To Live and Die in New York: Recent Tax Changes Affecting Estates and Trusts

By:
KEVIN MATZ, JD, LLM, CPA
Published Date:
Oct 2, 2014

On Apr. 1, 2014, Governor Andrew M. Cuomo signed into law, as part of the New York State Executive Budget, what might appear to be sweeping changes affecting estate planning and trusts. But the new law falls short of achieving the laudable objective that Governor Cuomo had specified in his State of the State address: keeping wealthy New Yorkers in the Empire State during their golden years.

Although it does accomplish the important goal of increasing the New York estate tax exemption—now at $2,062,500 for persons dying between Apr. 1, 2014, and Mar. 31, 2015, and scheduled to increase over time to match the federal applicable exclusion amount (currently $5,340,000) by 2019—there is an effective “cliff” within the new estate tax law that snatches all of the benefits of the “tax-free zone” by imposing a marginal tax rate substantially in excess of 100 percent until all of the benefits of the tax-free zone have been undone.

The New York estate tax exemption amount under the new law is as follows:

  • $2,062,500 for decedents dying between Apr. 1, 2014 and Mar. 31, 2015
  • $3,125,000 for decedents dying between Apr. 1, 2015 and Mar. 31, 2016
  • $4,187,500 for decedents dying between Apr. 1, 2016 and Mar. 31, 2017
  • $5,250,000 for decedents dying between Apr. 1, 2017 and Dec. 31, 2018
  • The federal basic exclusion amount for decedents dying on or after Jan. 1, 2019.

The effect of this cliff, which is accomplished through a hyper-accelerated phaseout of the applicable credit amount for New York taxable estates that are between 100 and 105 percent of the basic exclusion amount [N.Y. Tax Law section 952(c)(1)], is to render illusory any New York estate tax savings for persons dying with taxable estates in excess of 105 percent of the tax-free zone; thus, a New Yorker who dies on Apr. 1, 2014, with a taxable estate of $2,165,625 (105 percent of $2,062,500) will pay New York estate tax of $112,050, even though the taxable estate has exceeded the basic exclusion amount by only $103,125 (the difference between $2,165,625 and $2,062,500). That dynamic produces an effective marginal estate tax rate of approximately 109 percent ($112,050 divided by $103,125 equals 1.0865, which rounds to 109 percent). This marginal estate tax rate becomes higher in subsequent years as the basic exclusion amount increases from year to year, traversing into higher marginal tax rates that would otherwise be soaked up by the applicable credit amount.

If one were to regard this dynamic as merely warranting a no-harm, no-foul conclusion that wealthy New Yorkers are in the same position for New York estate tax purposes as they were prior to Apr. 1, 2014, such an outlook would be sorely mistaken. In fact, wealthy New Yorkers whose taxable estates are more than 5 percent above the basic exclusion amount are potentially worse off under this new law. Although the top New York state estate tax rate has remained at 16 percent (instead of being reduced to 10 percent, as Governor Cuomo had proposed), the new law tags for addback taxable gifts that New Yorkers make after Mar. 31, 2014, while a resident of New York State during the three-year period immediately preceding their death and prior to Jan. 1, 2019 [N.Y. Tax Law section 954(a)(3)]. Significantly, this potential addback also applies to post–Mar. 31 2014 gifts of real and tangible property located outside of New York state, even though such property would not be subject to the New York estate tax if the donor were to die the next day.

It is questionable whether this addback component for certain lifetime taxable gifts would be deductible for federal estate tax purposes under Internal Revenue Code (IRC) section 2058, which applies to state death taxes. To be deductible under IRC section 2058, the state death tax must be paid “in respect of any property included in the gross estate.” An addback gift that is not part of the federal gross estate would not seem to meet this definition. What this means is that wealthy New Yorkers may be penalized—for federal estate tax purposes—for having lived and died in New York. This tax trap could potentially be corrected if the New York Legislature were to amend section 13-1.3 of the New York Estates, Powers, and Trusts Law to statutorily treat the estate tax attributable to the taxable gift addback as a debt allocable to the residuary estate, except as may be otherwise provided in the deed of gift, will, or other governing instrument. (See Comm’r v. Estate of Bosch.)

The Throwback Tax

There are also the accounting aspects of tracking and computing New York’s introduction of a “throwback tax” on certain distributions to New York resident beneficiaries from trusts qualifying for the New York resident trust exception, other than incomplete gift nongrantor (ING) trusts. (Much less controversial, the new law subjects New York grantors of ING trusts qualifying for the New York Resident Trust Exception to New York income tax by treating such trusts as grantor trusts for New York income tax purposes [N.Y. Tax Law section 612(b)(41)]. Section 9 to the budget bill, which enacted this statute, provides that this provision does not apply to income from a trust that is liquidated before Jun. 1, 2014.) The New York resident trust exception applies to nongrantor trusts for which—

  • all of the trustees are domiciled outside of New York state;
  • all real and tangible trust property is located outside of New York state; and
  • all trust income and gains are derived from sources outside of New York state. (See N.Y. Tax Law section 605[b][3][D]).

The throwback tax is extraordinarily complicated both in its statutory formulation (relying upon extensive cross-references to complex IRC provisions that have been effectively repealed except in the case of foreign nongrantor trusts) and in its practical application. In an oversimplified definition, it applies to income of a trust qualifying for the New York resident trust exception, distributed to a New York resident beneficiary (at least 21 years old) who was not previously taxed by New York and accumulated during taxable years beginning on or after Jan. 1, 2014. [See N.Y. Tax Law section 612(b)(40)]. This provision does not apply to income that is paid to a beneficiary before Jun. 1, 2014.

Additional Aspects of the New Law

The new law also includes the following:

  • Valuation: The New York gross estate shall be valued at the time of the decedent’s death. If a federal estate tax return is filed and alternate valuation is elected for federal estate tax purposes, however, then the New York estate must also be valued as of the federal valuation date. If an alternate valuation date could have been elected but for the absence of an estate sufficiently large to require the filing of a federal estate tax return, the New York estate may be valued by the federal valuation date that would have applied if a federal estate tax return had been filed. But no such election may be made unless it will decrease the value of the New York gross estate and the amount of New York estate tax. [See N.Y. Tax Law section 954(b)].
  • QTIP election: The qualified terminable interest property (QTIP) election will not be allowed unless it was made with respect to a federal estate tax return that was required to be filed. If such election is made for federal estate tax purposes, then it must also be made for New York estate tax purposes; however, where no federal estate tax return is required to be filed, a New York QTIP election is permitted. [See N.Y. Tax Law section 955(c)].
  •  Repeal of the New York GST tax: The New York generation-skipping transfer (GST) tax, which had applied to taxable distributions and taxable terminations from a trust to a “skip person” for GST tax purposes, has now been repealed.

Kevin Matz, JD, LLM, CPA is the managing attorney of the law firm Kevin Matz & Associates PLLC. His practice is devoted principally to domestic and international estate and tax planning. Mr. Matz is also the chair of the NYSSCPA’s Estate Planning Committee, and frequently writes and lectures on estate and tax planning topics. He can be reached by email at kmatz@kmatzlaw.com.

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