Estate Tax Changes under the 2014/2015 Executive Budget

By:
Jonathan Rikoon
Published Date:
Jun 1, 2014

Governor Andrew M. Cuomo announced in January that he would introduce legislation intended to reduce the estate tax provisions that may provide an incentive for New Yorkers to move out of the state shortly before death. But even though the new law, signed on Apr. 1, 2014, provides some tax relief for moderately well-off taxpayers, the wealthiest New Yorkers will see little—if any—change. In some cases, they will actually experience an increase in estate and income tax.

The major elements of the governor’s original proposal would have both reduced the top New York estate tax bracket from 16 percent to 10 percent and gradually increased the exemption amount (currently $1 million) to match the federal exemption (currently $5.34 million, adjusted for inflation going forward) over the course of the next several years. The proposal also included several other provisions that were less taxpayer friendly. As part of the budget process, however, the estate tax proposal has been modified substantially.

Exemption Amounts

The top estate tax bracket remains at 16 percent, which is disappointing in view of the governor’s proposal to reduce the top bracket to 10 percent. The exemption amount phases in to match the federal exemption by 2019; although somewhat delayed, this is welcome news. Unlike the federal exemption, however, estates that exceed these amounts by 5 percent do not benefit from the New York exemption at all, and even estates that exceed the exemption by a smaller percentage forfeit part of the exemption. This is due to an unresolved problem referred to as “the cliff,” whereby New York tax law continues to phase out the benefit of the estate tax exemption rapidly as the estate gets larger (and to phase it out completely once the taxable estate exceeds 105 percent of the exemption amount).

For example, for the next year, an estate in excess of $2,165,625 will be taxed on the entire estate, with no benefit from the exemption whatsoever. As the size of the state exemption increases over the next few years, the impact of the cliff grows along with it. By contrast, the federal estate tax only applies to the taxable estate in excess of the exemption, so that even the largest estates will not be taxed on the exempt amount for federal purposes.

Under the new law, the phase-in is as follows:

Date of Death

New York Exemption

Apr. 1, 2014–Mar. 31, 2015

$2,062,500

Apr. 1, 2015–Mar. 31, 2016

$3,125,000

Apr. 1, 2016–Mar. 31, 2017

$4,187,500

Apr. 1, 2017–Dec. 31, 2018

$5,250,000

On or after Jan.1, 2019

Same as the federal exemption

Gift Look-Back

The original proposal to include certain lifetime gifts in the taxable estate has been scaled back. The add-back is now only for taxable gifts made between Apr. 1, 2014, and Dec. 31, 2018, and within three years of death. This rule does not apply to annual exclusion gifts, payments of tuition or medical expenses that qualify for a federal gift tax exemption, or gifts made while the donor was not a New York resident.

The limited scope of the new estate tax on lifetime gifts certainly makes it less onerous than the original proposal, and it now coordinates better with the federal estate tax (which includes in the tax base any federal gift tax on gifts in excess of the federal exemption, made within three years of death).

Nevertheless, this remains a trap for the unwary, given that large lifetime gifts remain an important federal estate tax planning option in some circumstances. This new New York estate tax on lifetime gifts is especially expensive because of the interplay with the federal estate tax (see below for details).

The add-back seems to apply even to gifts of real estate or tangible personal property outside of New York state. If this property is owned at death, however, it is not subject to New York estate tax under current law or even under the revised law. Because such gifts would not reduce the taxable estate, imposing the add-back on these gifts seems out of place, like trying to close a loophole that doesn’t really exist. In fact, there are serious constitutional questions as to whether a non–New York gift can properly be included in the New York estate tax base at all.

Pernicious impact. If the New York estate tax does apply to lifetime gifts, the impact will be significantly worse than the usual tax bite. Unlike the New York estate tax in general, the estate tax on lifetime gifts would not be eligible for the deduction against the federal estate tax (currently worth 40 percent, given that federal estate tax rate). If an estate is at the top New York bracket, the general 16 percent New York estate tax, in effect, only costs 9.6 percent. If the New York estate tax applies to a lifetime gift, however, the 16 percent tax impact remains unreduced by a federal deduction.

