Benjamin G. Porter
Porter, Kohli & LeMaster, P.S.
1301 Fifth Avenue, Suite 2600
Seattle, Washington 98101
The estates of people who died after May 16, 2005 became subject to a separate Washington state estate tax at graduated tax rates of between 14% and 19% on Washington taxable estates of more than $1.5 million ($2 million after January 1, 2006). The Washington estate tax is in addition to the federal estate tax, although the Washington tax qualifies as a deduction for federal tax purposes. After the deduction for federal estate tax purposes, the net overall increase in death taxes due to the new Washington estate tax is nearly 9% for large estates. Under prior law, the Washington estate was a dollar-for-dollar credit against the federal estate tax.
The Washington estate tax is a ?stand alone? estate tax which is unaffected by changes in the federal estate tax laws. For example the $2 million Washington exemption effective in 2006 will not change when the federal exemption increases to $3.5 million in 2009, when the federal estate tax goes away entirely in 2010, or when the federal estate tax returns in 2011 with a $1 million exemption.
The Washington estate tax incorporates the definition of ?gross estate? as that term is used in Section 2031 of the Internal Revenue Code (?IRC?) for federal estate tax purposes. The Washington tax does not tax gifts and other lifetime transfers, except to the extent that certain transfers are taxed as part of the federal gross estate. Lifetime transfers that are treated as part of the federal gross estate are transfers, which are incomplete or revocable prior to death (IRC §§ 2036 ?2045).
Washington residents with large estates should consider making outright gifts to family members. Those gifts will not be included in the Washington taxable estate, although the gifts will reduce the unified credit against federal gift and estate taxes. Gifts to charities will be exempt from both the Washington estate tax and federal gift and estate taxes.
The Washington estate tax is based on the value of a decedent?s property located in Washington. In the case of a Washington resident all property interests are deemed to be Washington property, except only interests in real estate and tangible personal property physically located outside Washington. A Washington resident?s interest in intangible property is deemed to be located in Washington and subject to the Washington estate tax. Examples of intangible property include stocks, bonds, interests in partnerships and limited liability companies, life insurance, annuities, bank accounts, business interests, and retirement plan and IRAs. A nonresident of Washington is subject to estate tax on only interests in real estate and tangible personal property physically located in Washington at the time of death. Intangible property of a Washington nonresident is treated as property located outside Washington.
Washington residents should be careful in choosing the form of entity used to hold title to out of state real estate and tangible personal property. If the out of state real estate is held as a tenant in common, tenant with right of survivorship, or outright, it will not be included in the person?s Washington state taxable estate.
Planning for out of state residents is just the reverse. Interests in Washington real estate and tangible personal property owned outright, as a tenant in common, or as a joint tenant with right of survivorship will be included in the person?s Washington taxable estate as Washington property. However, if the property is held by a partnership or limited liability company, the property interest will be intangible property, not subject to the Washington estate tax.
Proposed Washington Department of Revenue regulations suggest that a trust beneficiary?s interest in a trust holding Washington real estate will be treated as Washington property. The proposed regulations do not make a distinction between properties held in a revocable (living) trusts and an irrevocable trusts. It would seem that a grantor-beneficiary?s interest in a revocable trust will be disregarded and the grantor-beneficiary will be treated as directly owning the trust real estate, tangible, and intangible property outright and taxed according to grantor-beneficiary?s residence and the situs of the property.
The interest of a beneficiary of an irrevocable trust would appear to be separate from the nature or location of the assets held by the trust. The beneficiary?s interest should be treated as an intangible property interest subject to tax depending on the beneficiary?s residence.
The Washington estate tax exempts from Washington tax certain farm real estate, tangible personal property located on qualified farm real estate used primarily for farming purposes, and qualified woodlands. To be eligible for the farm and woodlands exemption the property has to pass to a family member who continues to use the property primarily for farming or woodlands purposes.
In determining the Washington taxable estate deductions are available for mortgages and other debts of the decedent, claims against the decedent?s estate, funeral expenses (one-half for a married decedent), estate administrative expenses, unpaid real estate and income taxes, transfers to charities and to a surviving spouse, and other deductions allowed in determining the federal taxable estate under IRC §§ 2051 ? 2056A. The net Washington taxable estate is then reduced by exemptions for qualified farm and woodland interests and the Washington exemption ($1.5 million for decedents dying in 2005, $2 million for decedents dying after 2005).
Where a decedent owned out-of-state assets, the gross estate shown on the federal estate tax return must be apportioned between properties located in Washington and the total of all property included in the decedent?s gross estate for federal estate tax purposes. The tax is apportioned by multiplying the Washington estate tax by a fraction, the numerator of which is the value of Washington property and the denominator of which is the value of the decedent?s entire gross estate for federal estate tax purposes. If the decedent owned qualified farm or woodlands interests, the value of those interests are subtracted from both the denominator and numerator of the apportionment fraction.
A common estate planning technique for married couples which allows the estate of the first spouse of a married U.S. citizens to escape both federal and Washington estate taxes is the use of a trust in which the spouse is the only lifetime beneficiary and has at least an income interest for life. The spouse may have greater rights, e.g., the right to principal of the trust for certain purposes. The personal representative of the deceased spouse may claim a marital deduction in an amount necessary to reduce the taxable estate to an amount that will not require the payment of death taxes by the first spouse?s estate. The election, which qualifies the amount of the property as ?qualified terminable interest property? (?QTIP?) eligible for the marital deduction for estate tax when the first spouse dies, is made on the Washington and federal estate tax returns. Any remaining QTIP property when the second spouse dies is subject to estate tax at that time.
Proposed Department of Revenue regulations permit a different QTIP election on the Washington estate tax return from the QTIP election made on the federal estate tax return. The ability to plan for different Washington and federal QTIP elections is important because the taxable estate of a decedent for federal and Washington estate tax purposes may be very different, depending on the location and nature of a decedent?s property, the size of the applicable state and federal exemptions, and the difference in treatment of outright taxable gifts.