The New Hawaii Estate Tax (June 2010)

There is now a new Hawaii estate tax.  The bill proposing the tax (House Bill 2866) was vetoed by Governor Lingle on April 25, 2010.  The Hawaii legislature overrode the veto on April 29, 2010, and the bill became Act 74 on April 30, 2010.  It imposes a tax on the estates of persons dying after April 30, 2010.

Let me first explain the history of the Hawaii inheritance tax and the Hawaii estate tax.  An estate tax is a tax on the property of someone who has died.  The federal death tax is an estate tax. An inheritance tax is a tax on property that is inherited by each beneficiary or heir.  When I first became an attorney in 1976, there was a Hawaii inheritance tax.  I remember preparing Hawaii inheritance tax returns.  Then Hawaii adopted The Estate and Transfer Tax Reform Act of 1983.  When this law was adopted, the Hawaii death tax became an estate tax.  Hawaii’s estate tax was called a “pick-up tax.”  It allowed the State of Hawaii to pick up (or collect) for itself part of the estate tax which the federal government could collect.  The amount that Hawaii could collect was the maximum amount that the federal government allowed as a credit for state death taxes against the federal estate tax.  Later, the federal government passed the Economic Growth and Tax Reconciliation Act of 2001.    This tax act phased out the state death tax credit at the rate of 25% a year starting in 2002.  This meant that the amount of the federal death tax which Hawaii got to keep was reduced each year, until it became zero.  Since 2005, there has been no Hawaii death tax, until now.

The new Hawaii estate tax law is poorly written.  It would be difficult for someone to understand the new law without doing some tax research and without knowing the history of the federal estate tax and the Hawaii estate tax.  When you first read the new law, it sounds like the tax only affects nonresidents who are not citizens of the United States.  After researching the federal and state tax laws referred to, you realize that the new law affects Hawaii residents and citizens as well.

It appears that under the new law, there will be no Hawaii estate tax to pay unless you die with a taxable estate of more than $3,600,000.  Although the new law allows a $3,500,000 tax free amount, when you actually calculate the tax, another $100,000 is tax free, for a total of $3,600,000.   For the first $50,000 over $3,600,000, the tax rate is only .8%.  For those who die with a taxable estate of more than $10,100,000 the tax rate goes as high as 16%.

If a married person with an A-B trust with more than $3,600,000 dies in 2010, since there is no federal estate tax this year, the entire estate would go into the B trust, and nothing would go into the A trust (the marital trust). Everything going into the B trust in excess of $3,600,000 would be subject to the new Hawaii estate tax.  Some or all of that tax could be avoided by changing the trust to cause some assets to go into the A trust.  In 2011 or later years, under current law only $1,000,000 will be exempt from the federal estate tax but $3,600,000 will be exempt from the Hawaii estate tax.  Depending on the size of the estate, there may be tax savings by arranging the estate plan so that some tax is paid when the first spouse dies, instead of deferring all taxes until the second spouse dies.   Anyone with assets large enough to be taxed should have their estate plan reviewed to see if any changes are warranted as a result of the new Hawaii estate tax or the reduction in 2011 of the federal tax free amount to only $1,000,000.

13 replies
  1. lu fleming
    lu fleming says:

    what are pros/cons of creating an LLC in Nevada vs Hawaii for properties owned in Hawaii? am told it is preferred to do it in NV for (less) tax purposes? should one list the newly created LLC with a resident agent who would charge $100. annually so that no one would have access to your own address?

  2. Carol Ching
    Carol Ching says:

    Please tell me where I can find a chart of the estate value over $3,600,000 and the % tax rate per increasing values of $50,000.

    In other words, what is the tax rate of an estate valued at $5 mil?

    thank you

  3. Will
    Will says:

    I found this page and I wonder, does your article change in light of the new federal bill that raised the exempt amount to $5 million? Would it now be $5,100,000 that is tax-free? The 2010 revised M-6 form shows a deduction of $60,000, but maybe that deduction was in the earlier form? Thanks, your article was very clear and easy to understand.

  4. Sanford Okura
    Sanford Okura says:

    @lu – It depends on what kind of taxes you are concerned about. If you are concerned about income taxes, such as rental income, or capital gains taxes when you sell property, then it doesn’t matter whether the LLC is created in Nevada or Hawaii, because the State of Hawaii will tax the rental income earned in Hawaii and the gain on sale of property in Hawaii, regardless of where the LLC was set up. You will also have to pay the 4% Hawaii general excise tax on rental income earned in Hawaii, regardless of where the LLC was set up. In fact, it may cost a little more to set up a Nevada LLC, because you would then have to register it in Hawaii to do business in Hawaii, besides paying fees charged in Nevada. The property would be subject to both federal and State of Hawaii estate taxes, since the property is located in Hawaii. However, if you have a large estate and are concerned about reducing gift taxes or estate taxes, there can be an advantage to setting up a special kind of LLC found so far only in Nevada. It is called a Nevada Restricted LLC. When a business valuation (an appraisal) is done of the fair market value of shares of an LLC, it is possible to get a larger valuation discount, and therefore, a smaller estate for gift tax or estate tax purposes, when using a Nevada Restricted LLC than when using LLCs from other states. The Nevada law allowing this was pioneered by Steve Oshins, a nationally reknowned estate planning expert, who acts as co-counsel with our law firm for some of our wealthier clients in Hawaii.

