Planning for Kansas Death Taxes in 2003: a Notice-able Difference
| Publication year | 2003 |
| Pages | 28-41 |
| Citation | Vol. 72 No. 10 Pg. 28-41 |
72 J. Kan. Bar Assn. 10, 28-41 (2003). Planning for Kansas Death Taxes in 2003: A Notice-Able Difference
72 J. Kan. Bar Assn. 10, 28-41 (2003)
The 2002 Kansas Legislature failed to pass legislation proposed by the Estate Tax Advisory Committee to the Kansas Judicial Council, which would have conformed the Kansas Estate Tax Act[1](the Act) with the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA). Instead, the 2002 Kansas Legislature enacted an ill-conceived "inheritance tax." The failure to conform the Kansas estate tax to current federal law affects decedents dying on or after January 1, 2002 (the effective date of the estate tax provisions under EGTRRA). The enactment of a new "inheritance tax" affected decedents dying on or after June 6, 2002.
In reaction to these developments, the Real Property, Probate and Trust Section of the KBA formed an "ad hoc" committee consisting of Martin Dickinson, Terry Fry, Nancy Roush, Tim O'Sullivan, and Jim Weisgerber (of the Kansas Department of Revenue (KDOR)) to formulate a death tax proposal for introduction in the 2003 Kansas legislative session. The resultant proposal, approved by the KBA and supported by the Kansas Society of Certified Public Accountants, consisted of a "stand alone" Kansas estate tax that would be revenue neutral, i.e., it would raise the same amount of estate tax as under the Act (approximately $40 million per year). Although the proposal totally "decoupled" the determination of Kansas estate taxes from federal law, it nonetheless incorporated most of the current federal estate tax concepts in determining the value of the gross estate and allowable deductions in arriving at the taxable estate. The proposal anticipated a filing threshold of approximately $700,000 (the filing threshold in 2002 under the Act), but left it to the Legislature to determine the specific filing threshold and marginal estate tax brackets. The proposal also called for the retroactive repeal of the newly enacted Kansas inheritance tax, which the committee concluded was poorly drafted; virtually unworkable; and, in large measure, unenforceable.[2]
Although the 2003 Kansas Legislature conceded that the Kansas inheritance tax should be repealed (retroactively under provisions of Senate Bill 94), it did not enact the stand-alone Kansas estate tax proposal (Senate Bill 148). This latter failure continued the problematic dichotomy in which EGTRRA determines the taxable estate and filing threshold for federal estate tax purposes, while its 1997 predecessor law determines the filing threshold, taxable estate, and state death tax credit for Kansas estate tax purposes.
This article addresses the substantive problems presented by this continuing federal and Kansas estate tax disharmony. Additionally, the authors discuss a recent KDOR notice promulgated after the close of the 2003 legislative session. That notice clarifies in favor of taxpayers most of the statutory ambiguities latent in this nonconformity. Finally, the authors outline strategies for reducing Kansas estate taxation and drafting strategies for married clients, which provide maximum flexibility in minimizing both federal and Kansas estate taxation in a shifting death tax environment.
II. Genesis and Nature of Nonconformity Problem
In 1998, the Kansas Legislature enacted legislation, proposed and supported by the KBA, repealing the Kansas Inheritance Tax Act (KITA). In its place was enacted the Kansas Estate Tax Act, (the Act) found at K.S.A. 79-15,100 et seq., discarding taxation based upon relationship to the decedent, but preserving from the KITA, a Kansas death tax equal to the amount of the state death tax credit permitted under Section 2011 of the Internal Revenue Code (the Code). The Act specifically provides that the state death tax credit is to be determined under provisions of the Code as of December 31, 1997, (prior federal law). The federal state death tax credit is limited both by the scheduled amount under Section 2011 (based upon the value of the "adjusted taxable estate" as defined therein) and the actual federal estate tax liability. As a result, states such as Kansas, which imposed a death tax equal to the amount of the state death tax credit, did not increase the total death tax liability of an estate. Amounts equal to the available credit simply were payable to the state, rather than to the federal government.
