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

New Wis. Stat. section 72.02 provides:

"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. ..."

New Wis. Stat. section 72.01(11m) provides:

"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."

New Wis. Stat. section 72.01(11n) provides:

"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 December 31, 2000, and for deaths occurring after December 31, 2007, the federal estate tax as computed under the federal estate tax law in effect on the day of the decedent's death."

At first glance one might think, after reading new section 72.02, that a $1 million taxable estate in Wisconsin would be exempt under Wisconsin's new estate tax law after Oct. 1, 2002, because there is no federal estate tax payable on a $1 million taxable estate. No federal estate tax return is filed for estates worth less than the applicable exclusion amount, which is $1 million in 2002.12 However, even though a federal estate tax return is not required and no federal estate tax is due, all taxable estates are subject to federal estate tax no matter how small. (See Figure 2.) For example, the federal estate tax on a $1,000 taxable estate is $180. The applicable credit amount in IRC § 2010 for the year 2002 will be $345,800. The applicable credit amount eliminates the federal estate tax on the $1,000 taxable estate.

New Wis. Stat. section 72.01(11m) provides that the state death tax credit (that is, the new Wisconsin estate tax) for deaths during the five-year suspension period is the state death tax credit computed under the federal estate tax law in effect on Dec. 31, 2000. There are several ambiguities in this provision. One ambiguity involves the actual computation of the new Wisconsin estate tax. The federal applicable exclusion amount on Dec. 31, 2000, was $675,000, but the federal estate tax law in effect on Dec. 31, 2000, provided for future increases in the applicable exclusion amount ($700,000 in 2002, $850,000 in 2004, $950,000 in 2005, and $1 million in 2006). One interpretation of Wis. Stat. section 72.01(11m) and (11n) is that by requiring that the state death tax credit be computed under the federal estate tax law in effect at the end of 2000, the Wisconsin Legislature implicitly adopted the scheduled higher applicable exclusion amounts. However, the WDOR has decided that the federal estate tax should be computed as if the decedent died on Dec. 31, 2000.13 This WDOR interpretation means that the scheduled increases in the federal applicable exclusion amount are not part of the new Wisconsin estate tax law. Under this interpretation, Wisconsin's applicable exclusion amount is fixed at $675,000 until 2008, when Wisconsin resumes the pick-up tax. Figure 4 compares Wisconsin's fixed applicable exclusion amount to the changing federal applicable exclusion amount.

During the suspension period, Wisconsin's applicable exclusion amount will be less than the scheduled federal applicable exclusion amounts. Wisconsin will resume picking up the state death tax credit in 2008. However, because Congress repealed the state death tax credit in EGTRRA, there will be no state death tax credit to pick up in 2008. Under current state law, Wisconsin, in effect, has repealed its estate tax commencing in 2008. For that reason, Figure 4 shows Wisconsin as having no estate tax in 2008, 2009, or 2010. Since Congress in EGTRRA provided that the federal estate tax is restored in 2011 as it existed in 2001, Figure 4 shows a federal applicable exclusion amount of $1 million for 2011. In this case, the scheduled future increases in the applicable exclusion amount are included. Since the state death tax credit also is restored by Congress in 2011, Wisconsin will have a state death tax credit to pick up in 2011, as shown in Figure 4.

Another ambiguity in new Wis. Stat. section 72.01(11m) and (11n) relates to the determination of the gross estate and deductions from the gross estate for Wisconsin estate tax purposes. One interpretation is that Wisconsin adopted the federal estate tax law as it existed on Dec. 31, 2000. Another interpretation is that although Wisconsin adopted the federal estate tax computation in effect on Dec. 31, 2000, it adopted the federal estate tax law in effect on the date of the decedent's death for all other aspects of the new estate tax law. The WDOR has determined that the legislature incorporated the federal estate tax law as it exists on the date of death.14

The WDOR's date of death interpretation simplifies the administration of Wisconsin's new estate tax for both the WDOR and the taxpayer. If the legislature incorporated the federal estate tax law as it existed on Dec. 31, 2000, the Wisconsin and federal estate tax laws would be different. Wisconsin's estate tax law would be fixed as of one day in time, whereas the federal estate tax law would be changing constantly as Congress made changes and the courts and IRS made new interpretations of the federal law. Over time, the Wisconsin law and the federal estate tax law would diverge more and more.

