Wisconsin's New Estate Tax

by Michael W. Wilcox

On Aug. 30, 2001, Gov. McCallum signed the budget bill, 2001 Wis. Act 16. Among other things, the budget bill suspended Wisconsin's pick-up tax for five years and three months and, in its place, created a reestanding, independent estate tax system. Technically, the effective date of Wisconsin's new estate tax law is Oct. 1, 2002. However, as a practical matter, the new law is effective immediately because persons planning their estates between now and Oct. 1, 2002, should take Wisconsin's new estate tax into account. In addition, the Wisconsin Department of Revenue (WDOR) must begin to implement its administration of the new law.

The biggest change made by Act 16, as subsequently interpreted by the WDOR,1 is that during the five-year suspension period, Wisconsin's estate tax applicable exclusion amount will remain at $675,000, which is less than the new federal estate tax applicable exclusion amount. A Wisconsin taxable estate with a value of more than $675,000 will be subject to Wisconsin estate tax even though that estate is exempt from the federal estate tax.

This article is a preliminary analysis of Wisconsin's new estate tax because the WDOR has not yet published the tax return and instructions for the new tax. It is probable that, as the WDOR and the public begin working with the new law, unanticipated aspects of the new law will be discovered.

Background

Before 1992 Wisconsin had an independent transfer tax system consisting of a gift tax, an inheritance tax, and an estate tax.2 Beginning in 1992, Wisconsin abolished its three transfer taxes and elected to "pick up" the state death tax credit computed on the federal estate tax return. Wisconsin has no generation skipping tax.

Under section 2011 of the Internal Revenue Code of 1986,3 Congress grants a state death tax credit against the federal estate tax for amounts of transfer tax (estate or inheritance) paid to a state or the District of Columbia. By picking up the federal state death tax credit, Wisconsin was able to dismantle its transfer tax bureaucracy and couple its transfer-at-death tax to the federal estate tax. Thirty-seven states and the District of Columbia have elected to have a "pick-up tax."4 Reportedly, adoption of the pick-up tax was one of the proudest accomplishments of Gov. Tommy Thompson's administration.5

The pick-up tax system has several virtues. One virtue is simplicity. Because under the system a state's transfer-at-death tax law is identical to the federal estate tax law, there is one set of tax laws to learn and administer, not two. Wisconsin's former inheritance tax system differed considerably from the federal estate tax law. Not only were the two systems fundamentally different,6 but also it was common for Wisconsin auditors to disagree with IRS auditors regarding issues the two systems had in common, for example, valuation of an asset. Under a pick-up tax system only one tax return - the federal estate tax return - is prepared. Wisconsin has a short, one-page form (W706) that is used to report the picked-up amount due Wisconsin.

Another virtue of the pick-up tax is that the transfer-at-death tax of a jurisdiction adopting the pick-up tax is automatically the same as the transfer-at-death taxes of the other 37 pick-up jurisdictions. The pick-up tax system eliminates competition among the pick-up jurisdictions for high-wealth residents. During its inheritance tax era, Wisconsin was perceived to be a high transfer tax state and lost many residents who changed domicile to minimize their perceived higher transfer taxes at death.

On June 7, 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).7 EGTRRA made many significant changes to the federal estate tax law, including increases in the federal applicable exclusion amount.8 The federal applicable exclusion amount will be $1 million beginning in 2002, $1.5 million beginning in 2004, $2 million beginning in 2006, and $3.5 million beginning in 2009.

By themselves, the larger federal applicable exclusion amounts would have meant declining estate tax revenues for the 38 pick-up jurisdictions coupled to the federal estate tax system. But, in a surprise move, Congress reduced the state death tax credit in 2002, 2003, and 2004 by 25 percent a year and eliminated the state death tax credit beginning in 2005. Starting in 2005, any amount of transfer-at-death taxes paid to a state or the District of Columbia will be a deduction from the value of the gross estate. As a consequence of this radical and unexpected act by Congress, there will be no state death tax credit to pick up after 2004. Consequently, the ability of the 38 pick-up jurisdictions to couple their estate tax law to the federal estate tax law has been eliminated as of 2005. With nothing to pick up, all estate tax revenues of the 38 pick-up jurisdictions have been wiped out beginning in 2005 and their estate tax systems have been destabilized. In effect, Congress terminated the ability of the states and the District of Columbia to couple their transfer-at-death tax to the federal estate tax. Given the fact that 37 of the 50 states - 74 percent - are pick-up jurisdictions, Congress's action was very unexpected.

Even though in EGTRRA Congress granted significant federal estate tax relief in the form of larger applicable exclusion amounts from the federal estate tax and lower estate tax rates, it apparently was not willing to accept the declining revenues caused by the increased applicable exclusion amounts and other provisions of EGTRRA. To maintain as much of its estate tax revenues as possible, Congress decided to take the 37 states' and the District of Columbia's shares of the estate tax.

