New Hampshire Poised to Adopt State-Level Tax**

By Jan P. Myskowski

March 27, 2009

By now, many financial professionals are aware that New Hampshire’s legislature is considering a bill to introduce a new state-level estate tax, but events last week indicate it may be time to start making clients aware of this pending legislation. House Bill 691, captioned “An Act relative to the New Hampshire Estate Tax,” would impose an 8% tax on estates in excess of $2 million (the tax being imposed on the amount in excess of that exemption). Last week, the House Ways and Means Committee voted to send the bill out of committee with an ought to pass recommendation. Certain members later moved to retain the bill in committee so that it can be incorporated into House Bill 2, the omnibus budget bill, but the preliminary vote indicates that the bill has a good chance of surviving in some form.

The text of the bill leaves many unanswered questions in terms of the administration of a new state-level estate tax. One thing appears clear, however: New Hampshire will very likely have an exemption that is lower than the federal estate tax exemption, which stands at $3.5 million for deaths occurring in 2009. This “decoupling” of the New Hampshire estate tax regime from the federal estate tax regime would create some important drafting challenges for trust and estate attorneys.

New Hampshire currently has an estate tax on the books, but due to the federal Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), the law is effectively nullified. The existing law, known as a “sponge tax,” calls for collection at the state level of an amount equal to the maximum federal credit for state death taxes. EGTRRA phased out the state death tax credit (and replaced it with a less valuable deduction), so the existing New Hampshire law results in the collection of no state-level estate tax. New Hampshire is now poised to join the many states that have responded to this change in the federal law by enacting state-level estate taxes that operate independently of the federal regime, usually with exemptions much lower than the federal exemption.

Drafting concerns raised by the change primarily affect married couples. Old formula clauses geared entirely toward zeroing out the federal estate tax on the death of the first spouse to die worked just fine when states had sponge taxes because sponge taxes required no separate computation of a state-level taxable estate. With decoupled state-level tax regimes, a separate computation of a state-level taxable estate occurs. Under the typical “old” formula clauses, the surviving spouse received an amount equal to the federal exemption in a form not qualifying for the federal marital deduction. In rough terms, this non-deductible gift constituted the taxable estate, but it was offset by the federal estate tax exemption, so no tax came due on the first spouse’s death. Old formulas may result in surviving spouses receiving amounts in excess of the state level exemption in a form that will not qualify for a state-level marital deduction, leaving a state-level taxable estate. This would result in a state-level estate tax coming due on the first spouse’s death.

Drafters have addressed this challenge by modifying clauses to allow all amounts passing to surviving spouses in excess of the state-level exemption to be in a form that will qualify for both the federal and state-level marital deductions. Most states with decoupled taxes permit a state-only marital deduction for the spread between the state-level exemption and the federal exemption to avoid causing excess taxation of the surviving spouse’s estate for federal estate tax purposes (House Bill 691 does not address this issue, but it is likely that such a state-only marital deduction would be incorporated into the final version of the law).

Many New Hampshire practitioners have already incorporated these types of “new” clauses into their clients’ documents to account for the possible application of other states’ laws due to multi-jurisdictional property ownership and client relocation; but at the moment, this generally occurs only for new clients and for those who are seeking routine review of their existing plans. The prospect of New Hampshire’s adoption of a decoupled tax raises the urgency of getting existing documents updated, and getting clients with no documents to prepare them.

Fortunately, we appear to have dodged one bullet in the legislative arena this year. House Bill 543 would have resurrected the Legacies and Successions Tax, which imposed an 18% tax on gifts to non-lineal descendants. Although this tax did not apply to a high percentage of estates, every estate had to comply with onerous reporting procedures. Thankfully, House Bill 543 has been deemed inexpedient to legislate by the House Ways and Means Committee.

** This bill did not pass the Legislature in 2009.

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