Tennessee eliminated its “death tax” in 2016.  This is great news for Tennessee residents.  However, if you own property such as a vacation home in another state, you may owe “death taxes” in that estate when you die.  The following 18 states still impose a death tax:

Connecticut
Delaware
District of Columbia
Hawaii
Illinois
Iowa
Kentucky
Maine
Maryland
Massachusetts
Minnesota
Nebraska
New Jersey
New York
Oregon
Pennsylvania
Rhode Island
Vermont
Washington

If you own property in one of these states, proper planning may reduce or eliminate the potential death tax.  You can also avoid the need to probate your Will in that state by transferring your property to a revocable trust or a business entity such as an LLC.

A number of our clients have already changed their residency to a state with no income taxes – most often Florida, or have been considering making such a change.  They have moved to avoid paying the Tennessee Hall Income Tax which applies to dividends and certain interest.

If you have already moved, you can start making plans to move back in the year 2021.  The Tennessee legislature has just passed the Improve Act, which will permanently eliminate the Hall Income Tax in the year 2021.  The rate will also ratchet down by 1% per year every year between now and 2021.  The rate will be 4% in 2017, 3% in 2018, 2% in 2019, and 1% in 2020.

Unlike prior legislation which made these gradual decreases discretionary, these rate changes will not require any further action from the legislature.

Effective January 1, 2016, the Tennessee inheritance tax has been repealed, based on a law that was enacted in 2012.  The repeal does not help individuals who died in 2015.  They are still subject to the tax.  It only helps families of decedents who die this year or later. 

What is the effect of the repeal?  First of all, the maximum estate tax rate for decedents who are above the federal estate tax exemption (currently $5,450,000) will only be 40%, rather than approximately 46%.  Even though this represents a significant reduction, I see little impact on whether you implement strategies to avoid federal estate taxes.  40% is still a steep rate and most of our clients want to take reasonable measures to minimize or eliminate the federal estate tax. 

The repeal will affect the design of documents prepared for our married clients.  For many years, our documents have created two credit shelter trusts, a typical credit shelter trust (often referred to as a “Family Trust”) for the amount of the Tennessee inheritance tax exemption, and a second trust (sometimes referred to as a “Tennessee QTIP Trust” or a “Tennessee GAP Trust”) equal to the difference between the federal estate tax exemption and the Tennessee inheritance tax exemption.  In 2015, this formula resulted in $5,000,000 going to the Family Trust and $430,000 going to the Tennessee QTIP Trust.  Fortunately, we can now place the entire federal estate tax exemption, currently $5,450,000, in the Family Trust and will not need a Tennessee QTIP Trust.

Do you need to modify your current documents that contain Tennessee QTIP Trust provisions?  In most cases, the answer is no.  The funding language for the Tennessee QTIP Trust will not apply since there is no Tennessee inheritance tax.  Feel free to modify your documents if it bothers you to have unnecessary language in your Will; however, my advice is to wait until you need to make a change for other reasons. 

A few surviving spouses have asked us whether they can eliminate a Tennessee QTIP Trust that was established by a spouse who died prior to 2016.  Unfortunately, it is not possible to merge the Tennessee QTIP Trust into the Family Trust.  The Tennessee QTIP Trust will still avoid federal estate taxes upon the surviving spouse’s death.  Thus, as a general rule, my advice is to maintain the Tennessee QTIP Trust.  If the surviving spouse’s estate has declined below the federal estate tax exemption, then it might be acceptable to liquidate the Tennessee QTIP Trust in whole or in part. 

The repeal of the Tennessee inheritance tax is a welcome change.  Most individuals do not need to make any adjustments to their estate planning documents or planning in light of this change.

Two of my clients have already contacted me about the renewal form sent to them by the Tennessee Department of Revenue regarding the exemption of their LLC from Tennessee franchise and excise tax.  If your LLC (or limited partnership) is exempt from Tennessee franchise and excise tax, it is very important to fill out this form each year.  You do not have to pay anything to renew the exemption. 

The most common exemption is obligated member entity (“OME”).  The OME exemption applies when the members waive liability protection.  If you are relying on this exemption, check the obligated member entity box and all the boxes on Schedule F.  Additionally, if any new members have been admitted, they must sign an Amendment to the Articles of Organization that waives liability protection and file it with the Tennessee Secretary of State. 

The two most common other exemptions for our clients are the family owned non-corporate entity (“FONCE”) and the farming/personal residence exemptions.  My recommendation is to allow your CPA who prepares the tax return for the LLC to complete the form, if you are relying on either of these exemptions.  There is information from the LLC’s federal income tax return (Form 1065) that will be needed. 

Not all LLCs are exempt from franchise and excise taxes.  Generally, these LLCs operate a business or own commercial real estate.  Even though not exempt, the earnings from an LLC operating a business may not be subject to tax if they are treated as self-employment income by the owners of the LLC for federal income tax purposes.  No application for exemption is filed to claim this benefit.

In summary, you can avoid an unpleasant tax bill for your LLC if you or your CPA annually renews the exemption of your LLC from Tennessee franchise and excise taxes.

Prior to this year, all Tennessee trusts were required to file annual Tennessee income tax returns. This includes garden variety revocable trusts as well as irrevocable grantor trusts that use the grantor’s social security number as their EIN.

