Vol. 80, No. 12, December 2007
t the stroke of midnight on Dec. 31, 2007, Wisconsin will have no estate tax for the first time in more than 100 years. This means that estates of Wisconsin residents who die on or after Jan. 1, 2008, will pay no estate tax to the state of Wisconsin, regardless of the size of the estate. This will be the situation until the Wisconsin Legislature acts to reinstate some form of death tax in Wisconsin.
This article discusses how the demise of the Wisconsin estate tax came to be and how and when the tax might resurface.
History of the Wisconsin Estate Tax
The first Wisconsin tax on property bequeathed at death came in 1899, when the State Tax Commission recommended the tax as a solution to problems associated with taxing intangible property under the property tax. Enacted as Chapter 355, Laws of 1899, the tax was regarded as the most important state and local tax of the period. The tax was challenged later and evolved into a transfer tax that included an inheritance tax, gift tax, and estate tax. Because of increasing exceptions that made this tax system fiscally irrelevant and technically cumbersome, and out of a strong concern by Gov. Tommy Thompson's administration that the tax was causing a flight to tax haven states by some of Wisconsin's most affluent citizens, the tax was phased out over a five-year period by a provision of the 1987 biennial budget act.
The Wisconsin "Pick-up" Tax Beginning in 1992
The estate tax in its present form was adopted in 1992, after the five-year phase-out of the earlier transfer tax was complete.1 Having abolished its three transfer taxes, Wisconsin elected to "pick up" the state death-tax credit computed on the federal estate-tax return. Under section 2011 of the Internal Revenue Code of 1986, Congress had granted to individuals a state death-tax credit against the federal estate tax for the amount of the transfer tax (estate or inheritance) that a taxpayer paid to a state (subject to a cap fixed by section 2011). The state then claimed, or picked up, the whole amount allowed as a federal state death-tax credit. The pick-up tax thereby led to a dollar-for-dollar reduction in the federal estate tax on those estates that were not excluded from federal estate tax. The exact amount of the allowable state death-tax credit was then paid to the state of Wisconsin as a pick-up tax.
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. Wisconsin also eliminated the incentive for affluent citizens to move to one of the many other pick-up states. This move modernized Wisconsin's estate tax and brought it in line with the estate taxes of 36 other states and the District of Columbia. It further meant that Wisconsin no longer needed its own complicated estate tax system, because it piggy-backed on the federal tax code. Reportedly, the adoption of the pick-up tax was one of the accomplishments of which Gov. Thompson's administration was most proud.
David W. Reinecke, U.W. 1982, is a senior partner in Foley & Lardner LLP, Madison, and is chair of the firm?s nationwide tax and individual planning practice group.
Kate Botham is a third-year student at the U.W. Law School. She worked as a summer asociate and law clerk at Foley & Lardner LLP in Madison and San Francisco.
The pick-up tax system was particularly notable for its simplicity. Wisconsin no longer had to set estate tax rates, or exclusions. Because Wisconsin's transfer-at-death tax law was identical to the federal estate-tax law, there was only one set of tax laws to learn and administer, not two. In contrast, Wisconsin's former inheritance tax system had differed considerably from the federal estate-tax law, and Wisconsin auditors commonly disagreed with IRS auditors regarding issues such as asset valuation. Under the pick-up tax system, only one tax return - the federal estate-tax return - was prepared. Wisconsin simply had a one-page form (W706) that was used to report the picked-up amount owed to Wisconsin.
A second virtue of the pick-up tax was that it standardized the estate tax among all 38 jurisdictions that employed a pick-up tax. The pick-up tax system thereby eliminated competition among the pick-up jurisdictions for high-wealth residents. During Wisconsin's previous inheritance tax era, Wisconsin had been perceived to be a high transfer-tax state and lost many residents who changed domicile to minimize their perceived higher transfer taxes at death. With the pick-up tax, Wisconsin was on an even playing field with most other states.
Implications of Federal Estate Tax Changes in 2001
On June 7, 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which made many significant changes to the federal estate tax law, including increases in the federal applicable exclusion amount. 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. Compounding this loss, in a surprise move, Congress reduced the state death tax credit in 2002, 2003, and 2004 by 25 percent per 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 was a deduction from the value of the federal gross estate. As a consequence, there was no state death-tax credit after 2004, and the ability of the 38 pick-up jurisdictions to couple their estate tax laws to the federal estate-tax law was eliminated as of 2005. With nothing to pick up, all estate tax revenues of the 38 pick-up jurisdictions would have been wiped out beginning in 2005.