In addition, if the New York estate tax on lifetime gifts applies, it is imposed on the estate even though the estate no longer owns the asset that was given away, possibly years earlier; therefore, wills and revocable trusts of New York residents must be carefully drafted as to the allocation of estate taxes to ensure that, if the tax is due, it will be paid out of the fund that makes the most sense in terms of availability and fairness.

Old Problems Not Resolved

Aside from the cliff, a couple of other problems remain:

No portability of exemption between spouses. Under the current federal estate tax, the unused exemption of the first spouse to die may be carried forward and used by the second spouse (the concept of portability of exemption). While there was some interest, at least in the Assembly, in allowing New York portability, it became apparent that as long as New York has the exemption cliff, portability cannot possibly work in the state. As a result, New Yorkers cannot rely on portability to take advantage of the full New York exemptions in both estates of a married couple, but instead will require a credit shelter trust or other structure similar to what has been common for years.

No separate New York QTIP marital election. Because of the large difference between the federal and state exemption amounts, until the larger New York exemption is fully phased in, it might be advantageous in certain circumstances for an estate to treat certain trusts as qualified terminable interest property (or QTIP trusts) eligible for the New York estate tax marital deduction, even though the same trust would be better treated as nonmarital for federal purposes. The Senate’s version of the New York tax legislation would have authorized this separate election for estates smaller than the federal exemption amount, but that provision did not make the final bill. Guidance from the New York Department of Taxation and Finance suggests that a separate election is not available if a federal estate tax return is filed (as it must be to elect federal portability). The flexibility of estate tax planning thus remains incomplete for New Yorkers, and some estates will have difficult decisions to make.

Planning Tips

For those considering large gifts. Current New York residents who expect to remain in this state for the rest of their lives and who have not already made larger gifts to take advantage of the federal exemption should consider deferring major gifts until 2019, when the New York gift add-back expires, or using alternative approaches. Whether a gift will save overall taxes depends upon a variety of factors, including projected increase in value, cost basis for calculating capital gains upon a future sale (which might be higher in the case of a gift than if the asset is retained), anticipated longevity of the donor (with three years being a critical factor), and the interplay of the state and federal tax systems. In many instances, a large gift still makes sense in terms of the overall tax savings—but these gifts might now be more expensive for New Yorkers who make them during the next five years if they die within three years of the gift. New Yorkers can continue to make annual exclusion gifts and payments of qualified tuition and medical expenses without adverse consequences.

For those moving to or from New York. Individuals who are planning to move to New York might wish to engage in gift planning prior to becoming a resident of the state. In the opposite case, New York residents who are thinking of moving elsewhere should make sure to take all the steps necessary to have the move recognized for tax purposes. If the move is successfully completed, New York will not impose a gift tax or an estate tax on lifetime gifts, even those made while the decedent was a New York resident.

For married New Yorkers. Finally, because of the disconnect between the New York and federal exemptions, until the larger federal exempt amount is fully phased in for the New York estate tax in 2019, married New York residents must continue to consider whether to 1) carve out the entire federal exemption amount to a credit shelter or by-pass trust at the first spouse’s death and pay the resulting New York estate tax on the portion of the federal exemption amount that exceeds the New York exemption, or 2) limit the amount passing to these trusts to the lower state exemption amount (leaving unused a portion of the federal exemption, unless the circumstances permit federal portability rules to apply). The option of creating a separate trust for the difference between the state and federal exemptions and having it qualify for the state marital deduction while absorbing federal credit seems to be off the table, based on the position of the New York Department of Taxation and Finance.


Jonathan J. RikoonJonathan Rikoon is a partner at Loeb & Loeb LLP practicing in the areas of trust and estate planning, administration and litigation. He engages in sophisticated estate and tax planning for wealthy individuals and families, preparation of wills and trusts, and the administration of trusts and estates. He helps to establish various tax-efficient multitier family, business, and investment vehicles, such as partnerships, limited liability companies, and closely held corporations with trust ownership, and he structures third-party business transactions to facilitate tax and estate planning. Mr. Rikoon has also pioneered the development of estate planning techniques customized for private equity fund principals and hedge fund managers. He was instrumental in the N.Y. State and City bar comments on the legislation discussed in this article. He can be reached at 212.407.4844 or jrikoon@loeb.com.

 
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