The WDOR's administrative interpretations can be illustrated by an example. Assume the decedent dies in 2003 with a $2.5 million gross estate. To determine the gross estate and the deductions from it, the federal estate tax law in effect on the date of death is used. Thus, the gross estate and the deductions from it for Wisconsin and federal purposes are the same. However, in computing the federal estate tax, the federal applicable credit amount is $345,800, while Wisconsin's applicable credit amount is $220,550. The rates applied by Wisconsin also differ from the rates applied by the IRS. The WDOR uses the rates in effect on Dec. 31, 2000. The IRS uses the rates in effect on the date of death.

If the Wisconsin estate tax law is the same as the federal estate tax law, the WDOR does not have to audit the gross estate or its deductions (lines 1 and 2 of the current Form 706). If the Wisconsin estate tax law differs from the federal estate tax law, the WDOR will have to increase its audit staff in order to audit the new tax. Also, if the Wisconsin and federal estate tax laws are the same, the basis of assets can be the same for Wisconsin and federal income tax purposes. Under the pick-up tax system, the Wisconsin basis of assets acquired from a decedent was the same as the federal basis.15 If assets are treated differently for Wisconsin estate tax purposes than they are for federal estate tax purposes, the assets may not have the same basis for Wisconsin and federal estate tax purposes. The WDOR's date of death interpretation retains Wis. Stat. section 71.05(10)(e), making the Wisconsin basis of assets acquired from a decedent the same as the federal basis for those assets. Having different bases for the same assets would add one more layer of complexity.

Beginning in 2005, the Wisconsin estate tax will be a deduction from the federal gross estate. As a result, under the WDOR's date of death interpretation, since the Wisconsin estate tax is a deduction, the computation of the federal taxable estate and the Wisconsin estate tax will be interrelated. The federal taxable estate must first be computed without deducting the Wisconsin estate tax. Once the taxable estate is known, the Wisconsin estate tax is computed by using Table B in Figure 3. The Wisconsin estate tax is deducted from the federal gross estate, which reduces the taxable estate. The reduced taxable estate lowers the Wisconsin estate tax, which in turn changes the taxable estate, which changes the Wisconsin estate tax and so forth. The computations must continue round-robin until the Wisconsin estate tax stops changing. Unless software is made available, those calculations will have to be made by repetition or use of an algebraic formula. The computation would not be interrelated if the 2000 federal estate tax applied because a state estate tax was not a federal deduction in 2000.

The WDOR's date of death interpretation will be advantageous for some taxpayers and disadvantageous for others. For example, in EGTRRA, Congress expanded the scope of conservation easements as a deduction from the gross estate. Under EGTRRA, qualifying real property located anywhere in the United States qualifies for a conservation easement. Under the federal estate tax law in effect on Dec. 31, 2000, the qualifying real property must be located within 25 miles of a metropolitan area, national park, or wilderness area, or within 10 miles of an urban national forest. If the 2000 law applies, Wisconsin has adopted the more restrictive conservation easement definition. If the date of death law applies, the Wisconsin and federal deductions are the same.

As another example, under the 2000 federal estate tax law, there was a deduction of up to $625,000 from the gross estate for a qualified family-owned business (QFOBI). In EGTRRA, Congress repealed the QFOBI deduction for estates of decedents dying after 2003. In 2002 and 2003, the federal QFOBI deduction will be $300,000. If the federal law in 2000 is applied, the Wisconsin QFOBI deduction is fixed at $625,000 for 2002 through 2007. Under the date of death interpretation, the Wisconsin QFOBI deduction will be the same as the federal deduction, that is, $300,000 in 2002 and 2003 and repealed in 2004.

The WDOR's date of death interpretation implicates the Wisconsin Constitution. Under Article IV, section 1, the legislative power is vested in the Wisconsin Legislature. WDOR's interpretation that the federal estate tax law on the date of death applies could be viewed as an improper delegation of legislative authority to the federal government.16 One way to eliminate that argument is for the legislature to periodically adopt the previous year's federal estate tax law as it does with the federal income tax.17

Examples

The following examples have two purposes: 1) to show how the new Wisconsin estate tax is computed; and 2) to show how the new Wisconsin applicable exclusion amount can be used in conjunction with the higher federal applicable exclusion amounts. These examples are based on the WDOR's interpretations of the new law as described earlier.