Fortunately, the Tennessee legislature decided to solve this problem. Public Chapter 480 now allows grantor trusts to avoid filing a Tennessee income tax return. Instead of filing a return, the trustee must report the trust income to the grantor so that the grantor may include it on the grantor’s personal Tennessee income tax return. In order to take advantage of this simplified filing procedure, you must use the grantor’s social security number as the EIN for the trust. The Internal Revenue Service regulations allow revocable and irrevocable grantor trusts to use the grantor’s social security number as their EIN if certain procedures are followed. We routinely recommend this approach, because it avoids the need to file a federal income tax return for the trust. Now, it will also avoid the need to file a Tennessee income tax return.

Even though the IRS regulations have allowed irrevocable grantor trusts to use the grantor’s social security number as their EIN for approximately 15 years, there are numerous financial institutions that will attempt to make you obtain a separate EIN for any irrevocable trust, whether or not it is a grantor trust. I occasionally have to show the IRS regulations to these financial institutions, and I have to overcome some very strong misinformation that has been in the marketplace. If you encounter a financial institution that refuses to open an account without a separate EIN for the trust, let them know that several of their competitors permit what is allowed by the IRS regulations.

In a surprising move, the Tennessee legislature has repealed Tennessee gift taxes, effective for gifts made on or after January 1, 2012. This is welcome news for a lot of our clients who plan to make a $5.12 million gift later this year. Our clients have been considering various ways to make their gifts without paying Tennessee gift tax. They will no longer have to worry about the gift tax.

Some of our clients knew that a change in the gift tax might occur later this year and have made large loans to their children. These clients will now consider forgiving the loans or giving other assets to their children.

Tennessee’s repeal of its gift tax leaves Connecticut as the only state that charges gift taxes.

The fiscal note for this bill estimated that it will cost the state approximately $15 million per year in revenue. I am sure that the revenue loss for 2012 will be a significantly higher amount due to the window of opportunity for making tax-free gifts at the federal level.

The Tennessee legislature repealed Tennessee’s inheritance tax, effective as of January 1, 2016. This means that if you can survive until 2016, you will not owe any Tennessee inheritance taxes. If you die before that date, you will owe taxes if your taxable estate exceeds the following exemption levels:

 

2012

$1,000,000

2013

$1,250,000

2014

$2,000,000

2015

$5,000,000

Since the tax still applies until 2016, Wills of married persons should still establish Tennessee QTIP Trusts. This will avoid tax at the first death. As long as the surviving spouse survives at least until 2016, the Tennessee inheritance tax will be permanently eliminated.

There are a lot of existing Tennessee QTIP Trusts (sometimes referred to as Tennessee Gap Trusts) for married individuals who died over the last few years or chose to make a gift to such a trust. These trusts are irrevocable and cannot be modified to add the children as beneficiaries or to change the income payout requirements for the spouse. Depending on the terms of the trust, it may be possible to distribute corpus of the trust to the spouse. Unfortunately, due to the instability of the federal estate tax laws, it would be imprudent to distribute assets from a TN QTIP trust to the spouse. As of January 1, 2013, the federal estate tax exemption is scheduled to be only $1 million. Distributing assets from the Tennessee QTIP Trust might increase federal estate taxes payable by the spouse’s estate.

The elimination of the Tennessee inheritance tax will eventually simplify estate planning for our clients. However, for the next four years, we must pay attention to this tax.

The potential repeal of Tennessee’s inheritance tax has once again drawn national attention. Last week, the Wall Street Journal published an article and a letter to the editor regarding this matter. This week, the Institute on Taxation and Economic Policy has published a scathing rebuttal of an analysis done by Arthur Laffer and Wayne Winegarden.

In stark contrast to the Laffer article, the ITEP article concludes that repealing the inheritance tax will not significantly increase jobs in Tennessee. I sincerely doubt that Governor Haslam and the legislature believe that repealing the inheritance tax will create 220,000 new jobs. Rather, they perceive the tax to be unfair and realize that some of our wealthiest citizens have left Tennessee to avoid the tax.

Over the last several years, several of our clients have changed their residences to Florida to avoid certain Tennessee taxes, including our inheritance taxes. Migration to avoid state inheritance taxes has also been occurring in other states.

Last week, the Wall Street Journal published an article about various states, including Tennessee, that are considering a repeal of their death taxes. The article states that “the main obstacle to reform in Nashville is GOP Governor Bill Haslam…”

Governor Haslam responded to the Wall Street Journal by writing a letter to the editor. In his letter, the governor points out that he has recommended repealing the taxes in the next three years and that he has worked with House Finance Committee Chairman Charles Sargent to completely repeal the taxes in four years. Indeed, the House Finance Subcommittee has recommended an amendment to House Bill No. 3760 that would increase the inheritance tax exemption to $1,250,000 in the year 2013, $2 million in the year 2014, $5 million in the year 2015, and would totally repeal Tennessee inheritance taxes beginning in the year 2016. I find it interesting that our state legislature has taken some lessons from recent federal tax cuts. If we can’t afford a tax cut now, phase it in so that the impact will be postponed to future years when revenue collections will hopefully be better. The danger with a phase-in approach is that it is easier for future legislatures to “change their mind.”

Normally, I would be skeptical that a bill with a large tax cut would survive the final budget cut. However, the governor’s unusual public support for the cut gives me reason to hope that this change will be made.

Tax Foundation has published a map showing the top income tax rates in all 50 states. There are seven states that have no income taxes at all: Alaska, Washington, Nevada, Wyoming, South Dakota, Texas, and Florida. Tennessee and New Hampshire only tax dividends and interest. Except for Iowa, the high tax states are on the coasts.