3 Reasons Why Almost Every State (Except Nebraska) Ended Its Inheritance Tax

3 Reasons Why Almost Every State (Except Nebraska) Ended Its Inheritance Tax

What happens to your soul after you die is a matter of faith, but in Nebraska, what happens to your property after death is a matter of cold, hard fact.

With our neighbors in Iowa recently passing a law to phase out its inheritance tax, Nebraska is on track to be one of only five states that still levies an inheritance tax. This is a tax everyday Nebraskans often learn they have to pay when they receive property from a loved one who has died.

Nebraska will soon have the dubious distinction of being the only state west of the Mississippi to have an inheritance tax. We’re already called out every year on Forbes magazine’s annual list—and this 100% real, I’m not joking here—of “Where Not To Die.”

Title image for podcast episode featuring Jim Vokal. The image reads, "The Inheritance Tax, Why Do We Still Have It?"

You can watch the video on YouTube here or listen to the podcast episode on Apple Podcasts or Spotify.

Nebraska’s inheritance tax has been on the books since 1901, so it’s certainly had its defenders in Lincoln over the last century. But I’m also confident Nebraska can find a way to end the inheritance tax, because it’s something that almost every state has already figured out.

So today I’m going to discuss why so many states have ended their inheritance tax and why we’ve struggled in Nebraska. And stay tuned until the end, where I’ll share with you what senators in the Nebraska Legislature are currently doing to try to fix problems with the inheritance tax, and how those efforts can be built upon.

Believe it or not, the inheritance tax is one of the most searched for subjects at PlatteInstitute.org. Now, there’s nobody alive today in Nebraska who was around at the time the inheritance tax was adopted, so you could get lost in the history of the tax for a long time. But nowadays, there are three main issues for why most states don’t have inheritance taxes anymore, and Nebraska still does.

1. States no longer get a freebie on Death Taxes from the federal government.
2. Nebraska is the only state that gave local governments the authority to tax inheritances.
3. Reducing or eliminating the inheritance tax is actually popular with Nebraska voters, but it’s not popular with county governments and policymakers in Lincoln.

#1. States no longer get a freebie on Death Taxes from the federal government.

Over 100 years ago, the situation was the reverse of what it is in the U.S. today. Only three states and the District of Columbia didn’t have an inheritance tax. Because states rarely had income or sales taxes, inheritance taxes were a major supplement to property tax.

Federal policymakers wanted to prevent states from attempting to compete with each other on the basis of not having a death tax. So, Congress offered a federal tax credit that would offset some of the cost of state inheritance or estate taxes.

The result was that at least some amount of the tax paid to the states was being subsidized by the federal government. It was basically free money for the states, because their taxpayers were paying state inheritance taxes and getting an equivalent break on their federal taxes.

Generations later, in 2001, federal policymakers arrived at a different view. Providing the federal credit for death taxes was holding up reforms in the states, and costing the federal government revenue it could use for its own tax changes.

Some states had already gotten wise to this and had eliminated their inheritance taxes anyway.

But, with the federal death tax credit being phased out through 2004, the remaining states had to decide what to do, now that their state taxpayers wouldn’t be getting a break for the inheritance and estate taxes they were paying.

As taxpayers in the remaining states had to pay the true burden of inheritance taxes, state leaders quickly became responsive to the competitive reality. Since 2001, more than a dozen states have eliminated their inheritance taxes.

And these were not just low-tax states raring to get rid of taxes. Yes, states like Texas, South Dakota, and Tennessee scrapped their inheritance taxes during these years, but so did high-tax states, including California and Hawaii.

The economist Thomas Sowell once wrote that the first rule of economics is scarcity, and the first rule of politics is to disregard the first rule of economics. But the lesson here is that there are sometimes economic realities stark enough that traditional party politics has to be cast aside.

Today, now that Iowa is on track to end its inheritance tax over the next four years, most of the remaining states with an inheritance tax are a group of neighbors in the Mid-Atlantic: Pennsylvania, New Jersey, and Maryland. Like Nebraska, Kentucky is the other state alone among its neighbors, who have all ended the inheritance tax.

