New York has at Last Updated its Estate, Gift & Trust Income Taxes – But Were These the Requested Changes
NEW YORK HAS AT LAST UPDATED ITS ESTATE, GIFT, AND TRUST INCOME TAXES – BUT WERE THESE THE REQUESTED CHANGES?
Susan Taxin Baer
and Howell Bramson
Effective April 1, 2014, the 2014-2015 budget legislation (the “Executive Budget”) makes significant changes to New York’s estate tax and the income taxation of certain trusts. But will these changes keep wealthier New Yorkers in New York? Stated another way, will the Executive Budget accomplish what Governor Cuomo verbalized frequently as one of his primary purposes in advocating sweeping changes in New York’s estate tax law: “to eliminate the incentive for older middle-class and wealthy New Yorkers to leave the State.”
These changes will have a major effect on estate planning for both New York residents and non-residents. Although these changes provide some tax relief for the moderately wealthy, wealthier New Yorkers will see little, if any, change, except under certain circumstances that will cause an increase in estate and income tax. See “Gifts” and “ING Trusts” below.
Recognizing that New York’s estate “tax [was] woefully out of date,” in December 2012, Governor Cuomo established the New York State Tax Reform and Fairness Commission to conduct a comprehensive and objective review of the State’s tax structure. Charged with modernizing the current tax system by increasing its simplicity, fairness, economic competitiveness, and affordability, the Fairness Commission issued its final report on November 11, 2013. Its recommendations included:
- Raising the estate tax threshold from $1 million to $3 million;
- Eliminating New York’s GST tax;
- Reinstating New York’s gift tax; and
- Closing the resident trust “loophole,” a New York resident trust’s exemption from tax.
It had been clear that lifetime gifting had been an effective means of reducing the estate tax. This was particularly evident in New York where there has been no gift tax since its repeal in 2000, and even more so since 2010 with the large number of tax free gifts that were made as a result of the significant increase in the federal exemption. Thus, the Fairness Commission sought reinstatement of the gift tax as an important complement to the estate tax. The Fairness Commission Report was then sent to the New York State Tax Relief Commission for its review and recommendations for the Governor’s 2014 State of the State message. The Tax Relief Commission issued its Report on December 6, 2013, in which it proposed (a) bringing the state exemption threshold up to the 2013 federal level of $5.25 million with indexing and (b) lowering the top estate tax rate from 16% to 10%. The Tax Relief Commission Report, however, did not even mention the following three (3) significant recommendations that had been highlighted in the Fairness Commission Report: (i) reinstituting the gift tax, (ii) closing the “resident trust “loophole,” and (iii) eliminating the GST tax.
Four days after the Final Report of the Tax Relief Commission had been released, the Governor announced his acceptance of its provisions and on January 6, 2014 issued a press release in which he proposed a phase in of the changes. The Governor noted that “New York is only one of 15 states that impose an estate tax and [New York’s] current estate tax level is badly in need of reform.” He proposed reducing the top estate tax bracket to 10% and increasing New York’s estate tax threshold to $5.25 million over four years, so that beginning in 2019, the estate tax exemption in New York would equal the federal exemption, indexed to inflation. This change, the Governor claimed, “would exempt nearly 90% of all estates from the tax, restore fairness, and eliminate the incentive for older middle class and wealthy New Yorkers to leave the State” in favor of tax-favored jurisdictions. While the Governor’s 2014-2015 budget bill, more commonly referred to as the “Executive Budget,” incorporates some of the Tax relief Commission proposals, there is definitely a disconnect between the public relations surrounding the Governor’s press releases and speeches on the one hand, and certain provisions written into the Executive Budget.
Estate Tax Exclusion Increased – but only for Some. The Executive Budget increases New York’s basic exclusion amount ($1 million per decedent prior to April 1, 2014) to $2.0625 million per decedent as of April 1, 2014, with annual increases of $1.0625 million until April 1, 2017 when the basic exclusion amount will reach $5.25 million. Beginning January 1, 2019 and thereafter, it will be indexed for inflation, which should link New York’s basic exclusion amount to the federal amount (presently $5.34 million, but also indexed for inflation). The basic exclusion amount is increased as follows:
Death on or After:
|April 1, 2014||April 1, 2015||$2,062,500|
|April 1, 2015||April 1, 2016||$3,125,000|
|April 1, 2016||April 1, 2017||$4,187,500|
|April 1, 2017||January l , 2019||$5,250,000|
Read on, however, because what appears to benefit New Yorkers does not really favor the very wealthy under what is referred to as the “cliff.” Because of this quirk in the way New York calculates its estate tax, the basic exclusion amount is rapidly phased out once the value of a decedent’s taxable estate exceeds the basic exclusion amount in the year of death, and is totally phased out (e.g., is not available) when the value of a decedent’s taxable estate is greater than 105% of the basic exclusion amount.