In effect, Congress eliminated the revenue sharing (from the federal government to the states) concept embodied in the state death-tax credit and at the same time terminated the ability of the states and the District of Columbia to couple their transfer-at-death tax to the federal estate tax. This action was especially unexpected considering that the District of Columbia, along with 37 (74 percent) of 50 states, had been pick-up jurisdictions. Even more surprisingly, it appeared as though Congress had "taken" the 37 states' and the District of Columbia's shares of the estate tax in order to maintain as much of its estate tax revenues as possible. On the one hand, Congress granted significant federal estate-tax relief through larger applicable exclusion amounts from the federal estate tax and lower estate-tax rates. On the other hand, by eliminating the state death-tax credit, Congress also was offsetting a portion of the declining revenues caused by the increased applicable exclusion amounts and other provisions of EGTRRA.
EGTRRA is still unfinished business. As part of EGTRRA, Congress created a $3.5 million federal estate-tax exclusion for 2009, repealed the federal estate tax for 2010, and reinstated the tax for 2011 with a $1 million exclusion. A law that provides for an estate tax in 2009, no estate tax in 2010, and a higher estate tax in 2011 will probably not withstand the test of time. Most observers agree that Congress will revisit the federal estate tax before 2011, if not before 2009 or 2010. Most predict that Congress will extend EGTRRA or some of its provisions beyond 2010, in lieu of repeal for one year. However, the more important issue is how EGTRRA will affect the estate tax in Wisconsin.
The Wisconsin Estate Tax: Oct. 1, 2002 to Dec. 31, 2007
Congress's phase out and elimination of the pick-up tax under EGTRRA challenged the Wisconsin Legislature. Faced with declining estate-tax revenues over the first three years and total elimination of those revenues in 2005, Wisconsin suspended its pick-up tax from Oct. 1, 2002 to Jan. 1, 2008, and enacted its own freestanding, independent estate-tax system.
On Aug. 30, 2001, Gov. Scott McCallum signed 2001 Wis. Act 16, the biennial budget bill, which effectively suspended Wisconsin's pick-up tax for five years and three months. Technically, the effective date of the new Wisconsin estate-tax law was Oct. 1, 2002. The most significant change made by Act 16 was that during the suspension period, Wisconsin's estate-tax applicable exclusion amount was set at $675,000, substantially less than the federal estate-tax applicable exclusion amount. Under Act 16, Wisconsin is set to return to the pick-up tax on Jan. 1, 2008, when the suspension ends. The text of the relevant law is as follows:
Wis. Stat. section 72.02:
"Estate tax imposed. An estate tax is imposed upon the transfer of all property that is subject to a federal estate tax and that has a taxable situs in this state. The tax imposed is equal to the federal credit against the federal estate tax as finally determined."
Wis. Stat. section 72.01(11m):
"`Federal credit' means, for deaths occurring after September 30, 2002, and before January 1, 2008, the federal estate tax credit allowed for state death taxes as computed under the federal estate tax law in effect on December 31, 2000, and for deaths occurring after December 31, 2007, the federal estate tax credit allowed for state death taxes as computed under the federal estate tax law in effect on the day of the decedent's death."
Wis. Stat. section 72.01(11n):
"`Federal estate tax' means, for deaths occurring after September 30, 2002, and before January 1, 2008, the federal estate tax as computed under the federal estate tax law in effect on the day of the decedent's death."
It appears that Wisconsin decided on a temporary fix so it could wait and see what Congress ultimately does with the federal estate-tax system, and in particular with the state death-tax credit. When Act 16 became law, the Wisconsin Legislature and governor indicated that they were willing to return to the pick-up tax system if Congress restored it.2 Although for the past several years Congress has considered numerous proposals to resolve the uncertainty embodied in the current federal estate-tax system, no proposal to restore the state death-tax credit (which provides the foundation for the state pick-up tax) has been given serious consideration. In addition, no proposal pending in Congress would restore the state death-tax credit.
Congress probably will not revisit the federal estate tax until 2009 at the earliest. Because the Wisconsin Legislature and Gov. Jim Doyle did not address this issue in the 2007-2009 state budget (which passed in the Wisconsin Legislature on Oct. 24, 2007 and was signed into law by Gov. Doyle on Oct. 26, 2007), and because the Wisconsin Legislature is not likely to take up tax legislation this year, it is difficult to predict when and how the future of the Wisconsin estate tax will be addressed. The uncertainty surrounding the federal and Wisconsin estate tax laws is unprecedented and makes Wisconsin estate planning more difficult, especially as the sunset date approaches.
