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DC Taxpayers Should Beware of Low Local Estate Tax Threshold 

When planning their estates, District of Columbia residents, in particular, need to structure their Wills to maximize their estate tax avoidance. 

While the federal threshold for paying estate taxes has been raised in recent years to $15 million per spouse, DC’s threshold is much lower, and the rate of tax is higher than the DC “universal” income tax rate of around 10%. In addition, from a federal perspective, the first spouse to die may leave his or her exemption to the second spouse so that the second spouse to die pays federal estate tax only on amounts over $30 million, their combined exemption. This “portability” of the federal exemption is elected easily by clicking a couple of boxes in the first spouse’s estate tax return. 

In DC, the picture is very different. First of all, the exemption in DC is only $4.98 million per spouse, and, secondly, the individual exemption must be used by the first spouse to die or that tax break is lost forever. In other words, the DC estate tax exemption is not portable. The DC tax rate on estate assets starts at 11.2% on amounts over $4.98 million and goes up to 16% in graduated increments on all amounts over $10 million. See the chart below for the DC estate tax brackets. 

Estate’s   “Excess” Value   Tax Rate on   the excess value

 $4,988,400 -   $5 million           11.2 %

 $5 million -   $6 million              12 %

 $6 million -   $7 million             12.8%

 $7 million -   $8 million             13.6 %

 $8 million -   $9 million             14.4 %

 $9 million -   $10 million           15.2 %

 Over $10   million                     16 %

The growth in D.C. residential property values, retirement savings, and investment accounts means that estate-tax planning is no longer relevant only to extraordinarily wealthy families. A couple whose estate is below the D.C. exclusion today may exceed it by the time the second spouse dies because of appreciation, accumulated retirement assets, life insurance, or an inheritance. 

If the first spouse leaves everything outright to the survivor under the marital deduction, which might be one’s natural instinct, the first spouse's DC exemption is generally lost.  The “marital deduction” means simply that one spouse can leave assets to the other spouse without triggering a taxable event at that time. While this is very valuable, it is not the end of the equation. In order to maximize the DC estate tax exemption, making it worth the full $10 million, one must also utilize a by-pass trust (aka a credit shelter trust).

What the first to die spouse must do is transfer assets up to the exemption limit to a by-pass trust which is kept for the benefit of the second spouse and the balance of his or her estate may transfer under the marital deduction. The surviving spouse, who can serve as the trustee, gets the income, if any, from the by-pass trust and can even use the principal, if necessary, for health and welfare needs. Then, at the time of the surviving spouse’s death, the married couple (including same sex couples) is poised to shelter up to almost $10 million from DC estate tax. 

There are a couple of tradeoffs for putting specific assets rather than others into the by-pass trust. Generally, real estate will be valued at the date of the first spouse’s death and will not get the benefit of a second “stepped up basis.” Similarly, certain retirement accounts may lose some of their “roll over” benefits if they are the assets dedicated to the by-pass trust. Some testators choose to give their personal representatives the authority to select which assets to use to fund the by-pass trust after the testator’s death. Obviously, these details should be discussed with one’s financial planning professionals.