Some states eliminated their inheritance taxes right away, while others like Iowa used a gradual phase-out so that the disruption to revenue was not as significant.

This has been harder to accomplish in Nebraska politically speaking, and our second reason explains why.

#2. Nebraska is the only state that gave local governments the authority to tax inheritances.

It’s the state of Nebraska that made the decision to have an inheritance tax. But none of the money from the tax goes to the state budget. Instead, the inheritance tax in Nebraska has always been a source of revenue for county governments.

On one hand, it might seem like this would make it easier for the Legislature to end the inheritance tax. After all, none of their state budget priorities would be impacted by repealing the tax.

On the other hand, though, counties are subdivisions of the State of Nebraska. Originally, the inheritance tax was given to counties as a means of funding roads, but in the 1980s, that requirement was relaxed, allowing counties to treat inheritance tax receipts more like bonus money.

Now, counties are not the villain in this story. They provide many important services that have to be taken care of. But that doesn’t mean county leaders haven’t sometimes lacked imagination for how Nebraska could someday provide these services without an inheritance tax.

After all, as unique as Nebraska’s situation may be, there are 45 examples the state can learn from to get rid of the inheritance tax. Saying it can’t be done without terrible consequences strains credibility to say the least.

But in the Unicameral Legislature, local governments like counties get a lot of facetime with the 49 senators. We have more counties than senators, and some of the senators started their careers in county government, and see the issues through that lens.

The argument by county governments, pretty much forever, has been that the inheritance tax is essential for counties to be able to fund local services. And, if that wasn’t enough, counties hold the view that without inheritance taxes, property taxes would have to be higher.

In a state where property taxes dominate our tax discussion, these objections had a lot of sway in the Legislature for decades. Numerous lawmakers, from every party, have tried to improve or eliminate the inheritance tax over the years, but the law still closely resembles the legislation passed in 1901.

But in the big picture, the inheritance tax doesn’t raise a significant share of county revenues, nor is it really predictable on a year-to-year basis.

It makes sense if you think about it. For the inheritance tax to be collected in a county in the first place, someone owning property in your county has to die, and then, they have to leave a traceable amount of property—probably land or a building—to a relative or friend who would be responsible for the tax.

Well, if someone dies and leaves property to their spouse, that inheritance is exempt to begin with. If they sold the property before death, or have engaged in certain estate planning activities, there also may not be any tax owed.

Because of this, opponents to reforming the inheritance tax have often stated in legislative hearings that the inheritance tax is really not so bad, as long as you have an attorney to help you with estate planning. But that should be a sign that the tax really is bad and inequitable.

It means the taxpayers who have the least means to understand and anticipate inheritance taxes are also the taxpayers mostly likely to end up paying it and struggling with the consequences through the legal process.

Because Nebraska is the only state that gave counties the authority over inheritance taxes, the tax collection process is also currently run through the county court system. As a result, people receiving an inheritance in Nebraska will need to pay additional legal fees to get their property.

This makes the inheritance tax one of the most complex taxes we have on the books when it comes to compliance.

Compare this with real estate property tax, or sales tax, where you pay the county treasurer or a retailer and you’re done; or even with the income tax, which you might hire an accountant or purchase software for, but can still file free online with a little light reading.

Another problem of having each of the 93 counties taking responsibility for the inheritance tax was that there was no publicly-available statewide record about how the tax was really working. The Legislature sort of had to take the counties’ word for it when they would claim it was an indispensable tax that was working just fine.

That’s why our team took a deep dive into Nebraska’s inheritance tax in one of our Platte Institute policy studies. In our report, Death and Taxes, Sarah Curry was able to compile data on the inheritance tax, going back to the early 90s. This information was not previously available to lawmakers.

As it turns out, while in some years the inheritance tax can be significant for a county budget if a very large inheritance occurs, inheritance taxes often produce little or no revenue in some years, especially in less-populated counties. As you might guess, the most stable inheritance tax revenues can be found in our most-populated counties, like Douglas, Sarpy, and Lancaster.