Example 1. The taxpayer died on Sept. 20, 2002, before the effective date of the new Wisconsin estate tax, with a taxable estate of $1 million. Using Figure 2, the gross federal estate tax is $345,800. Wisconsin's applicable credit amount on Sept. 20, 2002, will be $345,800. Subtracting the applicable credit amount from the gross estate tax results in $0. Since there is no federal estate tax remaining after the applicable credit amount is subtracted, there is no tax against which to take the state death tax credit. Therefore, the state death tax credit is $0 and the Wisconsin estate tax is $0.

Example 2. This follows the same facts as example 1, except that the taxpayer dies on Oct. 10, 2002, after the new law is effective. The gross estate tax is still $345,800. The applicable credit amount allowed by Wisconsin beginning Oct. 1, 2002, is $220,550. Subtracting the applicable credit amount from $345,800 results in $125,250 of federal estate tax. The state death tax credit from Table B (Figure 3) is $33,200. The $125,000 absorbs the entire state death tax credit, so the Wisconsin estate tax is $33,200. The balance remaining after subtracting the state death tax credit is irrelevant, because the only purpose of the calculation is to determine the state death tax credit.

Examples 1 and 2 show how the state death tax credit is computed and the additional estate tax created by Wisconsin's new estate tax. The new Wisconsin estate tax on a federally exempt $1 million taxable estate will be $33,200. When the federal applicable exclusion amount increases to $1.5 million, the Wisconsin estate tax on a federally exempt taxable estate will be $64,400. When the federal applicable exclusion amount is $2 million, the Wisconsin estate tax on a federally exempt taxable estate will be $99,600.

Example 3. The taxpayer dies on Oct. 10, 2002, with a $900,000 taxable estate. The estate is exempt from federal estate tax because it is less than the federal estate tax applicable exclusion amount of $1 million. No federal estate tax return must be filed. The decedent's children believe that the estate is exempt from Wisconsin estate tax. No Wisconsin estate tax return is filed by the nine-month due date and no Wisconsin estate tax is paid. When the children attempt to sell the decedent's residence, the failure to pay the Wisconsin estate tax is discovered. One year after death, the Wisconsin estate tax return is filed and the Wisconsin estate tax of $27,600 is paid. The penalty for failure to timely file the return is $500.18 When the estate tax is not timely paid, the tax bears 12 percent simple interest from the date of death.19 The interest on $27,600 for late payment is $3,312. The total penalties and interest for late filing and late payment are $3,812.

Examples 4 through 7. One of the most difficult aspects of Wisconsin's new estate tax law is its application to married persons who wish to use a bypass arrangement on the death of the first spouse. Beginning Oct. 1, 2002, married persons may choose to base the bypass on the smaller Wisconsin applicable exclusion amount or the larger federal applicable exclusion amount. Examples 4 through 7 illustrate some of the complexities in choosing which exclusion to use. The analysis must be done on a case-by-case basis because the variables are so numerous. Creating a table aids in the analysis. The table can be filled in with the appropriate applicable exclusion amounts. Examples 4 through 7, Figure 5, illustrate the use of the table based on the Wisconsin applicable exclusion amount fixed at $675,000 and the federal applicable exclusion amount of $1 million in 2002. Space does not permit examples using the $1.5 million and $2 million federal applicable exclusion amounts scheduled to take effect in 2004 and 2006 respectively.

Example 4.In this example, each spouse's estate before the death of the first spouse is $675,000. S1 dies first; S2 is the surviving spouse. If S1 left S1's entire estate to S2, S2's estate would be $1.35 million. $1.35 million is more than both the Wisconsin and federal applicable exclusion amounts and is subject to both federal and Wisconsin estate tax. If S1 bypasses S2 with S1's entire estate (via a bypass trust for S2's benefit or perhaps an outright disposition to S1's and S2's children), the value of S2's estate can be held below the Wisconsin and federal applicable exclusion amounts. In this example, S1 based the bypass on Wisconsin's smaller applicable exclusion amount. Example 4 illustrates the point that if the surviving spouse's estate, after the distribution of S1's estate, will be equal to or less than $675,000, there will no federal or Wisconsin estate tax on S2's death. Spouses in this position can base the bypass on the smaller Wisconsin applicable exclusion amount. Of course, this example is an oversimplification. S2's estate may grow due to investment returns, inflation, inheritance, and so forth. Any expected future increases in the value of S2's estate must be considered.

Examples 5a and 5b. In these examples, two couples have identical estates. Before the first death, S1's estate is $1 million and S2's estate is $500,000. Each couple wants to base a bypass at the first death on the estate tax applicable exclusion amount and leave the excess estate to the surviving spouse. The couple in 5a uses the smaller Wisconsin applicable exclusion amount. The couple in 5b uses the larger federal applicable exclusion amount.