The Executive Budget implements the exclusion by allowing a credit of the “Applicable Credit Amount” to be taken against the tax imposed by the statute, as follows:
- If the New York taxable estate is less than or equal to the basic exclusion amount, the Applicable Credit Amount will be the amount of the tax so computed and, therefore, serves as a wash.
- If the New York taxable estate is up to 5% greater than the basic exclusion amount, the Applicable Credit Amount will be limited based on a formula, resulting in a rapidly increasing tax for each percent over the basic exclusion amount.
- If the New York taxable estate is greater than 105% of the basic exclusion amount, no credit is allowed.
By way of example of the first dot point above, suppose D dies on April 20, 2014 with a New York taxable estate of $2,062,500. Because $2,062,500 is the basic exclusion amount at the time of death, there will be no estate tax due.
The second two dot points describe the infamous “cliff” language in the statute, section 952(c), which provides, in pertinent part:
In the case of a decedent whose New York taxable estate exceeds the basic exclusion amount by an amount that is less than or equal to five percent of such amount, the applicable credit amount shall be the amount of tax that would be due under subsection (b) of this section if the amount on which the tax is to be computed were equal to the basic exclusion amount multiplied by one minus a fraction, the numerator of which is the decedent’s New York taxable estate minus the basic exclusion amount, and the denominator of which is five percent of the basic exclusion amount. Provided, however, that the credit allowed by this subsection shall not exceed the tax imposed by this section, and no credit shall be allowed to the estate of any decedent whose New York taxable estate exceeds one hundred five percent of the basic exclusion amount.
In other words, if D’s taxable estate is $2,165,625 (i.e., 105 % of the basic exclusion amount), two (2) tax calculations would be required: one on the applicable credit amount (“ACA”) and the second on the taxable estate. The ACA is determined by multiplying the basic exclusion amount (“BEA”) (currently, $2,062,500 through March 31, 2015), by one (1) minus a fraction, the numerator of which is $2,165,625 – $2,062,500 (the taxable estate minus the BEA), and the denominator of which is $103,125 (5% of the BEA). Once you compute the ACA, you must look at the table in section 952(b) to compute the tax on the ACA. Since the ACA is zero (0) when the taxable estate is 105% of the BEA, the tax on the ACA (the first tax calculation) is zero (0). You must then compute the tax on the taxable estate, once again using the table in section 952(b). Finally, you subtract the tax computed above on the ACA from the tax computed on the taxable income to arrive at the net estate tax.
D’s estate would pay a New York State estate tax of $112,050, as reflected in Exhibit A:
|Taxable Estate =||$2,165,625|
|Computation of Tax on ACA||$0||@||3.06%||=||$0.00|
|Computation of Tax on Taxable Estate||$2,165,625|
|Tax on excess over $2,100,000 @||8.0%||$65,625||=||$5,250|
|Tax before ACA||$112,050|
|Less Tax on ACA||=||$0|
|Tax on first||$103,125||above BEA||=||$112,050|||
A similar computation would apply if the taxable estate is less than 105% of the basic exclusion amount. Each percent above the basic exclusion amount (up to 4%) would reduce the applicable credit amount by an additional 20%, thereby rapidly phasing out the applicable credit amount, which, in turn, increases the tax due for such estates.
For example, if D’s taxable estate is $2,124,375, which is 3% greater than the basic exclusion amount ($2,062,500 x 3% = $2,124,375), D’s estate tax would be $77,200, computed as shown in Exhibit B:
|Taxable Estate =||$2,124,375|
|ACA =||$2,062,500||x||(1||–||$ $2,124,375||–||$2,062,500||)|
|Computation of Tax on ACA||$825,000|
|Tax on excess over $500,000 @||5.0%||$325,000||=||$16,250||=||$31,550|
|Computation of Tax on Taxable Estate||$2,124,375|
|Tax on excess over $2,100,000 @||8.0%||$24,375||=||$1,950|
|Tax before ACA||$108,750|
|Less Tax on ACA||=||($31,550)|
|Tax on first||$61,875||above BEA||=||$77,200|||
Now, suppose D’s taxable estate is significantly greater than the basic exclusion amount, say $6,200,000, and no credit is allowed. This would bring the tax calculation into a higher tax bracket (i.e., 12.8%), and D’s estate would pay a New York State estate tax of $535,600 (tax on $6.l million = $522,800 plus $12,800 (12.8% on the excess of $100,000)). That is, taxable assets of slightly more than 200% of the basic exclusion amount (i.e., $2,062,000 x 200.6% = $4,137,375) will cause D’s estate to pay a New York estate tax of $535,600.