Even when factoring in these areas, typical inheritance tax collections in a given year are around 3 or 4% of county receipts.

In 2020, statewide inheritance tax collections were an inflation-adjusted $74.5 million. By comparison, counties collected $748 million in property taxes. In that fiscal year, the State of Nebraska collected $4.9 billion from income, sales, and miscellaneous taxes.

The average county brings in less than $1 million a year from inheritance tax.

So, in the big picture, inheritance taxes are far more trouble for the state’s economic competitiveness, and for taxpayers, than they are a valuable resource for public services.

As well, county property taxes increased by 52% from 2010 to 2020, or an average of 4.28% a year. So, if inheritance taxes are meant to keep county property taxes from rising, we don’t have any evidence of that actually happening.

This means it would not be disruptive for Nebraska to gradually ratchet down the inheritance tax like Iowa.

So let’s talk a bit more about the real barrier here:

#3. Reducing or eliminating the inheritance tax is actually popular with Nebraska voters, but it’s not popular with county governments and policymakers in Lincoln.

In full disclosure, I was always a little unsure about how the inheritance tax was perceived among Nebraskans.

Yeah, I personally thought it was strange—and not very wise—that Nebraska remained one of the few states with an inheritance tax. After all, we’re a state with a well-known issue retaining and attracting residents, and investment from outside the state, and yet we insist on levying a 19th-century-inspired tax that people can avoid by choosing to put down roots pretty much anywhere else in the country.

But in every poll we’ve ever conducted at the Platte Institute, property tax has always been seen as the state’s most urgent tax problem. And this was the argument counties were making: don’t change inheritance taxes, or we’ll have to raise property taxes.

But at the beginning of 2021, with an increasing conversation in Lincoln about modernizing Nebraska’s tax code, we finally decided to ask voters about the inheritance tax in a statewide poll. Here’s the question we asked:

“Nebraskans who inherit property from relatives or friends other than their spouses may have to pay county inheritance tax. Nebraska is one of only six states that collects an inheritance tax. Based on this information, how important do you think it would be for Nebraska to reduce or eliminate its inheritance tax?”

64% of voters said it was very important to address the inheritance tax, 15% said it was somewhat important, 8% said it was somewhat unimportant, 7% said it was very unimportant, and 5% were unsure.

What this means is that all of the objections to reforming the inheritance tax—as emotionally-loaded as some of them might be—actually aren’t closely held views for the vast majority of the population in Nebraska.

And as you might guess, if you only asked Republican voters in Nebraska, the result would be even more lopsided. While 79% of voters said changes to the inheritance tax were very or somewhat important, it was 91% among GOP voters.

And though the people who don’t care about inheritance taxes are more likely to be Democratic and independent voters, it’s important to recognize they are also a minority in their own voter groups.

66% of Democratic voters in Nebraska said reducing or eliminating the inheritance tax was very or somewhat important, while only 27% said it was somewhat or very unimportant. 7% were unsure.

74% of independents said addressing the inheritance tax was very or somewhat important for Nebraska. 22% said it was somewhat or very unimportant, and 5% were unsure.

Now, polling is an art as well as a science. All we asked these voters is to tell us how important they felt the issue was given that Nebraska is a clear outlier among states, and that the tax could affect them or people like them.

Certainly, you could get some more voters to think changing the inheritance tax is a bad idea if you said it was a tax only of concern to the wealthy, or that having the inheritance tax keeps property taxes low.

The problem with those assertions, as I’ve mentioned before, is that they’re just not true.

The inheritance tax is assessed on regular Nebraskans whose loved ones didn’t have sophisticated estate plans.

Because the tax was originally adopted in 1901, the amount of property a person needs to inherit to be subject to the tax is not very high. Depending on your relationship to the person that died, it could be due on any inheritance greater than $10,000, and you could have to pay as much as 18% of the value of the inheritance. The highest inheritance tax exemption right now is only $40,000.

