Federal estate tax often draws the most attention, but clients in the District of Columbia or the 12 states with state-level estate taxes—including New York, Massachusetts, and Washington—can face significant exposure well below the federal exemption threshold. For clients who intend to remain in these states, planning must account for lower exemptions, the likely absence of portability, and the potential need to raise liquidity within relatively short estate tax payment timelines. Coordinated strategies involving trusts, gifting, asset titling, and life insurance can help clients manage estate tax exposure while also supporting broader family, liquidity, and legacy goals.
Key Differences: State vs. Federal Estate Tax
Several important differences between state and federal rules can create unexpected tax exposure, liquidity concerns, and planning complications if these issues are not addressed early.
Lower Exemption Thresholds
State exemptions are often below $2 million, exposing families who may not consider themselves wealthy to estate tax concerns.
Lack of Portability
Federal law allows spouses to combine unused estate tax exemptions, but most states with estate taxes don’t offer this benefit. If assets pass outright to the surviving spouse, the first spouse’s exemption is often lost, potentially increasing the family’s state estate tax liability at the second death.
Liquidity Challenges
Families holding significant illiquid assets—such as real estate, privately held businesses, or long-term private investments that cannot easily be sold—may face significant pressure to meet state estate tax deadlines, which can require cash payments within a short time frame. Without proper planning, heirs may be forced to sell assets quickly, take on debt, or compromise financial and legacy goals to generate the necessary liquidity.
Planning Strategies for Clients with No Plans to Move
For clients who are deeply rooted in their home state and have no desire to move for tax reasons, the answer is not relocation but proactive planning. By addressing exposure early, you can help clients preserve family assets, maintain flexibility for surviving spouses and heirs, and reduce the likelihood that taxes force difficult financial decisions later.
Asset Location and Titling
Both the location and titling of certain assets significantly impact state estate tax liability. Clients should review how real estate, investments, and business interests are owned and titled, whether individually, jointly, or through trusts or entities. Ownership decisions can also affect how easily assets transfer to heirs and reduce the risk of rushed decisions during an already difficult time.
Even those in states without estate taxes may face nonresident estate tax exposure on out-of-state properties like vacation homes. Adjustments to reduce estate taxes, such as retitling assets, may limit the step-up in basis and potentially increase heirs’ capital gains taxes. Evaluating trade-offs early helps avoid surprises.
Strategic Trust Planning
Trusts are essential tools in jurisdictions with estate taxes, maximizing exemptions and preserving generational wealth. They work best when tailored to a client’s overall estate plan, family dynamics, and tax profile. Consider collaborating with the client’s legal and tax advisors to help the client consider appropriate trust structures.
• Bypass (credit shelter) trusts. For married clients, these trusts capture the first spouse’s exemption in states without portability. Assets in these trusts can benefit the surviving spouse and children, reducing total estate tax at the second death.
• QTIP trusts and state-only elections. Trust planning can sometimes defer state estate tax until the second death using qualified terminable interest property (QTIP) elections. In some cases, a “state-only” QTIP election can optimize both state and federal tax outcomes, though it requires careful legal drafting.
• Irrevocable trusts. Irrevocable life insurance trusts (ILITs) and certain other irrevocable grantor trusts can move appreciation out of the estate and create future liquidity.
• Spousal lifetime access trusts (SLATs). In states without a gift tax (currently all except Connecticut), SLATs can move highly appreciated assets and future growth outside the taxable estate while still providing indirect spousal access to assets. However, some states (including New York) apply gift addback rules that can pull recent gifts back into the taxable estate, making early planning essential.
Lifetime Gifting to Reduce Future Exposure
Lifetime gifting remains a cornerstone strategy for reducing potential state estate tax exposure by shifting high-growth assets and future appreciation out of the taxable estate. However, gifted assets generally retain the donor’s original cost basis, potentially increasing capital gains taxes upon sale. Balancing estate tax savings with future income tax liabilities can help ensure alignment with client goals and family circumstances.
Creating Liquidity to Prevent Forced Sales
For many families, life insurance remains one of the most effective ways to create liquidity and preserve illiquid assets when estate taxes are due. When structured correctly and ideally owned outside the taxable estate, insurance can provide immediate cash right when it’s needed most, helping heirs avoid the pressure to quickly sell real estate, family businesses, or other valuable illiquid assets.
A successful estate planning strategy involves balancing tax efficiency with client control, family harmony, and fairness among beneficiaries. By integrating insurance and working collaboratively with clients and their advisors, you can create a strategy that addresses liquidity needs while aligning with long-term family goals and values.
