Wisconsin's New Estate Tax

Wisconsin's New Law

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).