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Get Set for a $300-Millionish Problem – Estate Tax Ruling from Supreme Court Spells Trouble for Budget

Legislative Fix Could Require Difficult 2/3 Vote, Butts Up Against Move to Repeal Estate Tax – Department of Revenue Working on Final Numbers

The House Finance Committee, where the estate-tax issue will play out: Members will be briefed about the problem Friday.

The House Finance Committee, where the estate-tax issue will play out: Members will be briefed about the problem Friday.

OLYMPIA, Jan. 22.—A Supreme Court ruling last October in a complicated estate-tax case is looking like it might throw lawmakers for a nearly $300 million loop. The state Department of Revenue is preparing final numbers, but at a time when lawmakers don’t have a dime to spare, even the round numbers being whispered in hallways and legislative offices are enough to bring long whistles.

And the problem is that a legislative fix could require lawmakers to take a difficult two-thirds vote in the House and Senate to raise state estate taxes – at a time when some Republicans would rather ditch them entirely.

“We’re going to stand our ground because we’re not going to be taking a vote on a death tax, let me tell you that,” said state Rep. Cary Condotta, R-East Wenatchee.

It’s an issue that will be aired in full in coming days. The Department of Revenue expects shortly to come up with a formal estimate for the impact of the so-called Bracken Decision, issued last October by the state Supreme Court. The department is set to make a formal presentation Friday to the House Finance Committee. But lawmakers say they are being warned by DOR representatives to expect a figure somewhere just shy of $300 million – about $170 million in refunds and about $60 million a year for the next two years in lost tax revenue.

That’s if the Legislature does nothing. But doing something might be just as troublesome.

All About Q-TIPS

The decision had to do with a tax-planning mechanism called a “qualified terminable interest property” trust, QTIP for short. The mechanism, permitted under federal law, allows a spouse who dies first to delay estate taxes until the second spouse dies, without transferring property. The state collects money from its own estate tax at that point.

The state created its own estate tax in 2005 when Congress phased out a scheme that allowed states to piggy-back on federal estate taxes with a tax credit. But in a complicated ruling the court ruled that Washington’s new tax didn’t take into account the effect of QTIP trusts. What it means is that if a spouse set up a QTIP trust and died prior to 2005, it can’t be taxed under state law.

In the Bracken case, Jim Bracken died in 1984 but deferred taxes through use of a QTIP trust. His wife, Sharon, died in 2006. The estate counted the assets in the trust for federal tax purposes, but didn’t count them for state tax purposes – a $13.7 million difference. The state Department of Revenue argued that the assets shielded by the trust were subject to the tax, but the court ruled that because a transfer hadn’t occurred, the law didn’t allow for it. A similar challenge filed by the estate of a Barbara Nelson was included in the ruling. In its 5-4 decision, the court said, “We hold that DOR exceeded its authority in enacting regulations that allow it to treat transfers completed by William Nelson and Jim Bracken years ago as if the estates had elected to defer state estate tax on the transfers, to be paid by their wives’ estates.”

A Really Big Number

The court ruling is as about as complex as they come, but the impact is simple. Mike Gowrylow, spokesman for the state Department of Revenue, says the agency now is getting numerous requests for tax refunds. The Department asked the court to reconsider its ruling, pointing to what it described as numerous gray areas, but on Jan. 10 the court rejected the motion. “Our understanding is that the impact will be substantial,” he said.

Though DOR hasn’t arrived at a final figure, lawmakers say they are being briefed by officials of the agency, and the ballpark $300-millionish figures are enough to make them gulp.

State Rep. Gary Alexander, R-Olympia, the House Republican point-man on the budget, says he and House Appropriations chair Ross Hunter “are very aware on this one and we’re thinking about strategies. It could be a very troublesome decision. I don’t have an answer yet, because we haven’t sat down and talked about the implications of the decision and what it means to us in the Legislature. Just stay tuned.”

Hunter was not available to comment Monday. But state Rep. Reuven Carlyle, D-Seattle, chairman of the House Finance Committee, said state officials are scrambling to find some sort of a solution. “Gov. Inslee and the Department of Revenue are a dog on a bone in terms of analyzing the implications and assessing what the most responsible solution is. I think anybody would be hard-pressed to say that there is an ounce of rationality to the concept of eliminating the estate tax for married couples and not for singles. And I consider it a relatively technical glitch in the context of our tax policy. The implications could be very substantial if we don’t address it; we have a responsibility to address it, and I fully expect that the governor and the Senate and the House will coordinate in a completely non-partisan fashion to quickly resolve the issue.”

Remedies a Problem

Not so fast. A legislative fix poses a big political problem. Lawmakers could try to rewrite state estate-tax law and expand its effect to the QTIP trusts, perhaps making it retroactive – thus excluding all refund claimants except the two that won in the October decision. But under the terms of Initiative 1185, approved by the voters last fall, any bill that increases taxes requires a two-thirds vote of the Legislature. That means Republican votes would be required, and already there are many behind an effort to repeal the state estate tax as a whole. Condotta is among 10 Republicans sponsoring House Bill 1099, which would repeal the estate tax for those who die on or after Aug. 1, 2013. Prime sponsor is Jason Overstreet, R-Lynden.

“We never wanted the estate tax, and if they are going to bring up the equity issue, we are going to say they are absolutely right,” Condotta said. “You can’t charge married people a different level, so we should take it all out.”

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