The Wisconsin Estate Tax as of Jan. 1, 2008
Unless the Wisconsin Legislature and Gov. Doyle change the Wisconsin estate-tax law, Wisconsin will resume picking up the state death-tax credit in 2008. But, because Congress repealed the state death-tax credit in EGTRRA, there will be no state death-tax credit to pick up in 2008. Thus, in essence, Wisconsin has repealed its estate tax commencing in 2008 under current state law. Barring a change in the federal tax code, the estate tax in Wisconsin (Wis. Stat. section 72.02) will be ineffective, even though pick-up tax language will remain in the statutes if no changes are made.
However, because Congress provided in EGTRRA that in 2011 the federal estate tax will be restored as it existed in 2001, Wisconsin's estate-tax credit would correspondingly be automatically restored in 2011. That means that if EGTRRA's sunset occurs, then Wisconsin will have an estate-tax credit to pick up in 2011.
How Wisconsin Compares to Other States
Along with Wisconsin, 16 other states and the District of Columbia elected to modify their estate-tax laws after EGTRRA passed.3 Most of these states use a "decoupled" state estate tax.4 Illinois, Maine, Maryland, Massachusetts, North Carolina, Oregon, Rhode Island, and Vermont enacted legislation linking their estate taxes to the federal estate tax as it was in effect before EGTRRA in 2001. Minnesota, which plans a tax conformity package each year, elected not to change its estate tax to conform to the federal changes. In Kansas, New York, Oregon, and the District of Columbia, estate tax laws are written in such a way that the state will not conform to federal changes unless the state takes legislative action. Virginia's tax was completely repealed for deaths on or after July 1, 2007. Wisconsin is the only state that has decoupled for a limited time (that is, Wisconsin is the only state to decouple with a built-in sunset date).
Four states - Washington, Connecticut, Ohio, and Oklahoma - retained their taxes by electing stand-alone estate taxes, instead of decoupling from the federal estate tax and referring to an older federal credit and exclusion. After Washington's original decoupling was nullified in court in 2005, Washington enacted a separate tax with a rate structure that applies to estates that exceed $2 million. Connecticut also created a separate tax with a different rate structure that applies to estates of more than $2 million. However, these states are facing the same problem that led them to employ a pick-up tax in the first place: a complicated and unpopular tax.
Twenty-four of the remaining 25 states imposed a tax based on the federal credit for state death taxes paid under current federal law. Thus, there is no state estate tax in these states for deaths after Dec. 31, 2004, until EGTRRA sunsets in 2011. The 25th state, Arizona, repealed its estate tax during 2006, effective for deaths in 2006 and thereafter. In a few states, there are additional barriers to decoupling. For example, in California, decoupling would require a vote of the electorate. In Alabama, Florida, and Nevada, constitutional provisions restricting the amount of estate tax that may be levied likely would need to be altered.
The Future of the Wisconsin Estate Tax
Because the sunset date of Wisconsin's present estate tax law is Dec. 31, 2007, some observers predict that Wisconsin will address the future of its estate tax in the second half of the current 2007-2008 legislative session. Most observers feel that the Wisconsin Legislature will wait until Congress addresses the federal estate tax law instead of enacting new legislation that would have a limited shelf life. In the meantime, we can look to various past legislative proposals for some insights into how this issue ultimately will play out.
So far, two positions have emerged in the Wisconsin debate. Opponents of the tax seek to repeal it or limit how much the tax takes from an estate. They argue that the estate tax discourages earning and saving by Wisconsin residents and encourages wealthy residents to move from Wisconsin to a state without an, or with a lower, estate tax as they get older and begin estate planning. The migration of these taxpayers is believed to lead to lower revenues from other state taxes, fewer donations to charities in Wisconsin, and the loss of social, occupational, and commercial activities of such individuals within the state. These opponents also argue that imposition of the tax amounts to double taxation: once on the income when it is earned, and once when it is subject to taxation in an estate. They claim that the tax can result in the loss of small, well-established, family-owned businesses and agricultural operations, which may be forced to dissolve in order to pay the estate tax. In addition, the tax is seen as placing a financial hardship on heirs. Finally, opponents suggest that charitable giving decreases because of the estate tax; that is, assets normally given to charity before death are retained to pay the estate tax.