EGTRRA is unfinished business. In EGTRRA, Congress created a $3.5 million federal estate tax exclusion for 2009, repealed the federal estate tax for 2010, and reinstated it for 2011 with a $1 million exclusion, down from the $3.5 million applicable exclusion amount in 2009. A law that provides for an estate tax in 2009, no estate tax in 2010, and a higher estate tax in 2011 cannot stand. Clearly, Congress must revisit the federal estate tax law before 2011.

Congress's phase out and elimination of the pick-up tax put Wisconsin on the spot. Faced with declining estate tax revenues over the next three years and total elimination of those revenues in 2005, Wisconsin decided to suspend its pick-up tax from Oct. 1, 2002, to Jan. 1, 2008, and enact its own freestanding, independent estate tax system during the interim period. Wisconsin returns to the pick-up tax in 2008, when the suspension ends. It appears that Wisconsin decided on a temporary fix so it could wait and see whether Congress decides to restore the pick-up tax system. Indeed, section 9144(1q) of Act 16 provides:

"(1q) ESTATE TAX; PROPOSED LEGISLATION. If the federal government enacts any law that provides revenue to the state that is intended to offset any loss of estate tax revenue under chapter 72 of the statutes as a result of any federal law enacted in 2001, the department of revenue shall submit proposed legislation regarding modifications to the estate tax under chapter 72 of the statutes to the joint committee on finance. Proposed legislation submitted under this subsection may not, in conjunction with the fiscal effect of any federal law, result in any increase or decrease in total state tax revenues."

In his veto message,9 Gov. McCallum stated that "it is my intent to rescind the decoupling of Wisconsin's estate tax from the federal estate tax in my 2003-05 biennial budget."

The Wisconsin Legislature and governor have both indicated that they are willing to return to the pick-up tax system if Congress restores it. If Congress does not restore the pick-up tax system, Wisconsin will have to revisit its new Wisconsin estate tax and decide what to do.

The uncertainty surrounding the federal and Wisconsin estate tax laws is unprecedented. This uncertainty makes Wisconsin estate planning more difficult. Not only must the current unfinished federal and Wisconsin estate tax laws be understood and applied, but Wisconsin residents and planners also must be vigilant for follow-up legislation at the federal and state levels. Changes appear likely, although their timing is unknown. If Congress restores the state death tax credit, it would not be surprising if some states refuse to stay with or go back to the pick-up tax system. Having had its tax system destabilized once, a state may not want to risk destabilization again.

Since Wisconsin delayed its decoupling from the federal estate tax until Oct. 1, 2002, Wisconsin has a pick-up tax for the first nine months of 2002. The nine-month period presents a window of opportunity to the legislature and governor to make changes in the new legislation before it takes effect.

Michael W. Wilcox, Marquette 1966, practices estate planning and probate with DeWitt Ross & Stevens, Madison. He is a past chair of the State Bar Taxation Section, coauthor of the State Bar's three-volume treatise, Marital Property Law in Wisconsin, a fellow in the American College of Trust and Estate Counsel, and listed in The Best Lawyers in America.

Federal Statutory Scheme

To understand Wisconsin's new estate tax, it is necessary to understand how the federal estate tax and the state death tax credit are computed. Unfortunately, the computation of the two items is convoluted. In the usual case,10 the federal estate tax and state death tax credit are computed on federal form 706 as shown in Figure 1 (three different situations are shown): Under the federal statutory scheme, the first step is to determine the value of the gross estate. Next, deductions are subtracted from the gross estate to arrive at the taxable estate. The federal estate tax (called the tentative tax at this stage) on the taxable estate is computed by using Table A in the instructions to the federal estate tax return, Form 706.11 Table A is shown in Figure 2. Once the federal estate tax has been tentatively determined, the applicable credit amount in IRC § 2010 is subtracted. In Figure 1, the applicable credit amount for the years 2000 and 2001 is used. If any federal estate tax remains after subtracting the applicable credit amount, the state death tax credit is computed by using Table B in the Form 706 instructions. The state death tax credit is subtracted to the extent there is sufficient federal estate tax to absorb it. Table B is shown in Figure 3. The applicable credit amount may eliminate all federal estate tax, in which case there is no state death tax credit. Sometimes, there is some federal estate tax remaining after the applicable credit amount is subtracted, but not enough to absorb the full state death tax credit. In that case, there is a partial state death tax credit. Sometimes there is more than enough federal estate tax to absorb the full state death tax credit. In that case, a balance is due the IRS. The balance due is the federal estate tax as finally determined. Figure 1 illustrates situations in which there is no state death tax credit, a full state death tax credit but no federal estate tax, and a full state death tax credit plus federal estate tax due the IRS.

Wisconsin's New Law