Helsell Fetterman

Washington State Amends State Estate Taxes

by Laura Hoexter

Just before midnight last Thursday, June 13, 2013, the Washington State Legislature approved a new law that changed the Washington state estate tax in four major ways. While the fourth change discussed below, has received the bulk of the media’s attention, it only affects a handful of taxpayers. However, the first three changes, which are less public, affect a large number of Washington residents. This newsletter will briefly discuss all four changes.

1. Change to the Applicable Exclusion Amount: Currently, estates of Washington decedents with less than $2 million worth of assets are not subject to Washington state estate tax.  The $2 million limit is known as the Applicable Exclusion Amount.  Starting January 1, 2014, the $2 million Applicable Exclusion Amount will be indexed against the consumer price index for the Seattle-Tacoma-Bremerton metropolitan area as calculated by the US Bureau of Labor Statistics.  Therefore, next year, the Applicable Exclusion Amount can be expected to begin to increase with inflation, potentially exposing fewer estates to Washington’s estate tax.
2. Change to the Tax Rates: Currently, any amounts in a Washington decedent’s estate in excess of $2 million are subject to Washington state estate tax at rates ranging from 10% to 19%. Effective January 1, 2014, the upper bracket will be increased from 19% to 20%.
3. Change to the Deductions:Currently, other than out-of-state real estate, all assets in a Washington decedent’s estate are part of his Washington taxable estate.  Effective January 1, 2014, a deduction up to $2,500,000 is allowed for the value of a decedent’s Qualifying Family Owned Business Interest (QFOBI). This deduction is only available if (1) the qualified family-owned business interest exceeds fifty percent of the decedent’s Washington estate (before applying the Applicable Exclusion Amount), (2) during five of the eight years preceding his death, the decedent or his family owned and operated (or materially participated in) the business, (3) the decedent is passing his interest to a qualified heir, (4) the decedent was a US citizen or resident, and (5) the value of the decedent’s interest in the business is less than $6 million.If the estate meets the criteria above, it can claim the deduction.  However, the qualified heir receiving the business interest is not out of the woods.  For three years following the decedent’s death, the qualified heir (1) must materially participate or operate the business, (2) cannot transfer the interest to another party who is not a qualified heir or another owner, (3) must retain US citizenship, and (4) cannot move the business out of the United States.  If the qualified heir fails to meet any of the foregoing requirements during the three year period, the qualified heir must pay a tax equal to the tax savings that was given to the estate.
4.  Change of Language to Specifically Subject Pre-2005 QTIP Trusts to the Tax:  The fourth change is the most complicated.  To truly understand this change, you need look back to the 1980s, when the IRS gave decedents a 100% credit against federal estate tax for any amounts of estate tax paid to the state.  In 1984, Jim Bracken died, leaving more than $4M.  To avoid federal tax, his estate created a Qualified Terminal Interest Trust (QTIP Trust) to provide his wife, Sharon, with income for her lifetime.  Following her death, the remaining trust estate would be distributed to Jim’s heirs.  In 2006, Sharon Bracken died.  By then, a significant change had been made to the federal tax (the IRS no longer gave taxpayers a credit to offset taxes paid to a state) and to the state tax (one year prior to Sharon’s death, Washington State had created its own stand-alone estate tax system).When Sharon died, her estate paid its share of the federal and state estate taxes. The QTIP Trust holding Jim’s assets paid its share of tax to the IRS and distributed the balance to Jim’s heirs. Washington State claimed that the QTIP Trust was subject to state estate tax.The Bracken Estate took the case to the Washington Supreme Court.  They argued that the estate taxes only apply to transfersof assets.  When the trust was established, Jim’s estate transferred assets to the QTIP and the federal government agreed to defer taxes until Sharon’s death.  However, there was no state estate tax at the time to pay or defer.  The Bracken Estate argued that in 2006, when the trust terminated, no transfer occurred and therefore, the state had no right to tax the trust.The justices ruled 9-0 in favor of the Bracken Estate. A timeline was set for Washington to begin refunding taxpayers.  The first $13 million was required to be funded to 10 estates before a 9am hearing on Friday, June 14th, if the law was not changed.

   Realizing that the state would lose $160 million over the next two years (in the form of refunds and lost revenue), the state legislature quickly characterized the application of the state estate tax only to transfers as a “glitch,” and proposed new legislation to ensure that the tax applies to all such trusts.

   This new law states that all QTIP trusts, whether established prior to or after 2005, are subject to Washington State estate tax upon termination.  Some state congressmen have expressed concern about the retroactivity of the law, the uncertain constitutionality of a retroactive tax, and the disregard for the State Supreme Court’s decision.

   For now, the state no longer needs to send refunds.  However, not all taxpayers are happy with the decision and further challenges to this legislation are expected.

At Helsell Fetterman, we strive to keep you informed of changes in the estate and tax laws that may affect you. If you have any questions, please don’t hesitate to contact any member of our estate planning team.