In example 5a, the surviving spouse's estate will be $825,000 after S1's death, which is less than the federal applicable exclusion amount in 2002, but more than the Wisconsin applicable exclusion amount fixed at $675,000. There will be no federal or Wisconsin estate tax on the first death. There will be $24,000 of Wisconsin estate tax on the second death.

In example 5b, a Wisconsin estate tax of $33,200 is incurred at the first death. There is no federal or Wisconsin estate tax at the second death.

Using the smaller Wisconsin applicable exclusion amount (example 5a) appears to be the preferable choice. The total estate taxes are less in example 5a and are paid at the second death. In addition, in example 5a, S2 has time to lower the Wisconsin estate tax on his or her estate by using estate planning techniques such as annual exclusion gifts. Finally, given the uncertainty surrounding Wisconsin's estate tax law, namely that the Wisconsin Legislature may enact estate tax relief, it is better if all estate taxes are avoided at the first death in case the law is changed by the time S2 dies.

Examples 6a and 6b. These examples again illustrate two couples with identical estates. The couple in 6a uses the smaller Wisconsin applicable exclusion amount. The couple in 6b uses the larger federal applicable exclusion amount. Here, the total estate taxes are less if the larger federal applicable exclusion amount is used. Couples must decide if paying some estate tax at the first death is worth it. Using the smaller Wisconsin applicable exclusion amount saves Wisconsin estate tax at the first death but increases S2's estate to greater than the existing federal applicable exclusion amount of $1 million, thus risking federal estate tax in the second estate. However, if S2 survives until 2004, when the federal applicable exclusion amount will be $1.5 million, there will be no federal estate tax, so that example 6a would have the lowest estate tax.

Examples 6a and 6b illustrate a gray area where judgment is required to estimate the estate taxes to be levied on S2's estate. The choice between the smaller Wisconsin applicable exclusion amount or larger federal applicable exclusion amount will depend on the circumstances, such as the spouses' health, ages, economic circumstances, applicable exclusion amounts on S2's death, and so forth. There is no rule of thumb. The analysis must be made on a case-by-case basis. For example, if the couples in examples 6a and 6b are younger couples, they might use the smaller Wisconsin applicable exclusion amount on the expectation that S2 will survive until the federal applicable exclusion amount is $1.5 million.

Examples 7a and 7b. In these examples, the use of the larger federal applicable exclusion amount seems preferable. Using the smaller Wisconsin applicable exclusion amount exposes S2 to much higher federal estate tax. The payment of $33,200 at the first death may be worth it.

Example 7c. Assume that the clients in example 7b, who use the larger federal applicable exclusion amount, executed their estate planning documents in 1997. Assume their estate plan calls for a bypass at the death of the first spouse in an amount that eliminates any federal or state death tax at the first death.

The 1997 estate planning documents in example 7c call for no estate tax at the first death. To comply with the 1997 documents, the smaller Wisconsin applicable exclusion amount must be used. Since the couple in example 7b wishes to use the larger federal applicable exclusion amount, they will have to revise their existing documents and indicate they want the bypass to be based on the higher federal exclusion.

Practice Tips

Wisconsin's applicable exclusion amount will be fixed at $675,000 from Oct. 1, 2002 until 2008. Wisconsin's applicable exclusion amount will be less than the corresponding federal applicable exclusion amount from federal estate tax.

Beginning Oct. 1, 2002, if married couples wish to do a bypass arrangement at the first death, they will have a choice between using the smaller Wisconsin applicable exclusion amount or the larger federal applicable exclusion amount.

Using the larger federal applicable exclusion amount at the first death will incur Wisconsin estate tax. The consideration will be whether paying Wisconsin estate tax at the first death is worth the risk of incurring federal estate tax at the second death. At some point, as imposition of federal estate tax on the survivor's estate becomes more and more likely, use of the larger applicable exclusion amount at the first death is indicated.