Supporters of the tax want to see it stabilized after years of changes and uncertainty. They do not want the tax to be reduced or eliminated. They point out that the tax generates large sums of revenue that are important to both state and federal programs that benefit all citizens, such as health care, education, and infrastructure. They believe that the tax is appropriate because the government contributes to wealth accumulation by defining and protecting property rights. Supporters also argue that the estate tax is a progressive tax because its high exclusion means it generally only affects the estates of very wealthy persons. According to estate tax proponents, an exclusion amount of more than $1 million means that small and medium farms and businesses are rarely subject to the tax, and they are not forced to dissolve to pay it. Finally, supporters of the tax say that any increasing private charitable giving resulting from the repeal of the estate tax cannot possibly offset the revenue that the tax creates.
The Wisconsin Legislature already has considered several bills to address the repeal or reform of the Wisconsin estate tax. In the 2005-2006 legislative session, the Legislature considered 2005 Senate Bills 9 and 16, which would have lowered the estate tax by one-third and one-fourth, respectively, in each year until 2008, when the tax would effectively be repealed due to its reliance on the no-longer-existing federal tax credit. 2005 Senate Bill 35 also was introduced, seeking to eliminate the Wisconsin estate tax entirely as of the first day of 2007.5 There also was discussion by its supporters about ways to preserve or improve the estate tax during the 2005-2006 session, but no legislation was introduced that addressed the pro-estate tax positions. In 2007, Republicans (assisted by one Democrat) again led the charge against the Wisconsin estate tax. 2007 Assembly Bill 149 and 2007 Senate Bill 68, both of which are still under consideration, seek to eliminate the Wisconsin estate tax for deaths occurring on or after Jan. 1, 2008.
In an effort to inform the Legislature before deliberations commenced on the state's budget, Robert Lang, director of the Legislative Fiscal Bureau, sent a letter on Jan. 30, 2007, to the Senate and Assembly chairs of the Joint Committee on Finance, Sen. Russell Decker and Rep. Kitty Rhoades, respectively, summarizing the Legislative Fiscal Bureau's analysis of estimated state revenues and projected tax collections. With regard to the estate tax, Lang stated:
"State tax revenues from the estate tax totaled $108.6 million in 2005-06. For the current fiscal year, estate tax revenues are down 6.6%, compared to the same period in 2005-06. Based on the general trend in monthly collections to-date, estate tax revenues for 2006-07 are currently estimated at $100 million (a 7.9% decrease compared to 2005-06). For the 2007-09 biennium, estate tax revenues are estimated at $95 million in the first year, and $25 million the second year. The significant reduction in estimated revenues in 2008-09 is the result of provisions under current law that eliminate the state estate tax for deaths on or after January 1, 2008. [The elimination of the state estate tax for deaths on or after Jan. 1, 2008, is based on conforming with federal estate-tax law, which includes certain provisions that are scheduled to sunset on Dec. 31, 2010. Based on current federal and state laws, Wisconsin's estate tax will again apply with respect to estates of decedents dying after Dec. 31, 2010.]
"An additional issue that could affect state estate tax revenues in the forecast period relates to a case pending before the Court of Appeals with respect to the taxability of gifts made in contemplation of death [Wisconsin Department of Revenue v. the Estate of Ott E. Schweitzer6]. The appeal has been brought by the Wisconsin Department of Revenue, following a decision by the Circuit Court that there is no legal basis for a state estate tax on gifts made in contemplation of death. If the decision were to be upheld, there is the potential that estate tax revenues would be reduced significantly compared to the estimates provided."
According to the Legislative Reference Bureau, a major element in considering the future of this tax appears to be finding a balance between the impact that the tax has on residents' decisions to continue to live in Wisconsin as they begin their estate planning and the state's need for the revenue that the estate tax generates. One suggested compromise involves a relatively high exemption so that only the largest estates are taxed, and correspondingly high tax rates for these large estates. Other possibilities include a very low exemption and lower tax rates, so that essentially all estates would be taxed a small amount. In either case, the amount of revenue taken in by the tax would remain relatively steady, and the tax would either affect very few residents to a large degree or most residents to a small degree.
