In our last column, we discussed changes to the Federal Estate Tax. This writer’s conclusion was that, despite a personal philosophical aversion to the statist premises on which the edifice of the estate tax is built, that disagreeable tax is preferable to the unmanageable alternative.

Maryland’s estate tax system has undergone significant changes since last year. In prior days, the Maryland estate tax simply "soaked up" a credit to the federal estate tax, so estates not subject to the federal tax also had no liability for the Maryland tax.

Effective in 2001, changes to the federal estate tax effectively eliminated that credit, and states were forced to rewrite their estate tax laws to preserve the revenue generated by the credit. Declining state budgets combined with rising federal estate tax exemptions forced states to make even more drastic changes in the years since 2001.

The result is that about one-third of the states have "decoupled," that is, unlinked their state estate tax exemption from that of the federal government. In most cases, the state exemption is the same as the federal exemption in 2001 – that is, $1 million.

The rationale for this change is not hard to understand, since the federal exemption rises in an uneven stairstep pattern from 2004 through 2009, then is eliminated due to the repeal of the estate tax for one year, then reappears as a $1 million exemption in 2011. Rather than participate in the federal government’s crazy-quilt loss of revenue, the states have chosen to stabilize their exemption and their revenues.

Maryland is one of the states that has decoupled its estate tax exemption from the federal exemption. The Maryland exemption is currently $1 million – sort of. In reality, the Maryland exemption – the estate on which no Maryland estate tax is paid – is $100,000, but the filing and tax payment threshold is $1 million.

That means that an estate of $900,000 would file no return and pay no tax, but an estate of $1.1 million would file a return and pay a tax of $38,800. The stated rate of tax for an estate of $1.1 million is 6.4%, but the effective rate of tax on the $100,000 over the filing threshold is 38.8%, which feels a lot like the federal estate tax rates.

At the 2005 federal estate tax threshold of $1.5 million, at which point no federal estate tax is owed, the estate would pay $64,400 of Maryland estate tax. All of these computations are simplified for illustration purposes and use the 2004 forms released by the Comptroller’s office. The 2005 forms have not yet been released.

Many of this writer’s clients are dismayed to find that the estate that they thought would be tax-free is actually taxable, and taxable in significant amounts. Maryland estate tax avoidance planning is becoming as common as the federal estate tax planning practiced in the past by this writer and others, but with a twist requiring careful explanation and reasoned decisions. Consult your tax counsel to be sure your estate and financial plan account for this complexity.