The Tax Foundation recently released a report comparing state inheritance and estate taxes for 2014. In addition to federal estate taxes, individual states can choose to levy their own estate and inheritance taxes. Estate taxes are levied against the estate of the deceased regardless of who inherits the assets (except for property left to a surviving spouse, which is exempt). However, inheritance taxes are charged on the transfer of assets to heirs based on the relationship of the deceased to the inheritor.
Estate taxes impose a higher tax burden on state residents than federal estate taxes, and state inheritance tax laws may have a significant effect on the way a person chooses or is able to transfer assets upon his or her death. States that impose these “death” taxes drive residents out of state to retire in states with “warmer” estate and inheritance tax climates.
According to the Tax Foundation’s report, fifteen states and the District of Columbia currently levy an estate tax in addition to federal estate taxes, and six states impose an additional inheritance tax. Maryland is one of only two states that levy both an estate and inheritance tax on its residents (the other state is New Jersey).
However, there is some good news. In March, the Maryland General Assembly passed and the governor signed a measure that gradually raises the amount exempt from the state’s estate tax to coincide with the more generous exemptions allowed by federal estate taxes. The reform increases the amount exempt from the state estate tax from $1 million this year, to $1.5 million in 2015, $2 million in 2016, $3 million in 2017, and $4 million in 2018. By 2019 it will match the federal exemption which is projected to be $5.9 million, up from $5.34 million today (indexed for inflation).
The Maryland legislature should be applauded for initiating this reform process. But there are still more reforms to Maryland’s state tax policies that should be undertaken. First, Maryland legislators should repeal or reduce the state’s 10% state inheritance tax. Even if no state estate tax is due thanks to the exemption or other factors, Maryland residents may owe a separate inheritance tax depending on the relationship of the parties inheriting assets with the deceased.
As the Tax Foundation’s map below shows, neighboring states like Pennsylvania and Delaware only impose either a state estate or a state inheritance tax on residents. Delaware alleviates this tax burden by allowing the second highest exemption threshold in the country -- over $5 million (trailing only Hawaii). And Virginia and West Virginia do not impose either state estate or inheritance taxes.
According to the Tax Foundation “state and inheritance taxes have large compliance costs, have been shown to suppress entrepreneurship, and are among the most harmful taxes to economic growth.” In addition to whatever other more direct negative economic effects they cause, high inheritance and estate taxes have another negative effect: they spur migration out of the state.
I have previously written about the effect of state tax policies on interstate migration on the FSF blog. In high-tax states like Maryland as well as New York, Illinois, and Connecticut, taxes were a major factor in residents’ decisions to leave the state according to a Gallup poll. Maryland’s poor business tax climate is partially to blame for this effect, since the state ranked number 33 in ALEC’s 2014 annual state economic outlook “Rich States, Poor States.” And, Maryland ranked near the bottom of the Tax Foundation’s State Business Tax Index at number 47. But estate and inheritance taxes are clearly a factor as well.
This type of thinking is also common in other states that levy a high estate or inheritance tax on residents. For example, the Illinois Policy Institute recently reported that state “death” taxes “chase wealthy retirees out of state.” Illinois loses a large number of residents who migrate to states with no “death” taxes. Commonly, Illinois residents are drawn to Florida, Texas, Indiana, and Wisconsin, which have no estate or inheritance taxes and also have a better business tax climate and no state income taxation.
The reforms to state estate taxes recently adopted by the Maryland legislature, commendably, are a step in the right direction. But, clearly more work needs to be done to improve Maryland’s tax climate. Policymakers in Maryland should consider state tax reforms that encourage entrepreneurs to start and keep business in state, foster a healthy business climate, and discourage wealthy residents from retiring elsewhere. Doing so will help keep investment, consumer spending and wealth in state for the benefit of present and future residents of the Free State.