What it means
In the United States, the federal government taxes large estates, and for many years it allowed a credit for death taxes paid to a state. If an estate owed a state tax, the federal tax bill fell by the same amount, up to a limit.
States noticed that if they set their tax equal to the credit, the estate paid nothing extra, but the state gained revenue. This arrangement made the tax painless for families, since the total bill stayed the same and only the split between the two governments changed.
It was popular with state officials because it raised money without causing estates to move or taxpayers to complain. Many states adopted it and tied their rules to the federal credit.
The situation changed when federal law later replaced the credit with a deduction. Because the credit no longer existed, the pickup tax in many states had nothing to pick up, and the revenue disappeared.
Some states then chose to keep or create their own estate or inheritance taxes, which are no longer painless for the estate because they add to the total bill. For advisers and families, the history explains why state death taxes differ so much.
Some states have no such tax, some have separate estate taxes with their own thresholds, and some have inheritance taxes charged on the recipients. Anyone with substantial assets, or with property in more than one state, should review the rules where they live and where assets are located.
For students of finance, the concept shows how tax rules interact. A credit is a dollar-for-dollar reduction of tax, while a deduction only reduces the amount subject to tax.
The change from one to the other turned a costless state tax into a real cost. Rates and thresholds change from time to time, so any figure should be checked against current state guidance.
The example below uses hypothetical numbers to explain the mechanism.
In practice
Real-world examples.
Example
A family with a large estate in a state with a pickup tax pays $50,000 to the state and $150,000 to the federal government. Their advisers confirm that the total is the same as if no state tax had applied.
Example
A state budget officer relies on the pickup tax for steady revenue. When the federal credit is replaced, she projects a large fall in collections and begins to plan for a shortfall.
Example
A wealthy retiree considers moving to a state with no estate tax. His adviser calculates that the savings on a $9,000,000 estate would outweigh the costs of the move, then checks which of his assets would still be taxed where they are located.
Formula
Calculation
State pickup tax = federal credit for state death taxes
Total tax with the credit = federal tax before credit - credit + state pickup tax
Suppose an estate has a federal tax of $200,000 before the credit and the credit allowed is $50,000. The state sets its pickup tax at $50,000. The federal tax after the credit is 200,000 - 50,000 = $150,000. The total paid is 150,000 + 50,000 = $200,000, the same as the federal tax would have been without any state tax.Case study
Seen in the real world.
Bayview State is an illustrative, fictional state that had relied on a pickup tax for decades. Its estate tax collections were about $120,000,000 a year, and no taxpayer complained, because the tax cost estates nothing extra.
When the federal credit was replaced with a deduction, Bayview's collections fell towards zero, leaving a hole in its budget. The legislature debated whether to create a separate estate tax with its own threshold, knowing that it would now be a real additional cost to families.
It eventually adopted a tax with a high exemption to protect smaller estates. The illustrative lesson is that a tax can be painless only when another government is bearing the cost.
Watch out
Common mistakes.
- Assuming a pickup tax is an extra tax on top of the federal bill, when it was designed to be offset by the federal credit.
- Assuming that state death taxes work the same way everywhere, when states differ widely.
- Believing the pickup tax still produces the same result today, when the federal credit it depended on was replaced by a deduction.
Questions
People also ask.
Why was it called a pickup tax?
Because the state picked up an amount that would otherwise have been paid to the federal government.
Does it still exist?
In many states the pickup mechanism has lost its effect, and states now use separate estate or inheritance taxes, so local rules must be checked.
What is the difference between a credit and a deduction?
A credit reduces tax dollar for dollar, whereas a deduction reduces the amount of income or estate that is taxed.
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