Predictions with Respect to the Wisconsin Estate Tax
It appears that Gov. Doyle has no intention of playing a lead role in the estate tax debate in Wisconsin. When Gov. Doyle submitted his 2007-2009 budget proposal to the Wisconsin Legislature, there was no mention of the Wisconsin estate tax. Indeed, the governor's office specifically stated that the governor did not intend to make a recommendation. The revenue projections in Gov. Doyle's proposed budget strongly suggest that the governor does not expect the estate tax to return in 2007-2009. During the last election debates, Gov. Doyle referred to the demise of the "death tax," perhaps indicating he supports the sunset. Accordingly, it seems likely that Gov. Doyle's administration will not provide the impetus to resolve the current state of uncertainty. However, what is much less clear is whether Gov. Doyle would go so far as to veto future legislation intended to reinstate the Wisconsin estate tax after the sunset.
That said, most political observers speculate that it is unlikely that a situation would be allowed to exist in which there was a long-term loss of estate-tax revenue. The estimated budget deficit resulting from the recently enacted budget bill is $840 million. The loss of the estate tax will further squeeze Wisconsin's fiscal belt.
Future proposals originating in the Senate (currently controlled by Democrats) will likely seek an extension of the current estate tax with a retroactive date to Jan. 1, 2008. The Assembly (currently controlled by Republicans), on the other hand, will likely seek a permanent repeal of the existing estate tax (unless EGTRRA in fact sunsets, in which case the pick-up tax automatically comes back into play). The issue then would go to a conference committee, most likely resulting in a contentious battle that would not be resolved for a long time if the recent experience with the budget bill is any indication. A reasonable compromise might extend the estate tax after the sunset date at a higher exemption amount, perhaps at the current federal applicable exclusion amount of $2 million.
Many observers believe the Wisconsin Legislature should wait until Congress has addressed the federal estate tax before enacting state legislation. The Wisconsin estate tax can then dovetail with the federal law, thereby eliminating Wisconsin's complicated estate tax system and the transfer tax bureaucracy it created. Any state legislation passed now would have to be repealed or revised after the federal law is finalized. Because Democrats control both houses of Congress and may capture the White House in 2008, it is very likely that new federal estate-tax legislation will be passed before estate-tax repeal takes effect in 2010. The only real question relates to the form of the final federal estate tax.
What does this mean for Wisconsin lawyers? The potential outcomes for Wisconsin seem to boil down to the following:
1) The Wisconsin Legislature might not do anything. Under this scenario, if Congress allows EGTRRA to run its course, Wisconsin will have no estate tax for three years (from Jan. 1, 2008 to Dec. 31, 2010). Then in 2011, the federal state death-tax credit will be restored, Wisconsin will revert to a pick-up state, and the exemption for both Wisconsin and federal purposes will be $1 million.
2) The Wisconsin Legislature might pass an extension of the current freestanding Wisconsin estate tax. Because of the split in control between the Senate and the Assembly, some give and take will have to occur and an increase in the exemption to something like $2 million is likely under this scenario. Considering how slowly things occur in the current political climate, this likely will not take place until at least late 2009 with an effective date on the date of enactment. Under this scenario, there will be no Wisconsin estate tax for 2008 and most of 2009.
3) The Wisconsin Legislature might do nothing until Congress passes permanent estate-tax legislation. Given the impasse between the current Congressional Democratic leaders (who favor modest increases in the applicable exclusion and modest decreases in rates) and President Bush (who favors total repeal), it is not likely that federal estate-tax legislation will be enacted during the Bush administration. It also is unlikely that Congress will ever reenact the state death-tax credit. Accordingly, under this approach, Wisconsin will be without an estate tax for almost two years and it will not return to a pick-up tax. Instead, a Wisconsin estate tax based on the federal estate tax (say, 20 percent of the federal tax) rather than the old state death-tax credit would make the most sense and is the most likely outcome.
The author's prediction is that the ultimate outcome will be a combination of the second and third scenarios above. Before the end of 2008, the Wisconsin Legislature will extend the freestanding Wisconsin estate tax through the end of 2010, but with an exemption of $2 million. Then, when Congress finally decides what to do regarding the federal estate tax, the Wisconsin Legislature will pass a new estate-tax regime that will piggy-back off the federal estate tax by simply computing the Wisconsin tax as a percentage of the federal tax actually paid.
For now, Wisconsin practitioners advising clients with large estates should make sure such clients' estate planning documents allow the credit shelter trust to be fully funded at the time of the first spouse's death (that is, funded with the maximum federal exclusion amount). After Dec. 31 of this year, that complete funding can occur without triggering a Wisconsin estate tax. Other than this advice, we need to sit back and wait to see how this all sorts out in the future.