New Estate Tax. Under federal estate tax rules, a decedent's estate is given a "Credit for State Death Taxes" subject to limits contained in a schedule contained in the Code. This credit is not available unless the amount of the credit is actually paid to the state in question. Many states have abolished their separate estate and inheritance tax systems and have adopted a "pick-up" system that requires the estate to pay to the state the amount that is allowed as a credit by the federal system. While "arriving late for the dance" by doing this after most other states, North Carolina has now adopted a "pick-up" tax system. The effect of North Carolina's new estate tax being tied to the state death tax credit allowed for federal estate tax purposes is that our residents will automatically receive the benefit of the federal applicable credit amount as it increases to $1,000,000 on January 1, 2006. As an example, if a North Carolina resident dies in 1999 with a taxable estate of $750,000, the tentative federal estate tax is $248,300, reduced by the applicable credit of $211,300 and by the credit for state death taxes of $20,400, for a net estate tax due to the I.R.S. of $16,600. Under the new North Carolina estate tax, the estate will owe North Carolina $20,400, the amount allowed on the federal return as a credit for state death taxes.
Unified Federal Transfer Tax System. For federal tax purposes, the estate and gift tax systems are "unified", that is, the tax rates for transfers at death and for lifetime gifts are the same and the federal system provides an "applicable credit" which allows a person to transfer $650,000 by gift or at death in 1999. This "applicable credit" will increase yearly until January 1, 2006 when it will protect transfers of $1,000,000 from estate and gift tax.
Other Related Gift Tax Rules. North Carolina is already consistent with the federal system in allowing an unlimited marital deduction for transfers between spouses during life and at death. Therefore, there is no tax cost to couples who need to rearrange the ownership of assets between themselves.
In addition, both North Carolina and the federal system allow a person to make tax-free gifts of $10,000 per year to any number of donees. Both systems allow a married couple to treat a $20,000 gift by one spouse as a "split-gift", thereby allowing both spouses to obtain the benefit of a $10,000 annual exclusion even though one spouse owned all of the property that was given away.
Unfinished Business. Despite the inheritance tax repeal which gives North Carolina residents the benefit of the full applicable credit amount for transfers at death, North Carolina has not fully unified its estate and gift tax system. For federal transfer tax purposes, the applicable credit amount of $650,000 can be transferred during life or at death without tax. North Carolina's gift tax law retains several undesirable features:
* North Carolina only allows gifts of $100,000 during life without gift tax.
* North Carolina retains different tax rates depending on the relationship of the donee to the donor, so North Carolina residents are penalized if they choose to make gifts to siblings, in-laws, loyal employees, etc., as opposed to gifts to children and grandchildren.
* The $100,000 exemption for lifetime gifts is only available for gifts to children, grandchildren, stepchildren and parents, a fact which often surprises taxpayers who want to make gifts to spouses of their children.
The result of North Carolina's retention of separate estate and gift tax systems is that it can be very expensive for a North Carolina resident to take advantage of the applicable credit amount by making a lifetime gift. If a North Carolina resident desires to give a $500,000 farm equally to three children in 1999, there would be no federal gift tax because the value of the gift is less than the applicable credit amount of $650,000. However, assuming that the $10,000 annual exclusion gifts had already been made, there would be North Carolina gift tax due of $14,450. Many clients find that this tax is a significant deterrent to moving assets to children during life.
Editorial Comment. At the present time, North Carolina is in a distinct minority of states that retain such an archaic gift tax system. In 1999, it seems out-of-step with modern views of appropriate tax policy for North Carolina to maintain a tax system that effectively makes judgments about whom a taxpayer chooses to be the recipient of his or her gifts. The North Carolina General Assembly should unify the State's estate and gift tax system so that our citizens will have the opportunity to transfer the same property during life and at death and so that there is no tax penalty for making gifts to in-laws, siblings or other donees who do not happen to be children or grandchildren.