Tax-Smart Moves: Why State Estate Tax Planning Matters More Than You Think

For many affluent households, estate planning begins and ends with the federal estate tax. The federal exemption, currently $15 million per individual, often feels comfortably out of reach. 

For high-net-worth families, however, state estate and inheritance taxes present a real and frequently overlooked risk. 

State estate tax planning plays a critical role in making tax-smart moves. Understanding how state rules differ from federal law and how those rules interact with an overall estate plan may help families evaluate planning alternatives, identify potential risks, and make more informed decisions. 

Federal vs. State Estate and Inheritance Taxes: Key Differences 

The federal estate tax applies uniformly across the United States. It assesses tax based on the value of an estate above the federal exemption at death. For married couples, portability generally allows a surviving spouse to use a deceased spouse’s unused federal exemption, provided certain requirements are met. 

State-level transfer taxes follow an entirely separate set of rules. States impose two primary types of taxes: 

• State estate taxes, assessed on the estate before assets are distributed  
• State inheritance taxes, assessed on individuals who receive an inheritance, often with exemptions for spouses or close relatives 

State exemptions often sit far below the federal threshold. In some cases, state taxes begin at estate values well under $5 million. A household that owes no federal estate tax may still face significant state tax liability, depending on domicile and applicable law at death. 

Each state also sets its own exemption amounts, tax rates, portability rules, and definitions of taxable estates. This patchwork of laws adds complexity and increases the risk of costly planning gaps. 

Portability at the State Level Is Not Guaranteed 

Portability is the ability for a surviving spouse to “inherit” a deceased spouse’s unused estate tax exemption. Many families assume portability applies automatically at both the federal and state levels. That assumption often proves incorrect. 

Only a limited number of states recognize portability for state estate tax purposes. Many do not. In those states, failure to use the first spouse’s exemption at death can permanently eliminate it. 

For families with estates near or above a state exemption level, planning at the first death can be just as important as planning for the second. Relying solely on portability may increase future state estate tax exposure. 

Credit Shelter Trusts and Smart State Planning 

A credit shelter trust, also known as a bypass trust, is one commonly used planning tool for addressing nonportable state estate tax exemptions. 

At the first death, assets up to the applicable exemption amount can pass into the trust. This approach locks in the exemption and removes those assets and their future appreciation from the surviving spouse’s taxable estate for federal and state purposes, depending on the structure. 

Key benefits of credit shelter trusts include: 

• Preservation of the first spouse’s exemption when portability does not apply 
• Sheltering of post-death asset growth from future estate taxes 
• Asset protection and controlled distributions for beneficiaries 

Potential trade-offs include: 

• Reduced access to trust assets for the surviving spouse  
• Added administrative complexity  
• Possible income tax considerations, depending on trust design and funding 

For families subject to state estate taxes, the long-term tax savings and control often outweigh these drawbacks. 

Domicile Planning: Moving with Purpose 

Many affluent families explore changing legal domicile to a state without an estate or inheritance tax. 

From a tax perspective, the appeal is clear. Domicile planning, however, requires more than purchasing a second home or changing a mailing address. 

Potential advantages include: 

• Elimination or reduction of state estate or inheritance tax exposure 
• Simplified long-term estate planning 
• Alignment with retirement or lifestyle goals 

Risks and considerations include: 

• Increased scrutiny from taxing authorities 

• Ongoing emotional, family, or business ties to the former state 
• Trade-offs involving income, property, and sales taxes 
• The need to demonstrate clear intent and consistent behavior 

Successful domicile planning requires a holistic approach that integrates tax considerations with lifestyle preferences, family dynamics, and long-term objectives. 

Lifetime Gifting as a Tax-Smart Strategy 

Lifetime gifting plays a central role in state estate tax planning, particularly in states with low exemptions and limited portability. 

By transferring assets during life, families may be able to reduce future estate tax exposure while supporting children, grandchildren, or other beneficiaries today. 

Common gifting strategies include: 

• Annual exclusion gifts to family members, currently $19,000 per recipient 
• Direct payments for tuition or medical expenses 
• Larger strategic gifts using remaining lifetime exemptions 
• Trust-based gifting to maintain control and provide asset protection 

The most effective approach depends on asset composition, cash flow needs, and state-specific rules related to gift add-back or clawback provisions. 

Philanthropy and State Estate Taxes 

For charitably inclined families, philanthropy can serve both personal values and tax efficiency. 

Charitable gifts made during life or at death typically reduce the taxable estate at both the federal and state levels.

Common strategies include: 

• Outright charitable bequests 
• Donor-advised funds 
• Charitable remainder or charitable lead trusts 

When coordinated thoughtfully, charitable planning can potentially mitigate state estate taxes while supporting a family’s broader legacy goals. 

Integrating State Estate Tax Planning Into the Bigger Picture 

State estate tax planning works best when integrated with other elements of a comprehensive wealth strategy, including: 

• Federal estate planning 
• Income tax planning 
• Retirement and cash flow projections 
• Investment management 
• Family governance and legacy planning 

For families with net worth between $2 million and $10 million where state estate taxes may apply, proactive planning can materially affect long-term outcomes. Strategies must be evaluated based on individual circumstances and applicable law. 

Planning Ahead Is the Smartest Tax Move 

State estate and inheritance taxes often remain underappreciated until late in the planning process. Reviewing how state systems differ from federal rules and considering available planning approaches may help families reduce uncertainty and better align plans with long-term objectives. 

Regular reviews with qualified advisors can help ensure estate and domicile strategies stay aligned with changing laws, evolving family needs, and long-term financial goals. 

This material is for educational and informational purposes only and is not intended as legal or tax advice. Estate and tax laws vary by state and are subject to change. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment or tax advice from Savant. Please consult your investment or tax professional regarding your unique situation.