Estate Tax Bracket. The Governor’s budget bill originally included a reduction of the estate tax bracket from 16% to 10%. The Executive Budget, however, keeps the top bracket at 16%.
Interestingly, the rates included in the Executive Budget only cover the period for a decedent dying on or after April 1, 2014 and before April 1, 2015. While this might have been an error that will require a technical correction, there is some question as to whether it is a time-limited compromise, test period or mandate reached during the budget negotiations.
Note that although the top bracket is still 16%, there has been a change in bracket structure. As a result, estates valued in excess of 105% of the basic exclusion amount will have the same tax they would have had under the old law.
Gifts. New York has not had a gift tax since 2000 when New York’s gift tax was repealed. Consequently, a commonly used estate planning technique to reduce the size of a New York resident’s estate tax was to make gifts within the allowable federal exemption. Not only was the donor able to make a completed gift without incurring gift tax liability in New York, but so long as she had not retained an interest in the gifted property, she was assured that the value of the gift would not come back into her estate for estate tax purposes. The Governor’s budget bill proposed to close this loophole by including in one’s New York taxable estate certain gifts made after April 1, 2014. The legislature, however, pared back the extent to which lifetime gifts must be added back by limiting this add back to taxable gifts made within three (3) years of death (if not otherwise includible in the federal gross estate), exclusive of gifts made (i) when the decedent was not a resident of New York, (ii) before April 1, 2014 or (iii) after December 31, 2018. (In general, “taxable gifts” do not include annual exclusion gifts (currently $14,000 per donee) and payments made directly for tuition and medical expenses.) The add back, however, does not appear to exclude gifts of real or tangible personal property outside of New York State, which, if owned at a decedent’s death, would not be subject to New York’s estate tax. Let’s say, for example, that D purchased a vacation home on the Atlantic Coast in Florida that he has used every winter while visiting his son (“S”) who lives in Miami. In 2016 D decides to reduce his New York taxable estate and gives the vacation home to S. If D dies in 2018, the value of the vacation home will be added back to D’s New York taxable estate. Had D not made the gift, the vacation home (real property in Oregon), would not be included in D’s New York estate.
Although the add back provision under the new law is not nearly as onerous as originally proposed, gifts that are added back are not likely to be eligible for the state death tax deduction against the federal estate tax. This is because this deduction, as allowed under section 2058 of the Internal Revenue Code, must be paid “in respect of any property included in the [federal] gross estate . . . .” Since gifts added back under the new law would not be a part of the federal gross estate, they would not likely be eligible for the state estate tax deduction for federal estate tax purposes.
The top estate tax rate on property included in decedent’s federal and New York gross estate is 40% federal plus 16% New York. However, since estate taxes paid to New York on property includible in the decedent’s federal gross estate are deductible in computing the federal estate tax, the top effective New York rate is 9.6% (i.e., 16% – [16% x 40%] = 9.6%). Hence, gifts added back to the decedent’s estate under the new law will be subject to an additional tax of 6.4% as compared to having the same property included in the decedent’s gross estate. Deathbed gifts will thus rarely be tax efficient. Exhibit C below illustrates the effect of making deathbed gifts. The taxable estate for a New York decedent is assumed to be $7 million (for this purpose, assume all of the property is located in New York). If no deathbed gifts are made the New York estate tax would be $638,000 and the Federal estate tax would be $408,800 (reflecting a deduction for the entire New York estate tax), for a total estate tax of $1,046,800. If a deathbed gift of $1 million is made, the New York tax would remain the same $638,000, but the portion attributable to the gift add-back ($127,200) is not deductible for Federal purposes. Thus, the Federal estate tax would be $510,800, resulting in an additional tax of $50,880.
Now let’s assume that the $7 Million estate includes the vacation home in Florida and that the deathbed gift is comprised of the vacation home. Had D not made the gift (or had he not made it within three (3) years of his death and before 2019), his New York taxable estate would be $6 million, the federal estate tax would be $445,268, based on an estate of $7 million, and the New York State estate tax would be $546,830. From a planning standpoint, elderly clients or clients in bad health (where death within 3 years is a strong possibility) should defer making large gifts until 2019, particularly if they are not planning to move out of state.
|New York Decedent (April 1, 2014 – December 31, 2014)|
|Federal Estate Tax||$408,800|
|New York Estate Tax||$638,000|
|Total Estate Taxes||$1,046,800|
|New York Decedent (April 1, 2014 – December 31, 2014)|
|Federal Estate Tax||$459,680|
|New York Estate Tax||$510,800|
|Tax on New York Gift Add back||$127,200|
|Total Estate Taxes||$1,097,680|
|Cost of Deathbed Gifts||$50,880|
Furthermore, because the New York estate tax will be imposed on gifts that are no longer held in the estate, when drafting Wills and revocable trust agreements it will be important for attorneys to consider and specify the estate assets that would be the best source against which to allocate the New York estate tax due on such gifted assets, particularly in those instances where the donee of the gift is not the beneficiary of the donor’s estate at the donor’s death.
