Oregon’s New (Stealth) Tax: The State Inheritance Tax

Oregon’s New (Stealth) Tax: The State Inheritance Tax

By Jeffrey G. Moore

Mention that the Oregon legislature intends to increase state income taxes and you’re likely to not only see the news splashed across the front pages, but some folks readying to storm the castle. There is a new tax, however, that seems to have flown in under the radar: The new Oregon State Inheritance Tax.

Most people are aware that upon a person’s death, the federal government currently taxes the amount of a decedent’s estate that exceeds $1 million. The marginal tax rate ranges from 37% to 49% of that excess amount. What most people are not aware of is that Oregon now has a similar tax of its own.

Prior to 2002, the feds essentially “gave” the states a portion of the federal estate tax collected via a state death tax credit. As of 2002, and as a result of the federal Tax Act passed in 2001, the feds substantially increased the federal exemption amount from $675,000 to $1 million for 2003. The federal exemption amount increases again to $1.5 million in 2004; $2 million in 2006; $3.5 million in 2009; and possibly—but unlikely—a full repeal in 2010. With the decreasing federal revenues over time, Congress softened the pinch on the federal coffers by decreasing the amount of the estate taxes “given” to the states.

Because most states simply took what estate taxes the feds allocated to them, the decrease in the states’ tax allocation created quite a stir. With trying economic times and strapped state budgets, many states reacted, including Oregon. A few months ago, the Oregon legislature passed the new State Inheritance Tax under House Bill 3072 without much ado.

In short, this new Oregon Inheritance Tax taxes the amount of a decedent’s Oregon-based estate exceeding $700,000. Note that this Oregon tax is wholly independent of the federal estate tax. In 2004, the state exemption increases to $850,000; $950,000 in 2005; and then permanently caps at $1 million in 2006 and the years following. The marginal tax rate ranges from 4.8% to 16% for amounts over $700,000 (2003).

In addition to the tax itself, another problem is that existing estate plans were drafted when there was no separate State Inheritance Tax. Estate plans for married couples typically directed that the federal exemption amount be placed in a Bypass or credit-shelter type trust for the surviving spouse. Unless these plans are amended, an unwanted State Inheritance Tax can result at the first death. For example, a $1 million estate of a person who dies in 2003 will NOT incur any federal estate tax, but WILL incur $33,200 of Oregon taxes as a result of the death.

A related issue is the increasing federal exclusion. Estate plans that call for an automatic Bypass trust that is to be funded with the federal exemption amount will have an increasing Bypass trust. For example, under such a plan, if an estate is valued at $3 million and a spouse dies, one-third will go to the Bypass trust in 2003, two-thirds in 2006, and the entire decedent spouse’s estate in 2009. Thus, in some estates a Bypass trust may not actually be needed for federal estate tax purposes because of the increasing federal exemption. Any assets in a Bypass trust upon the surviving spouse’s death do not receive a stepped-up basis.

With the new State Inheritance Tax and the increasing federal exemption, estate plans should be reviewed to address these issues. In many cases it may be appropriate to amend the plan to provide flexibility by postponing the decision of the amount to fund a Bypass trust until the first death. We have developed several types of Amendments for existing estate plans to address the State Inheritance Tax issue, as well as the increasing federal exemption, so that clients can, if they wish, avoid automatically triggering any State Inheritance Tax. Oregon may also allow amendments that preserve both the federal and state exemptions so that the surviving spouse can defer paying federal estate tax until their own death.

We recommend that clients review their plans to determine what changes, if any, are appropriate in light of the new laws.