  5. Sanford Okura
    Sanford Okura says:

    @Will – That is a good question. Let me tell you an interesting story about the new Hawaii Estate Tax law. About the time that the new federal estate tax provisions became law in December of 2010, I received a communication from an associate editor of Forbes, asking me whether the Hawaii estate tax exemption would stay at $3.5 million, or increase to $5 million, since the federal exemption had been increased to $5 million. I was very busy at the time and by the time I got back to her a few days later, she had talked with someone at CCH who had told her that the Hawaii exemption would be $5 million. CCH is a very well established, highly regarded company that provides tax information for accountants and attorneys. Apparently, someone at CCH had read the new Hawaii estate tax law and had concluded that the Hawaii exemption moves in sync with the federal exemption. The Department of Taxation of the State of Hawaii, on the other hand, has told members of the public phoning them that the Hawaii estate tax exemption stays at $3.5 million in spite of the federal exemption being $5 million. The Hawaii statute on this subject is poorly written and is ambiguous. In my opinion there are at least 3 different interpretations that could be argued: 1) that the Hawaii exemption stays at $3.5 million regardless of what the federal exemption may be; 2) that the Hawaii exemption will always be the same as the federal exemption, whatever it may be; and 3) that the Hawaii exemption will be the same as the federal exemption if the federal exemption is at or lower than $3.5 million, but will never exceed $3.5 million if the federal exemption is greater than $3.5 million. If the Hawaii legislature does not clear up the language in the statute, I predict that the estate of a Hawaii resident who dies in 2011 with more than $3.5 million will challenge the state’s interpretation of the statute and claim that the Hawaii exemption should be $5 million. As to your question about the $60,000 figure, please see our law firm’s version of the Hawaii Death Tax Calculation Chart, which is now posted on our website. You will note that you subtract $60,000 from the taxable estate (as shown on the federal estate tax return) before you use the chart. Then, the first $40,000 of assets have a tax rate of 0%. Add the $60,000 and $40,000 together, and that is how you get the extra $100,000 of exemption above the $3.5 or $5 million exemption.

  6. Jeannie Yoshida
    Jeannie Yoshida says:

    My mom wants to pass on her money and property to her children. What is the best way to do it to avoid inheritance taxes?

  7. Sanford Okura
    Sanford Okura says:

    @Jeannie – The answer to your question depends on many different factors, such as: how much she has in assets, how much of her lifetime exemption from gift taxes she has already used up, how many children she has, whether the children would like to receive their inheritance with protection against divorce and against estate taxes when the children die, whether there is a concern about protecting her assets from nursing home costs, her current age, her health status, how important it would be to the children to received a stepped up tax basis upon mother’s death, etc. Generally, we have our clients consider the possibility of making the gift to an irrevocable generation skipping trust. The advantages of this are that 1) if any of the children ever get divorced, the divorcing spouse will not be able to take the assets inherited from mother; 2) if any of the children die, the inherited assets are guaranteed to pass to the children of that child, rather than to the surviving spouse of the child (who might leave the assets to a new spouse); and 3) when the children die, there will be no estate tax on the inherited assets, no matter how much they grow in value. If mother has more than $1,000,000 in assets, she probably should consider doing something soon, before the law changes. Right now, a person can give up to $5,000,000 of tax free gifts during her lifetime, in addition to the $13,000 per year annual exclusion. However, from January 1, 2013, only $1,000,000 can be given tax free. Some of our wealthy clients are giving away millions in assets this year tax free, because the law could change at any time. If potential nursing home costs are a concern, then there are special ways of giving to protect assets from nursing home costs. Your mother really should have an analysis of her estate done to determine the best way for her to give away assets. Our law firm does offer a free analysis and initial consultation for estate planning cases. Best wishes to you and your family.

  8. Mario Arnaldo
    Mario Arnaldo says:

    My wife and I are ready to file our joint income tax returns for 2011. Our estate and property in Hawaii is way below $3.6 million. I checked the DOT website and have asked DOT if there is any paperwork we have to fill out to validate we don’t have to file this estate tax. I’ve e-mailed them twice in the past 30 days and no response. I’ve tried calling, but I don’t have the time to stay on line if “You are caller #23 . . .”

    Can we proceed to file our normal income tax returns, or do we have ADDITIONAL estate-related paperwork to complete?

  9. Sanford Okura
    Sanford Okura says:

    Mario, an estate tax return needs to be filed only for the estate of someone who has already died. By now you would have filed your normal income tax returns, and you don’t have to worry about filing any estate tax return at this time.

  10. Mario Arnaldo
    Mario Arnaldo says:

    Atty Okura,
     
    Thank you for taking the time to reply. I also replied to you via my Gmail account. Appreciate your feedback, and I validate that we’ve already filed our “normal income tax returns”, and that my wife and I won’t worry about filing any estate tax return at this time. Should my mother-in-law pass away, is the correct form to use the m6_f Hi Estate Tax form?
     

  11. Damian in Ewa Beach
    Damian in Ewa Beach says:

    Mr. Okura, My mother-inlaw passed away last year and her house on the mainland just sold. The procedes are being split 3 ways and I was wondering if those monies are considered inheritance or an estate. We are expecting less than 100k and can’t determine what, if any tax liability we will have. If it is not taxable as inheritance or an estate, is it still taxable “income”?

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