In a recent article, I reviewed just how the Internal Revenue Service, sometimes endearing referred to as "Uncle Sam" is the hidden winner in every game show. Similarly, Uncle Sam’s "Okie" counterpart, the Oklahoma Tax Commission is has become the hidden beneficiary in many estates.

It has long been said that the certainties in life are death and taxes. With regard to the taxes that you pay to the state of Oklahoma, you have probably planned for recurring tax liabilities, such as ad valorem, income and sales taxes. Other tax liabilities that you might plan for are those that are generated by transactions that are less recurring, such as capital gains on the sale of assets or excise taxes on purchases of automobiles and other similar assets. Most people are unfamiliar with the Oklahoma estate tax, which can result in the tax commission being an unintended beneficiary in many estates.

Who should worry about estate taxes? Isn’t this a problem that is increasingly important only to the wealthy? After all, everyone knows that the federal estate tax exemption is steadily increasing and will continue to do so until it is phased out completely for one year only, in 2010, before it is re-instituted, unless subsequent legislation alters this plan. What very few know is this: the Oklahoma estate tax is not linked to the federal estate tax and although many of the same concepts and planning tools can be applied, because the Oklahoma exemption amount is lower and because of the limitation of the application of the exemption to certain classes of beneficiaries, even a person of modest means could end up owing estate taxes in Oklahoma.

Unless all of the decedent’s property is passing to a surviving spouse, an Oklahoma Estate Tax Return must be filed by the Administrator, Personal Representative, Trustee, surviving joint tenant or other beneficiary on behalf of the estate. The return is due nine months after the date of death, and must disclose all property in which the decedent had an interest at the time of death along with the value of the property as of the date of death. This includes proceeds of life insurance policies and property passing by virtue of joint tenancy or contractual arrangements, such as revocable trusts or pay on death designations, as well as gifts made within three years of death. A federal estate tax return is only required if the value of the decedent’s estate, which includes all property discussed above, is equal to or greater than the exemption amount. If the value of the property of the estate is less than the exemption, no federal estate tax return is required.

Although the Oklahoma exemption for estate taxes is also increasing on a regular schedule, it will not keep pace with the federal exemption. The Oklahoma and federal estate tax exemptions have both increased in recent years, and will continue to do so as follows:

The variance in the exemption amounts is just one illustration of the vast departure of the Oklahoma and Federal estate tax systems. Another critical departure of Oklahoma from the federal estate tax system is that not all testamentary or lifetime gifts qualify for the exemption. In order to qualify for the Oklahoma estate tax exemption, the beneficiary must be a "lineal" heir as defined by our state’s tax statutes. A lineal heir is statutorily defined very differently than the "heirs at law" for intestacy, and includes the decedent’s descendants (children, grandchildren, great grand children, etc.), parents, step-children, and a few others. Everyone other than the decedent’s spouse and those defined as lineal heirs are considered "collateral" heirs. This includes siblings, cousins, aunts, uncles, step-parents, step-grandchildren, pets and friends, among others. The classification of an heir as lineal or collateral impacts on (1) whether or not the gift is eligible for the exemption and (2) if the gift is not eligible for the exemption, the rate at which it will be taxed. Property passing to collateral heirs is taxed at a higher rate than lineal heirs. The spouse and any qualified charities are treated separately from lineal and collateral heirs. Like the federal estate tax provisions, Oklahoma law allows an unlimited marital and charitable deduction, meaning you can pass any amount of property to your spouse or to one or more qualified charities with no estate tax consequence.

The following example will illustrate these principles. A man with an estate valued at $500,000 (after payment of debts and expenses of administration) dies with no spouse and no children. His Will directs his property shall pass ½ to his mother, 1/4 to his sister, and 1/4 to a qualified charity. Will the man’s estate have to pay federal and/or Oklahoma estate taxes? Although no federal estate tax is due because the man’s estate is smaller than the current federal exemption amount, Oklahoma estate taxes will be due. Because the decedent’s mother is a lineal heir, no tax is generated by that bequest. However, the sister is a collateral heir, therefore every dollar that passes to her will generate estate tax liability. The unlimited exemption for charitable bequests ensures that no tax will be generated based upon the bequest to charity. Applying the current estate tax rates for 2004 for collateral heirs, the estate tax due prior to deductions for debts or expenses of administration (all of which is generated by the bequest to the sister) will be roughly $2,950.

In summary, the potential Oklahoma Estate Tax liability of any given estate is affected by who your property will pass to in addition to the size of your estate. Understanding the effect of the Oklahoma Estate Tax system can aid you in establishing a distribution scheme that will minimize taxes, to the extent possible and ensures that one or more beneficiary’s shares is not overly burdened by estate taxes. As with other areas of tax, often planning can be done to minimize or even eliminate estate tax liabilities. For example, certain kinds of property are specifically exempt from Oklahoma estate taxes. If you have questions, contact a tax specialist or qualified estate planning attorney for more information on the effect of the Oklahoma estate taxes on the plan for distribution set forth in your estate planning documents.

© Sarah J. Lane 2004

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