Just as many states impose an income tax, many also impose estate or inheritance taxes. Most states used to calculate these taxes based on a credit on the federal Form 706. In other words, if the federal government was going to allow a credit for state estate or inheritance taxes, most states said, “Hey, just give us that money instead.”
You didn’t end up paying any less tax, but the total tax you paid was split between the IRS and the state. However, as the credit for state estate taxes paid was whittled away and then changed to a deduction on Form 706, some states stepped up to the plate and pegged their portion of the tax to what it would’ve been based on a prior year’s calculation.
For example, Vermont calculates its estate tax based on federal estate tax rules, but in 2012, taxes lifetime and after-death transfers in excess of $2,750,000. Other states have raised the amount exempt from estate tax or are choosing not to impose a tax so as not to give their residents a reason to choose another domicile.
You need to check with your state’s tax department to get the rules in effect at the time of your decedent’s death. And if you’re faced with an estate that owns property in more than one state, you may want to consult a competent tax professional because the estate may owe estate or inheritances taxes in each of those states.