Rhode Island estate tax can be avoided

Benjamin Franklin once opined that the only things certain in the world are death and taxes. If Franklin were alive today and living in Rhode Island, he would certainly confirm the latter.
Rhode Island and New Jersey have the distinction of being two states with the most burdensome estate tax systems in the country, which is proving costly for a growing number of families in the Ocean State, particularly retirees.
Simply put, the estates of Rhode Islanders valued at $675,000 or more are taxed on the transfer of assets to non-spouses. By comparison, under the federal system, the transfer of estate assets is not taxed until the estate assets exceed $2 million and that figure will climb to $3.5 million in 2008. Rhode Islanders are taxed on such a low threshold that it has prompted in recent years an exodus from the state, especially by retirees.
Not all is bleak, however. There are several ways that families in this state can legally reduce the effect of the estate tax, sometimes referred to as “death tax.” By seeking the right advice, retirees may not have to flee to states with more favorable tax climates.
That’s a gift
Despite its taxing ways, unlike the federal system, Rhode Island does not tax gifts. So how can families apply this concept to their estate? Consider the following: An elderly Rhode Islander’s estate is valued at $1.1 million, which under Rhode Island’s current system would still subject him to the estate tax. However, if that same elderly parent gives away $425,000 of his estate to his children during his lifetime, he would reduce the estate’s value to $675,000. As a result, the individual’s heirs would avoid paying $38,800 in estate tax.
Before gifting, donors need to realize that it causes the loss of donor control over both assets and beneficiaries as well as the loss of an increased post-death income tax basis to the beneficiaries, further causing potential increased capital gain tax on assets. Any contemplated gifting should only be accomplished after consultation with a tax professional.
Use of revocable trusts
Another sound option is the use of revocable trusts with estate tax savings provisions. Just what does that mean? A married couple can establish two revocable trusts, essentially “souped-up” wills, which are amendable and “see-through” for income tax purpose, which contain provisions that cause the first $675,000 of estate assets to remain in the taxable estate of the deceased spouse and in trust for the benefit of the surviving spouse.
Upon the death of the survivor, both spouses are able to pass assets in a manner which fully utilizes their respective $675,000 estate tax exemptions. Using our previous example of the $1.1 million estate, the couple would avoid paying the estate tax as a result of the doubled exemption.
Properly created revocable trusts are valuable on several fronts: They help families avoid the probate process, both in the event of incapacity as well as the death of the creator of the trust. They also provide an efficient and private manner to effectuate the passage of wealth.
Spousal disclaimers, a legal ‘No, thank you’
Even if a married couple has not set up revocable trusts, hope remains for reducing federal and state estate tax. If set up properly within someone’s estate plan, a spousal disclaimer is an effective way of skirting the estate tax.
For instance, let’s assume that the husband dies, leaving the entire amount of our previous $1.1 million example to his wife. The wife can decline or say “no thank you” to that amount of his estate necessary to reduce her remaining estate below the Rhode Island estate tax exemption amount. The declined portion of husband’s estate would be pushed back into the estate and could pass either into a trust for the wife or to the couple’s children or contingent beneficiaries, producing a similar estate tax result to the revocable trust tax planning method without the complexity of the drafting provisions.
Making the most of life insurance
In instances where families don’t want to face gifting or the potential complexity of the previous techniques, special types of trusts can be established to own life insurance in a manner that won’t cause the death proceeds to be counted for estate tax purposes. This can provide liquidity to the heirs to satisfy the estate tax, thereby preserving the estate assets. This technique can also be used to cover tax on those estates that exceed the doubled-exemption amounts outlined earlier.
One quick reality check: It’s important for families to remember that everything they own is included by the State of Rhode Island to calculate the $675,000 exemption, including real estate, insurance, investments and retirement assets. In addition, the state includes non-Rhode Island assets in its formula to calculate estate tax.
Still, despite the burden of estate taxes in Rhode Island, there exists the potential for considerable relief. And when done correctly – and in conjunction with a tax professional –these techniques can be very effective tools for reducing the burden of Rhode Island’s estate tax.
Even Mr. Franklin would approve. •
Joseph R. Marion III is an attorney with Burns & Levinson LLP in Providence and focuses his practice in estate and long-term care planning and estate administration.