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Pinnacle Resource Center Tennessee's Death Tax: What it Means for You If you thought death taxes were limited to Uncle Sam's pockets, you might be surprised to learn that Tennessee taxes people at death by applying an inheritance tax. Although the Tennessee tax rate is not as high as the federal tax rate, it can still be a significant amount of money. Tennessee's Inheritance Tax The Tennessee inheritance tax is levied on all assets that are transferred as the result of your death, plus any assets over which you had a general power of appointment. That includes real estate, securities, cash, bank accounts, interests in businesses, life insurance, annuities and personal property such as cars, furniture, jewelry and livestock. Families should check the value of all assets, including life insurance, as they consider their long-range planning. Your possessions are subject to the inheritance tax regardless of how ownership is set up. For example, property held jointly is still taxable, though usually only at 50% of value if owned with a spouse. Debts, the cost of administering your estate and certain other expenses are deductible from the value of your assets. The Tennessee Gap Until a few years ago, Tennessee and the federal government exempted the same amount of property from death taxes. Federal estate tax exemptions have significantly increased since Congress passed the Economic Growth and Tax Reconciliation Act of 2001. Tennessee, however, has not adjusted its exemption to match the federal exemption. This difference between the federal estate and Tennessee inheritance tax exemptions is known as the "Tennessee Gap." The Tennessee Gap has widened and will continue to widen over the next several years. For example, in 2002, you could pass $1 million dollars of assets free of federal estate taxes, but could only pass $700,000 of those assets free of Tennessee inheritance taxes. The current exemption for the federal estate tax is $2 million. However, the Tennessee inheritance tax has an exemption of only $1 million. Therefore, the Tennessee Gap is $1 million this year. Under the Act of 2001, the federal estate tax exemption amount will remain at $2 million until 2009, when it increases to $3.5 million. The federal estate tax will be repealed for one year in 2010. In 2011, the exemption returns to $1 million. This means the Tennessee Gap will continue to grow until the reversion in 2011. How the Tennessee Gap May Impact You Unfortunately, many individuals will inadvertently fall into the Tennessee Gap. People who designed their estate plan prior to the recent changes in the federal estate tax law are prime candidates to incur unexpected taxes because of this gap. Most estate plans were written so that, upon the death of the first spouse, an amount equal to the exemption is put in a family trust (or by-pass trust) for the benefit of the spouse and children, and the amount in excess of the exemption is distributed to the surviving spouse (either outright or in trust). The family trust is set up to avoid the federal estate tax on the amount in the family trust upon the death of the surviving spouse, which permits a married couple to effectively use both of their federal exemptions and save up to $1 million in estate taxes. When the state and federal exemptions were the same, any amount passing into a family trust upon the death of the first spouse would have been exempt from both the Tennessee inheritance and the federal estate taxes at the death of the surviving spouse. With a family trust, Tennessee inheritance tax is due when the first spouse dies since an amount in excess of the Tennessee exemption (i.e., the "Tennessee gap") passes to the family trust and not to the surviving spouse. This tax could come as a surprise to the surviving spouse who thought the estate postponed all taxes until his or her death. If you and your spouse have this type of plan in place today, you should consider revising your wills. If you are just beginning your estate plan, the Tennessee Gap will be an important consideration in your tax planning. No matter what your situation, it is a good idea to review your estate plan every few years. You should review your estate plan more frequently if there is a significant change in the tax laws or in your family situation. John may be reached at (615) 904-2727 or john.kea@pnfp.com. He works at Pinnacle's West College Street office in Murfreesboro. Return to the Resource Center Home Page
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