So, receiving a vehicle, a house, a savings account, or any significant real or personal property, could all potentially get you stuck in county court proceedings, all for the privilege of paying taxes.

What’s really scary is that the $10,000 exemption was the same amount set in the law in 1901. If it had been adjusted for inflation, there wouldn’t be an inheritance tax on anyone receiving less than $306,000 in property.

As far as inheritance taxes resulting in property tax relief, it’s worth noting that some of the remaining states with this tax are among the worst places for property taxpayers. Nebraska, obviously, has the country’s eighth highest property tax rates, but New Jersey has the highest property taxes in the country, and Pennsylvania is ranked only slightly lower than Nebraska.

So these objections by county governments and others may have held water in the Legislature in the past, but I don’t think they will if policymakers actually talk to their voters about them.

Besides the fact that the inheritance tax is relevant to average Nebraskans, a sizable number of voters in Nebraska likely object to the basic concept of the inheritance tax when they are given the opportunity to think about it.

And, after better understanding what the inheritance tax is and what it does to Nebraska families and businesses, voters are even more likely to oppose it when they learn that Nebraska is putting itself in an isolated position by having a tax that few states even have anymore.

All that said, counties have a significant voice in the Legislature, and even if most senators wanted to reform or repeal the inheritance tax, a bloc of 17 opponents could filibuster and hold things up.

But reforming the inheritance tax doesn’t mean counties have to get the short of the end of the stick. There are ways to give counties some alternatives.

Probably the most obvious one is that the state could pony up some money that would have otherwise come from inheritance tax. If that won’t fly, many states allow counties to collect a local sales tax with voter approval.

Nebraska does this somewhat, but currently hamstrings most counties by preventing them from collecting sales tax in any area where a city also collects a sales tax. That should be changed.

People who live, work, and do business in cities also do those things in counties, and use county services. Of course, it would be voters themselves who would get to decide if they wanted their county to collect a sales tax, and how much it should be.

And finally, the inheritance tax could be phased out over a long enough period of time that the disruption to revenues is not very noticeable to county boards.

So once again, here are 3 Reasons Almost Every State (Except Nebraska) Ended Its Inheritance Tax:

1. States no longer get a freebie on Death Taxes from the federal government.
2. Nebraska is the only state that gave local governments the authority to tax inheritances.
3. Reducing or eliminating the inheritance tax is actually popular with Nebraska voters, but it’s not popular with county governments and policymakers in Lincoln.

And as promised, here are two of the most recent proposals to reduce inheritance taxes in the Nebraska Legislature. You can contact your Nebraska state senator to show your support for these bills on our Take Action page at PlatteInstitute.org.

LB377 modernizes the definitions of relatives under Nebraska’s inheritance tax. Because the tax currently increases as the taxpayer’s relationship to the person who died becomes more distant, non-traditional families and blended family members are often stuck paying higher tax bills. For as long as we’re going to keep the inheritance tax, making it less arbitrary as this bill suggests, is a worthy goal.

Then you’ve got LB310. This bill increases the inheritance tax exemptions and reduces the inheritance tax rate. Nebraska would no longer have the country’s highest inheritance tax under this bill. But what’s especially ambitious about the amended version of LB310 is that a large group of Nebraskans would be completely spared from the hassle of the inheritance tax.

Under LB310, young Nebraskans under age 22 would never have to pay inheritance tax again, which I think sends a great message that we don’t want to put up obstacles to young people owning property, getting involved in a business, or just having some money to get their adult life started here in our state.

And, if policymakers wanted, they could gradually raise that exemption age over time, making fewer and fewer Nebraskans subject to the inheritance tax, until they were prepared for a complete repeal.

You might say the inheritance tax evokes some morbid curiosity, because it relates to our mortality and what we’ll inevitably leave behind for loved ones when we’re gone. But joining the vast majority of states that have modernized their tax systems by ending the inheritance tax won’t just make our state a better place to die, it will also make Nebraska a better place to live.

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It’s time to stop the status quo. Let’s remove economic barriers and make Nebraskans proud.

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