Connecticut law relating to estate and gift taxes has changed significantly, as the local governor attempts to cut the state deficit, warns international law firm Withers Worldwide.

On 4 May the governor signed the state budget into law, and announced that changes to estate and gift tax exemptions will be applied retroactively from 1 January 2011.

Estate tax exemption has been reduced from $3.5 million to $2 million - applicable to the estates of those dying on or after 1 January 2011 - the law firm said.

Gift tax exemption has also been reduced, from $3.5 million to $2 million, for gifts made on or after 1 January 2011. The new gift tax exemption level applies to all taxable gifts made since the tax was enacted on 1 January 2005. Connecticut taxable gifts include gifts of Connecticut real property made by anyone, gifts of tangible personal property situated within Connecticut made by anyone, and gifts of intangible personal property made by Connecticut residents.

The new law maintains the existing graduated estate and gift tax rates. The rates begin at 7.2 per cent for transfers over $2 million up to a maximum of 12 per cent for transfers over $10.1 million.

All estates are still required to file estate tax returns, including estates of non-resident decedents with Connecticut real or tangible property. If an estate is over the new tax exemption amount of $2 million, the return should be filed with the Connecticut Department of Revenue Services, with a copy to the local probate court. Smaller estates only file the return with the probate court.

Under Federal tax law, individuals have a maximum lifetime exemption amount for estate and gift tax purposes – currently $5 million under the 2010 Tax Act. But the act expires on 31 December 2012, and the rates will then revert to their 2001 levels of $1 million gift and estate tax exemption, Withers said.

However, Connecticut imposes a separate estate tax and the state’s estate tax exemption is autonomous from the federal amount. That means estates free of tax for Federal purposes may still be subject to Connecticut estate taxes.

Withers suggests portability, introduced as part of the 2010 Tax Act, can help individuals pass on more of their wealth in a tax-free way. Portability means a surviving spouse can inherit any unused estate tax exemption remaining from the first spouse to die. However, the firm also points out that Connecticut does not allow portability with respect to its new $2 million exemption amount, and federal laws relating to portability will expire with the 2010 Tax Act, at the end of 2012.

Withers is advising its clients to take advantage of portability in federal tax law while the opportunity is still available, and suggests they review estate plans to ensure any changes in both federal and Connecticut law do not lead to unexpected results. Clients should also review any gifts made this year along with any future planned gifts, since the changes made by the legislature are retroactive, says the firm.