If a couple has difficulty deciding which applicable exclusion amount to use at the first death, they can incorporate a disclaimer option into their estate plan. With the disclaimer option, the first spouse would leave everything to the surviving spouse and provide for a disposition to a bypass arrangement if the survivor disclaims. Flexibility is achieved with the disclaimer plan because the decision can be made at a later date when more facts may be known. The disadvantage of a disclaimer plan is that the first spouse may want to fix the amount of the bypass arrangement and may not want the surviving spouse to do it.20

Another way to achieve flexibility by postponing the determination of the amount of the bypass to a later date is through the use of a QTIP trust and the partial QTIP election. S1's estate plan could call for two shares, a QTIP trust qualifying for the marital deduction and a bypass share consisting of the balance of S1's estate. S1's fiduciary could be given discretion to make a partial QTIP election. With this approach, after S1's death, the fiduciary can decide the optimum values for the bypass share and the marital deduction share. After the election is made, the assets qualifying for the marital deduction can be transferred to the QTIP trust. The balance of the assets can be transferred to the bypass share.21 If the surviving spouse does not want a QTIP trust, the spouse can be given a power to withdraw assets from the QTIP trust so long as the power to withdraw does not qualify the trust for the marital deduction under the power of appointment provisions.22 A trust that qualifies for the marital deduction because the spouse has a power of appointment cannot be a QTIP trust.

Married persons who have an existing bypass estate plan may wish to check their documents to see if the existing plan uses the smaller Wisconsin exclusion or the larger federal exclusion and whether that is the appropriate exclusion. In some cases, the existing plan may use the larger exclusion when the smaller exclusion is more appropriate. Conversely, the existing plan may use the smaller exclusion at the first death when the larger exclusion is more appropriate.

Endnotes

1 The WDOR has made several significant interpretations of Wisconsin's new estate tax legislation as it prepares to administer the new tax. Neal E. Schmidt described these interpretations on Oct. 11, 2001, in Green Bay, Wis., at the 35th Annual CLEW Tax Workshop sponsored by the U.W. Law School and U.W. Extension. Mr. Schmidt is an attorney with the WDOR. The WDOR's interpretations are discussed later in this article.

2 Wisconsin's Gift, Inheritance and Estate Tax System can be found in chapter 72 of the 1991-92 Wisconsin Statutes. For excellent commentary on the Wisconsin estate tax, see Neal E. Schmidt, Wisconsin Estate Tax Handbook, U.W. Law School (2000).

3 Hereinafter, references to the Internal Revenue Code of 1986 are as "IRC."

4 5 CCH, Estate, Gift and Inheritance Tax Reporter, 1100.

5 Milwaukee Journal Sentinel, July 25, 2001, column by Avrum Lank.

6 An inheritance tax and estate tax are opposites. An inheritance tax is on the recipient's right to receive. The estate tax taxes the opposite end of the spectrum, the transferor's right to transfer.

7 Pub. L. No. 107-16.

8 In IRC § 2010, Congress allows a credit called the "applicable credit amount" against the federal estate tax. The applicable credit amount is equal to the tentative tax on the "applicable exclusion amount." Thus, the applicable exclusion amount is the amount that will result in $0 tentative estate tax. For example, in 2001, the applicable credit amount is $220,550. The tentative federal estate tax on a $675,000 taxable estate is $220,550. Since subtracting the applicable credit amount from the tentative tax results in $0 tax, the applicable exclusion amount in 2001 is $675,000. In 2002, the applicable credit amount will be $345,800 and the corresponding applicable exclusion amount will be $1,000,000. The applicable exclusion amount is often referred to as the "exemption equivalent."

9 Available on the Internet, www.legis.state.wi.us/billtrack.html.

10 This is an oversimplification done for purposes of illustration.

11 The instructions are available on the Internet, www.irs.ustreas.gov/prod/forms_pubs/index.html.

12 IRC § 6018.

13 Remarks of Neal E. Schmidt at 35th annual CLEW program in Green Bay.

14 Remarks of Neal E. Schmidt at 35th annual CLEW program in Green Bay.

15 Wis. Stat. § 71.05(10)(e).

16 Op. Atty. Gen. Dec. 15, 1977; 50 Op. Atty. Gen. 107 (1961).

17 See Wis. Stat. § 71.01.

18 Wis. Stat. § 72.235.

19 Wis. Stat. § 72.23.

20 For a discussion of disclaimers in estate planning, see Eckhardt's Workbook for Wisconsin Estate Planners, published by the State Bar of Wisconsin.

21 This type of contingent QTIP planning is authorized by Treas. Reg. § 20.2056(b)-7(d)(3). See also Clayton Estate v. Comm'r, 976 F.2d 1486 (5th Cir. 1992), and Clack Estate v. Comm'r, 106 T.C. 131 (1996).

22 IRC § 2056(b)(5).

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