A group known as Tennesseans Against Death Taxes is lobbying the Tennessee government to repeal Tennessee gift and inheritance taxes. Tennessee is one of only two states that charge gift taxes. Our state gift tax roadblocks a lot of good estate planning that could otherwise be done, with the result that families pay significantly more federal estate taxes. A number of our clients have moved to Florida to avoid these taxes and the Tennessee Hall income tax.

If you would like the Tennessee gift and inheritance taxes to be repealed, you should consider contacting your representatives in the near future. Enclosed are a sample letter in Word and PDF, a list of Senate and House contacts, and an economic study prepared by Art Laffer, a former economic advisor to President Reagan.

Bloomberg has published an article which concludes that Tennessee has the third lowest taxes of any state in the country. It is somewhat surprising to me that the two states that are ahead of Tennessee both have a state income tax. Mississippi has a 5% income tax, and South Carolina has a 7% income tax.

A lot of my clients feel like they are heavily taxed by Tennessee due to the Hall income tax on dividends and interest as well as gift or inheritance taxes upon transfers of wealth to younger generations. Several of our clients have moved to Florida to avoid the Hall tax, the gift tax, and the inheritance tax. It is somewhat ironic that Florida is not ranked in the best 5 states due to its heavy property taxes.

As usual, there are numerous bills before the Legislature to reduce or eliminate the Hall tax and gift and inheritiance taxes.  Lets hope that some of these bills are enacted so that we can take over the #1 ranking.

As April 15th draws near, a lot of us are thinking about income taxes. The Tax Foundation has concluded that the average American had to work from January 1st to April 12th to pay federal and state income taxes that will be owed in 2011.

The average Tennessean reached tax freedom day on March 27th, 2011. Only Mississippi reached tax freedom day before Tennessee. I am somewhat surprised that Mississippi beat us since Mississippi has a state income tax that applies to all types of income. Tennessee’s income tax only applies to dividends and interest. Our favorable income tax laws have been an important factor for a lot of high income individuals who have migrated to Tennessee.  

People who die in 2010 do not have to pay federal estate taxes (unless Congress enacts a retroactive change in the law). However, most people have assumed that there would be federal estate taxes at the time of their death. Based on this assumption, numerous Wills have formulas that are based on the federal estate tax system. In many cases, these formulas are either difficult or impossible to interpret in the current environment. These broken formulas will lead to distorted estate plans and needless litigation.

The Tennessee legislature has taken a bold move to revise wills of people dying in 2010 which contain references to the federal estate tax system. On Monday, March 1, 2010, the House approved SB 3045, which had previously been approved by the Senate. Assuming the bill is signed by the Governor, all references to the federal estate and generation-skipping transfer tax laws will be interpreted as they applied with respect to estates of decedents dying on December 31, 2009.

In order for the new law to apply, the Will must:

  1. contain a formula referring to the "unified credit," "estate tax exemption," "applicable exemption  amount," "applicable credit amount," " applicable exclusion amount," "generation-skipping transfer tax exemption," "GST exemption," "marital deduction," " maximum marital deduction," or " unlimited marital deduction."
  2. measure a share of an estate or trust, based on the amount that can pass free of federal estate taxes or the amount that can pass free of federal generation-skipping transfer taxes; or.
  3. is otherwise based on a similar provision of federal estate tax or generation-skipping transfer tax law.

The new law will apply to decedents who die after December 31, 2009, but before January 1, 2011. The new law will also apply to formulas contained in revocable trusts.

The new law will not apply if:

  1. federal estate taxes are reinstated retroactive to January 1, 2010;
  2. the Will or trust is executed or amended after December 31, 2009;
  3. the Will or trust manifests an intent that a contrary rule will apply if the decedent dies on a date on which there is no then-applicable federal estate or generation-skipping transfer tax;
  4. the Executor, or Trustee of a revocable trust, and all beneficiaries who would be affected by the new law, opt for the new law not to apply within nine months of the decedent’s death; or
  5. the Executor, or any affected beneficiary, files a court proceeding within 12 months following the decedent’s death, and convinces the court that the decedent intended for the formula to be construed based upon the law as it existed after December 31, 2009.

The great majority of wills that I have drafted over the last several years will actually work better without the new law. In order to get the full benefit allowed by the absence of federal estate taxes, the family will be forced to opt out of the new Tennessee law. There is always a danger that one or more family members will withhold their consent as a bargaining chip or because they are disappointed with the Will.

I knew several of my clients had a problem. I have been busy preparing codicils and amendments to revocable trusts to correct these problems. Though I hope to identify and fix all of the problem documents, it is certainly possible that one of my clients could die before fixing the problem and I will be glad that the new law was passed.

The new law will help numerous individuals who were unable to make changes or chose not to amend their documents. However, in some cases, the new law will be harmful and will force families to sign a unanimous agreement or file a court proceeding. In all cases, it is better to make sure that your documents clearly state your wishes without having to rely on the new law, or a lawsuit, or a document to be signed by your family after you die.

A total of 19 states and the District of Columbia assess estate and/or inheritance taxes. The enclosed map shows that virtually all of the states in the Northeastern sector of the country impose taxes.

Tennessee is the only southern state with death taxes. Even if you consider consider Kentucky a southern state, Kentucky’s tax is insignificant because it does not apply to transfers to immediate family members.

Tennessee exempts the first $1 million from taxation. For estates in excess of $1 million, the tax equals $30,200 on the first $440,000 (above $1 million) and 9.5% on the excess. The tax does not apply to amounts distributed to spouses or charities.

Several of my clients have moved to other states, primarily Florida, in order to avoid Tennessee inheritance taxes. Each year, bills are submitted to the legislature to repeal the Tennessee inheritance tax. These bills have no chance of passage because they would decrease tax revenue.

