North Carolina Estate and Gift Tax
After the Enactment of the 
Economic Growth and Tax Relief Reconciliation Act of 2001

"The Code" and EGTRRA. Under federal tax law, there was a state death tax credit available against federal estate taxes under Internal Revenue Code ("Code") Section 2011 equal to the lesser of (1) the amount actually paid to any State with respect to a decedent’s gross estate or (2) an amount determined by formula as a percentage of the adjusted gross estate of the decedent. Under North Carolina General Statutes Section ("N.C.G.S. §") 105-32.2, an estate tax is imposed on the estate of a decedent who is a resident of North Carolina at death, owns any real or tangible property located in North Carolina at death, or owns any intangible property with a tax situs in North Carolina at death equal to the maximum state death tax credit allowed "under Section 2011 of the Code." (If any property in the decedent’s estate is located in a state other than North Carolina, the amount of tax payable is the North Carolina percentage of the credit.) Thus, North Carolina has a "pick up" or "sponge" state death tax: the state death taxes due on a decedent’s estate in North Carolina (absent any reduction for out of state property) equal the state death tax credit against federal estate tax. Many other states have enacted a "pick up" state death tax.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") enacted on June 7, 2001, there is a four-year phaseout of the state death tax credit against federal estate taxes. For decedents dying during 2002, the state death tax credit is 75% of the credit amount as otherwise determined under Section 2011, for decedents dying during 2003, the state death tax credit is 50% of the credit amount as otherwise determined under Section 2011, and for decedents dying during 2004, the state death tax credit is 25% of the credit amount as otherwise determined under Section 2011. For decedents dying during and after 2005, and until the provisions of EGTRRA are repealed effective January 1, 2011, there is no state death tax credit available. The phase out of the state death tax credits appears to be a way for the Treasury to offset projected federal estate tax revenue loss at the expense of the treasuries of those states that have enacted a "pick up" state death tax.

However, whether the reduction and elimination of the state death tax credit under Section 2011 of the Code reduces and eliminates death taxes in those states that have enacted a "pick up" state death tax may depend on the jurisdiction properly imposing state death taxes. As stated above, under N.C.G.S. §105-32.2, for North Carolina decedents, North Carolina death taxes are due in an amount equal to the "maximum credit for state death taxes allowed under Section 2011 of the Code." The "Code" is defined in N.C.G.S. §105-228.90 as "The Internal Revenue Code as enacted as of January 1, 2001, including any provisions enacted as of that date which become effective either before or after that date." Based on this definition of "Code," North Carolina death taxes equal the maximum state death tax credit allowed under Section 2011 of the Code as enacted prior to EGTRRA! It is not clear from the legislative history of N.C.G.S. §105-228.90, which was revised by law on September 28, 2001 (after the enactment of EGTRRA) to update the reference to the Code enactment date from June 1, 1999 to January 1, 2001, whether it was intended by the legislature that North Carolina law take into account the reduction in the state death tax credit under Section 2011 of the Code. It is our understanding that it is the Department of Revenue’s position that, absent further legislation, it will administer North Carolina estate tax based on the Code as it existed prior to EGTRRA based on the plain language of N.C.G.S. §§ 105-32.2(b) and 105-228.90.

How does this affect estate planning for North Carolina residents? For married North Carolina decedents dying after December 31, 2001, the discrepancy between the state death tax credit for federal estate tax purposes and the North Carolina estate tax as calculated based on the pre-EGTRRA Code may result in North Carolina death taxes being due at the death of the first spouse to die under a plan that otherwise would have produced no federal or state death tax liability until the death of the second spouse to die under prior law. In most estate plans for married couples that contemplate maximum use of credits and deductions available against federal estate taxes, the plan provides that upon the death of the first spouse, that spouse’s estate is divided as follows: (1) the maximum amount that can be sheltered from federal estate taxes at the death of the first spouse to die is to be placed in a "credit shelter share," either for the benefit of the surviving spouse, the decedent’s children, or both, that will pass free of federal estate tax by reason of the deceased spouse’s applicable credit against federal estate taxes, and (2) the remainder of the estate is given to the surviving spouse in trust or outright, which share will not be subject to estate tax at the death of the first spouse to die by reason of the unlimited marital deduction. This "zero estate tax" plan traditionally results in no death taxes being due at the death of the first spouse to die; there may, however, be death taxes due at the death of the surviving spouse to the extent that his or her estate exceeds the applicable credit amount. However, for North Carolina decedents dying after December 31, 2001, this plan may result in North Carolina estate taxes being due at the death of the first spouse to die as a result of the estate tax being calculated based on the pre-EGTRRA Code, as per the example below:

