Pick-up Tax

A state-imposed estate tax known as a "pick-up tax" was imposed so that it could claim a share in the earnings and income generated by federal estate taxes. Despite the fact that states might deduct a percentage of a person's federal estate transfer tax, the pick-up tax had no impact on the amount of tax that would be due on the estate.

With the enactment of the Economic Growth Tax Relief Reconciliation Act (EGTRRA) in 2001, pickup tax was gradually eliminated, and it was eliminated entirely in 2005. Some states introduced their own new estate taxes to replace pickup tax.

Understanding Pick-up Tax

People have the right to leave their personal belongings to their heirs when they pass away. Cash, real estate, trusts, corporate assets, securities, and other investments may fall under this category. However, there is a cost that the deceased's heirs must bear. These assets are assessed a tax by the federal government based on their fair market value (FMV). Following a number of deductions and reductions, the taxable amount is determined.

Pick-up tax was often referred to as a sponge tax. This is because it was perceived as sponging off the taxes paid to the federal government. It did not impose an additional financial burden on an estate. Rather, it constituted a sharing agreement between the federal government and the states for the inheritance taxes that were gathered at the federal level by the Internal Revenue Service (IRS). It was a straightforward method for states to participate in federal estate taxes without having to establish their own rules and navigate legislative red tape.

Challenges of Pick-up Tax

Due to the small number of individuals with estates that reach the minimum level, the expenses of collecting estate taxes are disproportionately high. Pick-up tax left the burden with the federal government while allowing states to partake in the proceeds. Estate settlement involves a lot of audits and paperwork.

In response to the phase-out of the pick-up or sponge tax in 2001, some states passed new legislation enabling them to continue collecting estate taxes. By 2021, there will be estate taxes in 12 states plus the District of Columbia, with exclusion levels ranging from $1 million to $5.93 million.

In contrast to estate taxes, which are paid by the estate itself, certain states also collect inheritance taxes, which must be paid by the recipients of an estate's proceeds when they file.

Special Considerations

Since their inception in 1916, federal estate taxes have undergone numerous revisions, including when the Tax Cuts and Jobs Act (TCJA) of 2017 was passed. The estate tax threshold initially doubled.

The threshold for an individual filer for 2021 was $11.7 million, which means an estate with a value under this cap is exempt from paying any estate tax—at least at the federal level. Due to the new, higher standards, less estate tax revenue will be collected and fewer persons will be required to register.

Key Takeaways

Individual states imposed pick-up taxes on estates as a way to share in the proceeds from federal estate taxes.

In 2001, pick-up tax was tapered out, and it was finally abolished in 2005. While giving states a share of the federal estate tax, this levy did not raise the tax liability of an estate.

Several states created their own estate tax legislation after pick-up tax was abolished; as of 2021, 12 states and D.C. collect these levies.