Do death taxes make Iowa a bad place to die? You might think so if you saw a recent Wall Street Journal piece called “States You Shouldn’t Be Caught Dead In“*, or the Forbes online article “Where Not to Die in 2013“. The titles might even get you thinking about moving away from Iowa. The Wall Street Journal article actually featured a 90-year-old man who was considering moving out of Connecticut to avoid the estate and gift taxes imposed by that state. However, neither of these articles says much about death taxes in our Hawkeye State. If you are interested in knowing more about the death tax in Iowa, keep reading.
Two Different Death Taxes
The term “death taxes” is used to refer to the estate tax and the inheritance tax. The two taxes both take effect only after a person dies, but they operate differently. Nineteen states and the District of Columbia have an estate tax or inheritance tax on the books. [Interactive map that includes the most recent legislative changes is here.] Most of them have only the estate tax. Currently, in 2013, there are only 6 states that have an inheritance tax, and Iowa is one of them.
The estate tax based on the value of the estate held by the person who died. It is imposed after the estate’s total value passes a certain threshold. For the federal estate tax that threshold is currently $ 5.25 million. The lowest threshold for a state estate tax is $675,000 in New Jersey. The highest threshold is in Delaware and Hawaii at $5.34 million. Iowa does not have an estate tax.
The inheritance tax is based on the value of property that a beneficiary receives from a person who died. The relationship between the person receiving the property and the decedent determines whether the tax will be owed. In Iowa the nature of the relationship also determines the rate that applies. For example, if you received property from a spouse who dies, or a parent or grandparent, there is no tax. But if you receive property from a brother or sister who has died, there will be a tax that starts at the rate of 5%. And if you receive property from a cousin or a friend who is not a relative, the tax starts at the rate of 10% and goes up to a top rate of 15%. You can find more detail about the operation of Iowa’s inheritance tax and rates here and here.
Iowa Compared to Other States
Is Iowa a bad place to die? Compared to what? If we look at the 6 states surrounding Iowa, we see that Wisconsin, South Dakota and Missouri don’t have any death taxes. Illinois and Minnesota both have an estate tax. The top rate of that tax is 16% in each state, but between the two you would be better off dieing in Illinois. The estate tax there doesn’t apply until an estate’s value passes $4 million. In Minnesota the tax starts at the $1 million level, and the state just added a gift tax effective July 1, 2013 to make it more difficult for Minnesotans to avoid the estate tax.
The last of the 6 states is Nebraska. It has an inheritance tax with a top tax rate of 18%. That is worse than Iowa’s top inheritance tax rate of 15%. A bigger difference between the two states is how the exemptions to the tax work. Nebraska allows a person who is subject to inheritance tax to keep the first $10,000 free of tax, unlike Iowa, where the tax starts with the first dollar of value received. That slight advantage is offset by the fact that Nebraska’s inheritance tax applies to everybody except the surviving spouse. In Iowa the surviving spouse, children, grandchildren, parents, and some others are exempt from paying inheritance tax. Since children and grandchildren receive most estate property when there is no surviving spouse, the Nebraska inheritance tax will affect more people than Iowa’s.
Where does Iowa stand among all the states the have an inheritance tax? According to “These 6 States Tax Inheritances the Hardest“, of the 6 states with inheritance tax Iowa ranks number 4 in the burden imposed. However, the two states ranked below Iowa are Maryland and New Jersey, and both of those states also have an estate tax.
It is difficult to compare Iowa to states that have an estate tax, because the estate and inheritance taxes operate differently. That means several factors could affect the comparison. For the very rich, the estate tax in the other states will almost certainly apply. Advantage Iowa for the very wealthy. For people who have smaller estates, there will be no death tax imposed in the 13 states that have only an estate tax, whilc in Iowa there is a chance that inheritance tax would apply.
Iowa Inheritance Tax and Estate Planning
People living in Iowa who plan to leave everything to their surviving husband or wife, or to their children or grandchildren don’t have to worry about the Iowa inheritance tax affecting their estate plan, provided that two other conditions are also met. The conditions are: (1) they don’t own any property located in a state that does have an inheritance tax or estate tax; and (2) they will never move to the District of Columbia or one of the other 18 states with a death tax. If property is owned in a state with a death tax, some tax could be owed when the property owner dies. Similarly, moving from Iowa to the District of Columbia or a state with a death tax could have adverse consequences. For example, if a multimillionaire whose estate plan leaves everthing to chilren or grandchildren moves to Minnesota or Nebraska before death, there will be a significant amount of death tax to pay. There would be no death tax if that person stayed in Iowa.
The people in Iowa who should consider the inheritance tax when making an estate plan include the following groups:
- Those with no children or grandchildren
- Those who have a live-in boyfriend or girlfriend (significant other) that the person would want to inherit some or all of his or her assets
There are some techniques that can be used to minimize or avoid Iowa inheritance tax. These include:
- Making lifetime gifts
- Marrying the intended beneficiary
- Using life insurance proceeds or exempt retirement accounts as the source of funds to be transferred to nonrelatives
- Adoption of the intended beneficiary
- Leaving your assets to a qualified charity or nonprofit organization
- Moving from the State of Iowa
There are some advantages and potential disadvantanges to each of these techniques, and in some cases technicalities to follow to make sure the intended benefit is obtained. These are discussed in more detail in the post “Avoid Iowa Inheritance Tax – Some Suggestions” at my Iowa Planning and Probate blogsite.
(If, after considering every listed above, you still want to move from Iowa to minimize taxes, or if you want to move from Iowa for other reasons, you might want to check out “10 Best & Worst Tax States for Retirees“.)
* If link is blocked by the paywall, you can try here.
Posted by James Radig