State Estate Tax: Repeal of Virginia Estate Tax Highlights Importance of State Estate Tax in Estate Planning

Beginning on July 1, 2007, the repeal of Virginia’s state-level estate tax will become effective. Thus, like Florida and California, among other states, Virginia soon will have no state estate tax. In Virginia, however, the tax could be reinstated in the future by a new act of the legislature, whereas in Florida or California, reinstatement would require an amendment to the state constitution.

The Virginia repeal places in high relief the importance of taking the state-level estate tax into account in estate planning. For some clients, it may make sense to move to a state that does not impose a state estate tax.

Prior to the repeal, the Code of Virginia  (Section 58.1-900 et seq.) imposed an estate tax on a decedent's assets over $2,000,000. This means, for example, that the $5,000,000 net estate of a Virginia resident who died in 2006 will pay $352,158 in Virginia estate tax, which will be deductible on the federal estate tax return, reducing the federal estate tax by $161,993. Total federal and Virginia estate taxes will amount to $1,570,165.

If, however, that same resident dies after June 30, 2007, because of the repeal, no Virginia estate tax will be due. The estate will owe $1,380,000 of federal estate tax, with no deduction available for Virginia estate tax. In other words, the federal estate tax will be $161,993 more than if the decedent had died before June 30, 2007, but the estate will have paid no Virginia estate tax, so the only tax paid will be the $1,380,000 federal tax. The estate will have a total tax saving of $190,165.

The savings are greater for the larger estates; the estate of a Virginia resident who dies after June 30, 2007, with a $10,000,000 estate will pay federal estate tax of $3,680,000, but will save $500,538 in total estate tax due to the repeal of the Virginia estate tax.

The estate tax burden of a Virginia resident compares with those of residents of other jurisdictions that still have a state-level estate (or inheritance) tax as follows:

Maryland, the District of Columbia and New York impose a state-level estate tax on estates over $1,000,000, while New Jersey imposes its estate tax on estates over $675,000. A $5,000,000 net estate would pay $391,600 in D.C., Maryland, New York or New Jersey estate tax and $1,199,864 in federal estate tax, for a total estate tax of $1,591,464. This takes into account the federal deduction for District of Columbia, Maryland, New York or New Jersey estate taxes paid. In the case of a $10,000,000 D.C., Maryland, New York or New Jersey net estate, the total estate taxes paid would be $4,256,504.

Pennsylvania no longer imposes an estate tax but still has an inheritance tax. Unlike an estate tax, which is calculated on the value of the total estate assets, less allowable deductions, inheritance tax is calculated on the value of the assets each beneficiary receives, using a percentage that is based on the relationship of the beneficiary to the decedent. The tax rate for a spouse who receives assets is zero, but the rate for children and grandchildren (among others) is 4.5%.

Accordingly, a $5,000,000 Pennsylvania estate whose assets are distributable to the decedent's children or grandchildren would pay $225,000  in state inheritance tax and $1,276,500 in federal estate tax, for a total tax of $1,501,500. This takes into account the federal deduction for Pennsylvania inheritance tax paid. In the case of a $10,000,000 estate, the total taxes paid would be $3,923,000.

Thus, after repeal of the Virginia estate tax takes effect on July 1, 2007, a $5,000,000 Virginia net estate will pay $211,464 less total estate tax than would estates of the same size in the District of Columbia, Maryland, New York or New Jersey, and $121,500 less total tax than in Pennsylvania. A $10,000,000 Virginia net estate would pay $576,504 less total estate tax than estates of the same size in D.C., Maryland, New York or New Jersey, and $243,000 less total taxes than in Pennsylvania.

All of the above examples assume that the decedent had his or her entire federal unified credit available and that he or she owned no real estate or tangible personal property in a jurisdiction other than his or her state of residence. The estate of a decedent who had used all or part of the federal estate tax unified credit to offset tax due on lifetime gifts would owe more federal estate tax than shown in the above examples. Similarly, the estate of a Virginia decedent with real estate or tangible personal property located in another jurisdiction might owe estate taxes on those assets to the state or states where such property was located, even though Virginia would impose no estate tax on the rest of the estate assets.

While moving to avoid a state-level estate tax may seem to be a drastic measure, considering the numbers above, in some cases it could make financial sense.