Estate Planning: State Estate Taxes

How to reduce the state estate and inheritance taxation of your estate.

Once you understand your federal estate tax burden (read this article first if you haven’t already), the next step is to consider whether you may be subject to state estate and inheritance taxes.

State Estate and Inheritance Tax

Will I pay state tax on my estate?

Even if Federal estate tax does not apply, you may still be exposed to state estate or inheritance taxes. Each state has its own rules governing these taxes. We work with many clients in Vermont, so we explain Vermont’s rules below. Keep in mind that each state is different, and some states do not impose estate or inheritance taxes at all.

How can you avoid Vermont estate tax?

Vermont has its own estate tax, which is separate from the federal estate tax.¹ If your estate is values at $5 million or less, no Vermont estate tax is owed. If your estate exceeds $5 million, only the amount above that threshold is subject to Vermont estate tax, at a flat rate of 16%.²

Unlike the federal estate tax, which allows unused exemptions to be transferred between spouses, Vermont does not allow portability. Each spouse has a separate $5 million Vermont exemption, and any unused portion is lost when the first spouse dies. Vermont does, however, allow an unlimited marital deduction, meaning assets can pass to a surviving spouse without immediate Vermont estate tax.

As a result, if your estate does (or may) exceed $5 million and you plan to leave assets to beneficiaries other than your spouse (such as children or charities), advance planning is important. Lifetime gifting or an estate plan that fully uses the first spouse’s exemption can help reduce or avoid Vermont estate tax when the surviving spouse later passes away.

Example: If a married couple has a $9 million estate and everything passes to the surviving spouse, no Vermont estate tax is due at the first death. However, if the surviving spouse later dies owning the full $9 million, $4 million would be subject to Vermont estate tax, resulting in a potential tax of $640,000.

As you design your estate plan, it’s essential to consider which state is your primary residence, as this directly affects how your assets may be taxed at your death and, ultimately, at the death of a surviving spouse. In situations like those described above, it is not uncommon for retirees to establish residency in states with low — or no — income and estate taxes in order to preserve more of their wealth for themselves and their beneficiaries.

For example, Florida has no state income tax, does not tax Social Security or retirement distributions, and has no estate or inheritance tax. It’s more than just good weather!

Because tax laws at both the federal and state level are constantly evolving, it’s important to maintain an estate plan that minimizes taxes while continuing to reflect your intentions. Regularly reviewing your plan helps ensure it remains effective and incorporates any changes in the tax code.

1. State of Vermont. Estate Tax. https://tax.vermont.gov/individuals/estate-tax
2. State of Vermont. Estate Tax Return. https://tax.vermont.gov/instructions/form-EST-191