What Is the Pick-Up Tax?
The pick-up tax was an estate tax levied by individual states, allowing them to share in the proceeds and revenue from federal estate taxes. Although states were able to claim a portion of an individual's federal estate transfer tax, the pick-up tax did not increase the estate's tax liability.
The pick-up tax was phased out with the passage of the Economic Growth Tax Relief Reconciliation Act (EGTRRA) of 2001 and completely ended in 2005. Some states replaced the pick-up tax with their own new estate taxes.
- A pick-up tax was an estate tax levied by individual states, allowing them to share in the revenue from federal estate taxes.
- The pick-up tax was phased out in 2001 and eliminated in 2005.
- This tax didn't increase the tax liability of an estate but gave states a portion of the federal government's estate tax.
- After the pick-up tax was repealed, a number of states adopted their own estate tax laws—12 states and D.C. collect these taxes as of 2021.
Understanding the Pick-Up Tax
Individuals have the right to transfer their personal property to their heirs after they die. This may include cash, real estate, trusts, business assets, securities, and other investments. But there is a price that a person's heirs have to pay. The federal government collects a tax on these assets after determining the assets' fair market value (FMV). The taxable amount is calculated after taking certain deductions and reductions into consideration.
The pick-up tax was also known as a sponge tax. That's because it was seen as sponging off the taxes collected by the federal government. It did not assess an additional liability for an estate to pay. Instead, it represented a sharing arrangement between states and the federal government for the estate taxes collected at the federal level by the Internal Revenue Service (IRS). It was a convenient way for states to share in federal estate taxes without having to create their own guidelines and jump through legislative hoops.
The costs of collecting estate taxes are disproportionately high given there are not that many people with estates meeting the minimum threshold. There is a good deal of auditing and paperwork involved with settling estates, and the pick-up tax left that burden with the federal government while allowing states to share in the proceeds.
When the pick-up or sponge tax was phased out in 2001, a number of different states enacted new laws allowing them to continue collecting estate taxes. As of 2021, 12 states and the District of Columbia collect estate taxes, with exclusion amounts ranging from $1 million to $5.93 million. Some states collect inheritance taxes, which differ from estate taxes in that the individuals receiving the proceeds of an estate, and not the estate itself, are responsible for paying the state taxes when they file.
Estate taxes provide less than 1% of all state revenues.
Federal estate taxes have been around since 1916 and have seen many changes over the years, including when the Tax Cuts and Jobs Act (TCJA) of 2017 was passed. Initially, the estate tax threshold doubled. For 2021, the threshold stood at $11.7 million for an individual filer, meaning an estate with a value less than this amount is not required to pay any estate tax—at least at the federal level. The new higher thresholds mean there will be less estate tax money collected, and fewer people needing to file.
The Tax Cuts and Jobs Act of 2017 increased the threshold, meaning fewer people were responsible for paying an estate tax.
If no action is taken by President Biden and the Democrat-controlled Congress, today's lofty exemption amounts will revert to $5 million per person, adjusted for inflation, at the beginning of 2026. Some commentators believe it is likely that President Biden, who campaigned a lot on reforming the current tax regime, will look to push through these changes sooner.
That’s good news for states still collecting the tax. Had the federal government eventually completely phased out the federal estate tax, many states may have considered eliminating it as well, realizing that the administrative costs for auditing and collecting estate taxes on the state level from relatively few people may not be worth the potential revenues.