Written by David M. Hanson, CPA
Iowa Estate Tax
In recent years, the State of Iowa, like many other states in the U.S., had a state estate tax that subjected sufficiently large estates to tax. This tax was in addition to federal estate taxes that may have applied. The result – for sufficiently large estates a great deal of money, in the form of state and federal estate taxes, went to the government instead of estate beneficiaries.
Thankfully, due primarily to changes in federal estate tax law, most states, including Iowa, no longer have a state estate tax. States such as Iowa had an estate tax that was directly linked to the federal estate tax calculation. When the federal estate tax calculation was modified in 2005 to remove the direct link, the state estate tax was effectively eliminated. Needless to say, Iowa, and many other states, were not happy with this result caused by the federal law change. Bottom line to the states; less tax money coming to them.
Not much has been heard about the Iowa estate tax in recent years because it was repealed by the Iowa legislature effective July 1, 2008. However, a “loophole” was left in the Iowa law that if the federal estate tax calculation was revised back to what it was pre-2005 (see above) the Iowa estate tax would once again come back into existence and apply. The good news is that the Iowa legislature once and for all repealed the Iowa estate effective July 1, 2014.
Iowa Inheritance Tax
Unlike the above, there is no good news to share regarding the Iowa Inheritance Tax. It remains applicable and in force. This tax is Iowa’s principal “death tax” and is somewhat unusual in that very few states in the U. S. have such a tax. Just our luck….
The Iowa inheritance tax is relatively simple in terms of determining what is potentially taxable. Specifically, all assets of the decedent are determined and listed on the return. These assets are recorded at their fair market value as of the date of the decedent’s death. There are select assets that only part of which or no amount are required to be included on the return (such as, but not limited to, life insurance payable to someone other than the decedent, joint tenancy property, life estates, etc.). From the list of the decedent’s assets are subtracted certain liabilities and debts of the decedent. These liabilities and debts include items such as, but not limited to, mortgages on Iowa property, funeral expenses, and attorney fees. The net amount of assets minus liabilities/debts results in the amount of the estate that is potentially subject to the inheritance tax.
At this point, things start to get a bit tricky. The amount of tax that is ultimately owed is based upon an analysis of who the decedent’s property is being transferred to. The results of this analysis culminates in what the inheritance tax return calls the “Computation of Shares”. Specifically, the “Computation of Shares” looks at who is getting a share of the decedent’s estate and what their relationship was to the decedent. Certain relationships (“exempt relationships”) qualify for complete exemption from the inheritance tax; other relationships, i.e., “non-exempt relationships”, are subject to the tax at varying rates.
Examples of exempt relationships include the following; i) spouse, ii) parents, iii) great-grandparents, and iv) lineal descendants (such as children). Examples of non-exempt relationships include the following; i) aunts/uncles, ii) nieces/nephews, iii) brothers/sisters. The rate of tax that is applicable to the share allocable to a person who is considered to have a non-exempt relationship with the decedent ranges from 5% to 15%. As you might guess, depending on the size of the estate and to whom it is going, the amount of tax payable can add up to a sizable number.
For individuals who have determined to whom their estate is ultimately going to pass to it would be wise to recognize the potential applicability of the inheritance tax up front and make a rough calculation of what the tax might be. From there, those individuals, in consultation with their professional advisor, could investigate what planning alternatives may exist that could reduce or even eliminate the inheritance tax.
As is usually the case with the tax law, there are many variables and nuances to consider in each taxpayer’s situation. Seeking the advice of an experienced, qualified tax professional is highly recommended.