Judge Gideon Tucker, of the New York County Surrogate’s Court, perhaps said it best when he wrote in 1866 that "no man’s life, liberty, or property are safe while the Legislature is in session."
That statement recently hit home when just before the annual budget deadline, the New York State Legislature passed, and the Governor signed into law, a new budget that makes sweeping changes to the New York Tax Law. These changes could impact your estate plan.
Earlier versions of the proposed legislation would have increased the exemption from the New York estate tax from $1,000,000 to match the federal estate tax exemption amount (currently $5,340,000). However, the final version of the law contains a major (and costly) change that had not previously been widely reported that will substantially increase the New York estate tax on the estates of wealthy New Yorkers.
Most provisions of the new law, including those described below concerning the exemption from New York estate tax, took effect April 1, 2014. To borrow, again, from Judge Tucker: this is a law that requires diligent watchfulness, lest your estate plan of 2013 result in unintended consequences in 2014.
Increasing the Estate Tax Exemption (for Some, Not All)
At the end of last year, the exemption from the New York estate tax was $1,000,000 (one of the lowest in the country). This new law increases the exemption in each year so that in 2019, the New York estate tax exemption matches the federal estate tax exemption. Thereafter, the New York estate tax exemption is indexed for inflation from 2010, so that it will keep pace with the exemption from the federal estate tax. The exemption is phased in over the next few years as follows:
For a decedent dying:
Click here to view table.
In 2019 the exemption is indexed so that it should match the federal estate tax exemption, which could, at that time, be $5,900,000 (estimated). Thereafter, the New York and federal exemptions should keep pace with one another.
The New York estate tax rate ranges from 3.06% for taxable estates not over $500,000 to 16% for estates exceeding $10,100,000.
Falling Off the Cliff
Not everyone will be able to take advantage of the larger estate tax exemption amount. The exemption provision contains a "cliff" that will substantially increase the estate tax imposed on wealthy New Yorkers. Thus, for an individual who dies with an estate in excess of 105% of the exemption, the exemption will be lost and his or her entire estate will be subject to New York estate tax, beginning with its first dollar.
To illustrate, assume a New York domiciliary dies in 2019 when the federal and New York exemptions are each estimated to be $5,900,000.
A New Yorker with a taxable estate equal to $5,900,000 would pay no New York estate tax.
A New Yorker with a taxable estate equal to $6,195,100 (which is $100 more than 105% of the New York exemption amount) would pay a New York estate tax of $534,973.
In short, after it is phased in, the effect of the new law is to exempt fully from tax the comparatively "small" estates of most New Yorkers (i.e., estates having a value equal to the federal exemption or less) but to increase dramatically the tax on the "large" estates (those exceeding the federal exemption).
Lifetime Gifts Added Back to the Taxable Estate
The new law also increases a decedent’s New York estate by the value of any taxable gifts that were made after April 1, 2014 and in the three years prior to the decedent’s death. Gifts made while a person is not a resident of New York or on or after January 1, 2019 are not added back. Generally, taxable gifts do not include annual exclusion gifts (currently $14,000 per person) and gifts of tuition and medical expenses paid directly to the service provider.
In essence, even though New York does not impose a gift tax, these gifts will be taxed when a donor later dies (although the appreciation on the gift between the date of the gift and the donor’s death will continue to escape taxation).
Impact of These Changes on New York Estate Plans
These changes will have a significant impact on almost all New York estate plans.
The Wills of many New York residents direct that the when the first of two spouses dies, a trust is created to shelter the New York exemption amount from federal and New York tax at the first spouse’s death and from federal and New York estate tax when the second spouse later dies. The balance of the estate passes to or for the surviving spouse in some form that qualifies for the marital deduction (so that no estate tax is due when the first spouse dies). Applying such a formula today to a taxable estate that exceeds 105% of the New York exemption amount would cause all of the decedent’s property to pass to or for the surviving spouse in a form that qualifies for the marital deduction. While there would be no estate tax due in the first spouse’s estate, the second spouse’s estate would be increased, so that on the survivor’s later death the increased estate would be subject to both federal and New York estate tax.
To illustrate this, assume a married couple each of whom owns $7,000,000 (there is no joint property). Further, assume the first spouse died on March 15, 2014 (leaving a Will that, by formula, created a trust for the New York exemption amount) and the second spouse died on March 31, 2014. The death of the first spouse would not cause an estate tax. A trust would be created to hold $1,000,000 (the prior New York exemption amount) and the balance of the estate ($6,000,000) would pass to the surviving spouse. When the survivor later died, $1,000,000 of the survivor’s estate would also be exempt from New York estate tax. The balance of the estate would be subject to both federal and New York estate tax, generating a tax due of $3,992,080. The family would receive $10,007,920.
Assume the same facts except that the first spouse died April 1, 2014 and the surviving spouse died April 15, 2014. Because all of the first spouse’s property passed to the surviving spouse, there would be no estate tax due when the first spouse died. The death of the second spouse would cause an estate tax of $4,488,080. In this case the family would receive $9,511,920.
Thus, the new law cost this family $496,000.
Even comparatively "smaller" estates may be impacted by this new law. Many spouses whose combined estates are more than $5,340,000 but less than $10,680,000 have simplified their estate plans by taking advantage of the exemption portability provisions of the federal estate tax (New York does not allow portability). As such, many spouses have removed credit shelter trust planning from their Wills. Instead, those plans now allow the surviving spouse to inherit the entire estate and rely on the survivor’s ability the shelter the combined estate from the federal estate tax by using the survivor’s estate tax exemption in conjunction with the deceased spouse’s "ported" exemption. Now, following a simplified federal plan in New York could push the surviving spouse’s estate above 105%, the New York exemption amount, causing the survivor’s estate to "fall off the cliff" and be subjected to New York estate tax from the first dollar.
The End of DINGS
The new law also made some significant income tax changes that will impact the use of certain trusts to avoid New York State Income Tax.
Previously, New York residents could avoid the New York income tax on income from intangible personal property if such property was transferred to a trust so long as: (i) all the trustees were domiciled in a state other than New York, (ii) the entire corpus of the trust, including real and tangible property, was located outside the state of New York, and (iii) all income and gains of the trust were derived from or connected with sources outside of the state of New York, determined as if the trust were a non-resident trust. If such a trust accumulated its income, the trust would not pay New York income tax, even though it was a New York resident. In certain instances the creation of the trust would escape federal gift tax as well.
The new law removes the ability to escape New York income tax for such a trust by making an incomplete non-grantor trust (known as an ING) a grantor trust for New York income tax purposes. This means that the New York resident who creates such a trust will include in his or her own income the income of the ING Trust, thereby subjecting it to New York income tax.
There are additional rules that will ultimately tax New York beneficiaries of New York resident non-ING trusts that qualify for the exception described above or that are non-resident trusts. These rules are more complicated to describe than space allows. Nevertheless, New Yorkers who are beneficiaries of non-resident trusts may see a change in how their trust distributions are taxed in New York.
Trustees should also be aware that new return filing requirements are also imposed under the new law.
Time for a Review
Given these substantial changes to the New York estate tax, now would be a good time to review your Will and overall estate plan.