Effective January 1, 2016, the Tennessee inheritance tax has been repealed, based on a law that was enacted in 2012.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.