Married resident of North Carolina dies on March 1, 2002 without having previously used any of his applicable credit and survived by his wife. His will provides that the maximum amount that can pass free of federal estate tax (i.e. the equivalent of his remaining applicable credit amount, which in 2002 is $1,000,000) is to be held in a credit shelter share for the benefit of his wife. The remainder of his estate is to pass to his wife outright. With a taxable estate of $1,000,000 but an applicable credit equivalent of $1,000,000, no federal estate taxes will be due on the decedent’s estate. Under the pre-EGTRRA Code, a credit shelter share of $1,000,000 would have resulted in a state death tax credit of $33,200. Therefore, $33,200 in North Carolina estate taxes will be due on the decedent’s estate under the statutory interpretation of N.C.G.S. §105-32.2(b) discussed herein. Under this interpretation of N.C.G.S. §105-32.2(b), estimated North Carolina estate taxes under a "zero estate tax" plan would be $33,200 for decedents dying in 2002-2003, $64,000 for decedents dying in 2004-2005, $99,600 for decedents dying in 2006-2008, and $229,200 for decedents dying in 2009. For decedents dying in 2010, there is complete repeal of federal estate taxes, and depending on what a person’s documents provide in that event, North Carolina estate taxes may or may not be due.

For North Carolina decedents dying after December 31, 2001, then, this "zero estate tax" plan could result in North Carolina estate taxes being due at the death of the first spouse to die. Alternatively, the estate plan could provide that the credit shelter share is limited to that amount that will produce no federal or state death taxes. In that event, the credit shelter share will be limited to the pre-EGTRRA applicable credit amount, and as a result, the difference between the pre-EGTRRA applicable credit amount and the post-EGTRRA applicable credit amount in the year of the death of the first spouse to die will be added to the estate of the surviving spouse. This excess amount passing to the surviving spouse may cause the surviving spouse’s taxable estate to exceed his or her applicable credit equivalent, or may increase the amount by which the surviving spouse’s taxable estate already exceeds his or her applicable credit equivalent. Typically, to the extent that this excess is anticipated to produce federal estate taxes, or to produce an increase in federal estate taxes on the surviving spouse’s estate, it should be more advantageous to define the credit shelter share as the maximum amount that can pass free of federal estate taxes and incur some North Carolina estate taxes at the death of the first spouse because of the higher rates imposed under federal law. However, this determination will depend on the couple’s combined estates, the anticipated growth of their estates, any life expectancy information available and the exclusions, deductions and credits against federal and state death taxes that may be available under current legislation.

Absent legislation that would resolve the disparity between the federal and state calculation of the state death tax credit under "the Code," North Carolina couples whose estate plans maximize their credits against federal estate taxes may face payment of North Carolina estate taxes at the death of the first spouse to die. Clients should consult their estate planner to determine whether this is an acceptable result based on their particular situation.

Gift Taxes. One final note: The federal annual exclusion for gifts made in the year 2002 is $11,000 due to indexing for inflation. However, for North Carolina purposes, the annual exclusion for gifts is still $10,000 under N.C.G.S. §105-188(d), which does not provide for inflation indexing. Thus, for $11,000 gifts per donee made by North Carolina resident donors (or for such gifts of North Carolina situs property made by nonresidents) in 2002 that maximize the federal annual gift tax exclusion, there is a $1,000 taxable gift for North Carolina gift tax purposes that should be reported on a North Carolina gift tax return and upon which tax may be due. Each donor is allowed a lifetime exemption of $100,000 against North Carolina gift taxes for taxable gifts made to Class A beneficiaries. Class A beneficiaries are descendants, ancestors, and adopted children or stepchildren of the donor. Thus, absent a legislative change by the General Assembly, gifts made in excess of the $10,000 North Carolina annual exclusion, if not to a Class A beneficiary and covered by the donor’s $100,000 lifetime exemption, should result in North Carolina gift taxes on such excess. Clients should consult their estate planner or other tax advisor on the North Carolina gift tax implications of maximizing their federal annual gift tax exclusions.

This bulletin has been prepared jointly by the Estates, Trusts and Exempt Organizations Section and the Tax Section of Poyner & Spruill, LLP. Contributing editors include: Mark Edwards, Craig Dalton, Bill Belcher, Pearl Doherty, Laura Urich, Frank Meadows and Tom Norris.

If you have any questions regarding this bulletin, please contact Craig Dalton at (919) 783-2943 or craigdalton@poynerspruill.com.