tax changes of their own.  The changes are in response to the phase out of the State Death Tax Credit to the Federal Estate tax.  The 2001 Federal tax legislation, known as the Economic Growth and Tax Reconciliation Act of 2001, reduced the credit for state death taxes which were part of the calculation of Federal Estate Tax.  Prior to 2001, many states had imposed a tax on death equal to the amount of the credit the Internal Revenue Code allowed an estate to take against Federal Estate tax, which was commonly referred to as a “Pick-Up Tax”.  The credit was determined by a schedule set forth in a section of the Internal Revenue Code and had the effect of dividing the gross Federal Estate tax between the individual state in which the decedent resided and the Department of Treasury.  The 2001 tax legislation phased out the State Death Tax Credit gradually from 2001 to 2005.

This change in the law has had a domino effect in many states.  Some of those states, including Pennsylvania and New Jersey, stood to lose substantial revenue because their state’s death tax was linked to the Federal Estate tax calculation that was being phased out by the new law.

Pennsylvania and New Jersey, as well as a number of other states, have now enacted their own legislation to retain the death tax they would have otherwise lost.  Unfortunately, for many married couples this may have the effect of imposing a state death tax after the first spouse’s death where none was anticipated.

Prior to 2001, because the Pick-Up Tax was only imposed on estates that had to pay Federal Estate Tax, estates below a certain threshold did not have to worry about such a tax.  The threshold was the amount of the Federal Estate Tax exemption.  That is no longer the case.

The Federal Estate Tax exemption is currently $1,000,000, and increases to $1,500,000 on January 1, 2004, and to $3,500,000 by January 1, 2009.  However New Jersey’s estate tax exemption is only $675,000 and Pennsylvania’s is $700,000 increasing to $1,000,000 by 2006.  The practical effect of the difference between Pennsylvania’s and New Jersey’s exemption and the Federal exemption is that certain estates will now be subject to a Pick-Up Tax despite the fact that the estate is exempt from Federal Estate Tax.

If your estate plan directs your executor to fund the credit shelter trust to the fullest extent of the available Federal exemption, and the size of both the taxable estate and the Federal exemption exceed the amount of the state exemption, then the estate could pay a substantial Pick-Up Tax.  The amount of such a tax is reflected in the far right column of the table set forth below.  As you can see, the amount of the Pick-Up Tax increases dramatically as the Federal Estate Tax exemption increases.

The Pick-Up Tax may be able to be deferred or avoided altogether in some cases.  To do so it will be necessary to recreate certain estate plans so that the surviving spouse may have the flexibility needed to make decisions based upon the facts that exist on the date of death to have the flexibility to mitigate or avoid such a tax altogether.  Please give us a call to review and update your estate plan based on these recent changes.