Congress intended this revenue sharing/death tax neutral aspect of the state death tax credit when it was enacted in 1924. Predictably, all states chose to impose an estate tax at least equal to the amount of the federal state death tax credit. This estate tax is often referred to as the "pick-up" tax due to states having picked up the amount of such credit as a base estate tax liability.[3]
The death tax neutral aspect of the pick-up tax ended for Kansas decedents dying after December 31, 2001. EGTRRA provides for estate tax applicable exclusion amounts for decedents dying on or after January 1, 2002, substantially in excess of those under prior federal law. However, because provisions of the Act require it to be interpreted under federal law as in effect December 31, 1997, the lower applicable exclusion amounts under such prior federal law remain applicable in determining Kansas estate taxes under the Act. In drafting the Act, the Kansas Revisor of Statutes office did not "float" the amount of the pick-up tax with any subsequent change under federal law. The revisor no doubt concluded that the float alternative would violate the Kansas Constitution by impermissibly delegating Kansas legislative authority to the federal government.[4]
EGTRRA provides for a $1 million applicable exclusion amount for decedents dying on or after January 1, 2002, with further scheduled increases to $1.5 million for decedents dying in 2004 and 2005, $2 million for decedents dying in 2006 through 2008, and $3.5 million for decedents dying in 2009. There would be a one-year repeal for decedents dying in 2010 and a reversion to prior federal law for decedents dying in all subsequent years (i.e., a $1 million applicable exclusion amount). Thus, until 2011 when the applicable exclusion amounts under prior federal law and EGTRRA are scheduled to be identical, taxable estates in excess of the applicable exclusion amount under prior federal law ($700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in 2005, and $1 million in 2006 and subsequent years) will nonetheless remain liable for the pick-up tax assessed under the Act, irrespective of whether there is sufficient federal estate tax liability under EGTRRA against which the pick-up tax may be credited.
The position of the KDOR is consistent with this analysis. On June 27, 2002, the KDOR issued Notice 02-01.5 The notice states that "under current law, the Kansas estate tax will not be affected by the recent changes to federal law."6 Therefore, assuming no prior taxable gifts, a $1 million taxable estate of a decedent dying in 2002 or 2003 would have no federal estate tax liability. However, it would be liable for the Kansas pick-up tax in the amount of $33,200.7 This represents an approximate 11 percent Kansas pick-up tax rate on the $300,000 difference between the $700,000 applicable exclusion amount under prior federal law and the $1 million applicable exclusion amount under EGTRRA. The amount of pick-up tax caused by the Act's nonconformity with current federal law increases dramatically in subsequent years due to the increasing disparity between the scheduled federal applicable exclusion amount increases under EGTRRA and those under prior federal law. For example, the $64,400 pick-up tax liability for a decedent dying in 2004 is almost double that of a decedent dying in 2003 and an approximate 10 percent Kansas pick-up tax rate on the difference between the $1.5 million EGTRRA applicable exclusion amount and the $850,000 applicable exclusion amount under prior federal law.
In addition to lower applicable exclusion amounts, determining the pick-up tax under prior federal law creates other problems and inequities. First, the state death tax credit is predicated both upon the amount of the "adjusted taxable estate" (which in turn determines the available state death tax credit) and the actual federal estate tax liability (which "caps" the amount of such credit). Consequently, practitioners and the KDOR must apply tax principles under prior federal law irrespective of whether those principles have been modified or rendered moot through subsequent federal legislative or regulatory action.
Second, it creates the issue of whether such tax elections as the Qualified Terminable Interest Property (QTIP) and special use valuation elections can be made under the Act in circumstances where no federal estate tax return is filed or where an inconsistent election is made on the federal return in circumstances where both federal and state returns are filed.
Third, it creates a patent inequity in marginal Kansas estate tax brackets. The state death tax credit was enacted when the federal estate tax exemption was $60,000. Consequently, the "adjusted taxable estate" is defined as the taxable estate (net amount prior to tax of a decedent's estate for federal estate tax purposes, exclusive of prior "adjusted taxable gifts"), less $60,000 (the threshold at which estate tax was then imposed). As a result, the amount of the available state death tax credit at the threshold of the applicable exclusion amount of $700,000 in 2002 and 2003 under prior federal law is quite sizable ($18,000 based upon an adjusted taxable estate of $640,000). For adjusted taxable estates in excess of $640,000, the state death tax credit commences at a low bracket of 4.8...
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