A lot of my clients recently received a Franchise and Excise Tax Annual Exemption Renewal Form from the Tennessee Department of Revenue. This form applies to Limited Liability Companies and Limited Partnerships that claim an exemption from Tennessee Franchise and Excise Taxes.

The three most common exemptions that apply to my clients are the obligated member entity (“OME”) exemption, the family-owned non-corporate entity (“FONCE”) exemption, and the farm exemption. If your company qualifies for one of these exemptions, you need to fill out the renewal form with the help of your CPA and send it to the Department of Revenue no later than April 15, 2010. If your company qualifies for an exemption and you have not received the form, you can get the form at http://tennessee.gov/revenue/forms/fae/fae183.pdf, or you can call the Department of Revenue at (615) 253-0600.

If you do not file the form by April 15, 2010, you will lose your exemption for 2009. The Department has the discretion to allow a late filing. If they allow a late filing, they will charge you a $1,000 penalty.

The father of one of my clients is considering a move to Nashville in order to be closer to his daughter and grandchildren. He called me regarding the state tax consequences of moving to Tennessee.

The good news is that his income taxes will decrease slightly because Tennessee will not tax his IRA distributions. He will pay the Hall income tax on his dividends and interest, but he is already paying taxes on that income in the state where he currently lives.

The bad news is that Tennessee inheritance tax will apply to his estate when he dies. He currently lives in one of the many states that does not have a state inheritance tax. Based on his estate of $3.5 million, his Tennessee inheritance tax bill will be approximately $225,000.

Inheritance taxes would be much higher if his estate has to pay inheritance tax on the $6 million marital trust that his wife established upon her death. The marital trust will be taxable for federal estate tax purposes. However, Tennessee does not tax marital trusts that were established by residents of other states. Since the Tennessee inheritance tax rate is 9.5%, not having to pay Tennessee tax on the marital trust will reduce his estate’s Tennessee inheritance tax bill by $570,000. He told me that this tax reduction is good enough to allow him to move to Tennessee.  If the marital trust would be subject to Tennessee inheritance tax, he probably would not move.

The planning opportunity is to have a marital trust established for your benefit prior to moving to Tennessee. If you know friends or family members such as parents who are considering a move to Tennessee, encourage them to establish and fund a marital trust prior to moving to Tennessee. For example, a husband might establish a marital trust for his wife prior to moving. The marital trust will not escape federal taxes; however, it will escape Tennessee inheritance taxes because it was established by a non-resident of Tennessee.

Tennessee imposes Franchise and Excise Tax on limited partnerships and limited liability companies unless they qualify for an exemption. Due to a law change enacted earlier this year, numerous entities converted from the family owned non-corporate entity (“FONCE”) exemption to the obligated member entity (“OME”) exemption.

The OME exemption requires the entity’s owners to assume personal responsibility for liabilities of the entity. Most entities that switched to the OME exemption own commercial real estate.

In order to qualify for the OME exemption for 2009, appropriate documentation had to be filed with the Tennessee Secretary of State by October 1, 2009. On November 10, 2009, the Department of Revenue imposed an additional requirement to qualify for the OME exemption for 2009.

Each entity that switched to the OME exemption must file a new Application for Exemption with the Department of Revenue on or before November 30, 2009. If the entity does not file an Application for Exemption by November 30, 2009, it will not be exempt for 2009.

The Department of Revenue has discretion to allow a late filing of the application. However, if they permit the late filing, they must charge a $1,000 penalty.

If the entity failed to convert to an OME prior to October 1, 2009, it has the option of converting to an OME prior to December 31, 2009 if the entity wants to be exempt from franchise and excise taxes for 2010 and future years.

If you are an owner of an OME and are concerned about your potential exposure to liabilities of the entity, you should consider transferring a portion of your assets to an asset protection trust.

The estates of a lot of Tennessee decedents pay Tennessee inheritance taxes but do not pay federal estate taxes. The federal estate tax exemption is currently $3.5 million. As of the date of this article, various members of Congress favor extending this exemption amount indefinitely into the future. The Tennessee inheritance tax exemption is currently $1 million. There does not appear to be much likelihood that Tennessee will increase its exemption to match the federal exemption.

The difference between the federal and Tennessee exemptions means that unmarried decedents who die with a taxable estate with a value between $1 million and $3.5 million will pay Tennessee inheritance taxes but not federal estate taxes. There are several things that can be done to reduce the value of assets for Tennessee inheritance tax purposes.

Some of these steps can be taken shortly before death. As an example, a parent might make a deathbed gift of a fractional interest in real property to a child with the goal of capturing a fractional interest discount for the remaining portion of the property when the parent dies. There are also various post-mortem decisions that can affect the value of the assets owned by the estate.

Even though the estate is not subject to federal estate taxes, the date of death value of the assets becomes the basis of the assets for federal income tax purposes. Basis will be relevant when the estate or the beneficiaries later sell the assets. Federal capital gains taxes are 15% and are scheduled to increase to 20% in the year 2011. If the beneficiaries live in a state outside of Tennessee that imposes a capital gains tax, this will make the capital gains tax rate even higher. The maximum Tennessee inheritance tax rate is 9.5%.

Since capital gains tax rates are higher than the maximum Tennessee inheritance tax rate, it is generally not advisable to take steps that reduce the value of the decedent’s assets for Tennessee inheritance tax purposes, unless it is known that the beneficiaries will continue to own the assets in the estate for several years. The reduction in the value of the estate will increase capital gains taxes by more than the Tennessee inheritance taxes that are saved.

Making tax-free annual exclusion gifts is still a good idea. It is better to give cash as opposed to an appreciated asset that will receive a free basis increase upon death. A cash gift reduces Tennessee inheritance taxes without increasing capital gains taxes.