Throwback Tax on Distributions of Accumulated Income. Under the Executive Budget, New York resident beneficiaries may be subject to a “throwback tax” on certain distributions they receive from trusts qualifying for the “New York Resident Trust Exception” (except an incomplete gift non-grantor or “ING” Trust – see below) as if the income earned in the trust had been subject to New York income tax during the year the income was accumulated. A trust qualifying for the “New York Resident Trust Exception” is one created by a New York resident (ergo, a “Resident Trust”) but is exempt from New York tax under Tax Law Section 605(b)(3)(D)because under the prior law, a resident Trust was not taxed during a given year where (i) none of the trustees were domiciled in New York during that year, (ii) no real or tangible trust property was located in New York, and (iii) neither trust income nor gains were derived from New York sources, thereby allowing the trust to be exempt from New York income tax during that year. The throwback tax will apply if the exempt resident trust (a) accumulates income during a year in which it qualified as an “exempt trust,” and (b) accumulated income is distributed in a later year to a beneficiary who is then a New York resident. The throwback tax will not apply to income of a non-resident trust nor will it apply to distributions of income of an exempt Resident Trust accumulated prior to (i) January 1, 2014 or (ii) there being a New York resident beneficiary who was at least 21 years of age.
An earlier version of the throwback rules would have also taxed income accumulated before January 1, 2014 and trusts created by non-New York residents. Even as improved, though, the throwback tax provisions will cause burdens of record keeping not only to trustees but also to tax preparers.
ING Trusts. An ING Trust, referred to above, is an incomplete gift non-grantor trust created by a New York taxpayer in another state to avoid New York income tax on the income and gains from the assets transferred to the trust without current gift tax liability. Under the Executive Budget, effective immediately for tax years beginning on or after January 1, 2014, but excluding income earned by ING Trusts that are liquidated before June 1, 2014, an ING Trust created by a New York taxpayer will be treated as a grantor trust for New York purposes. As a result, the New York taxpayer who had been trying to avoid the New York tax will now be required to pick up all of the trust’s income on her income tax return. This, in turn, will cause a disconnect between the New York state and federal reporting of the same trust, because for federal tax purposes, taxpayer would continue to report the income as derived from a non-grantor Trust.
Valuation. Valuation of an estate as of date of death or the alternate valuation date for New York estate tax purposes must be the same as for federal estate tax purposes. If a federal return is filed, New York must use the same values and valuation date as shown on the federal estate tax return. If no federal return is filed, the New York return must reflect the same methodology as would have been used had a federal return been filed (e.g., no election to use alternate valuation may be made unless it will decrease the value of New York’s gross estate as well as the amount of tax).
Repeal of New York’s GST Tax. The Executive Budget has repealed New York’s generation skipping transfer (“GST”) tax, applicable to taxable distributions to “skip persons” and taxable terminations where “skip persons” receive a trust distribution on its termination.
QTIP Election. Although the Senate version of the budget bill included a provision specifically allowing for a separate New York qualified terminable interest property (“QTIP”) election to be made where a federal estate tax return was required for purposes of electing portability, that provision did not make it to the final version of the Executive Budget. As a result, a New York QTIP election will not be allowed where (i) a federal estate tax return is required to be filed and (ii) a QTIP election is not made on that return. A New York QTIP election will, however, be allowed where no federal estate tax return is required to be filed.
Portability. Although the Assembly had expressed an interest in a provision for the unused New York exemption of the first spouse to die to be “ported” to the surviving spouse who could then use the first spouse’s remaining exemption, and such a provision had been drafted and submitted to the Legislature, it was not included in the Executive Budget, most likely because of the difficulty in seeing it carried through in light of New York’s exemption cliff. This creates further issues for a New Yorker planning his or her estate. As a result, (i) New Yorkers should continue to use credit shelter trusts as part of their estate planning since they will not be able to rely on portability to take advantage of an otherwise wasted exemption; and (ii) New Yorkers who expect that their estate will not exceed the then applicable federal exemption will need to weigh the benefits of (aa) electing portability for federal estate tax purposes or (bb) not filing a federal estate tax return in order to make a New York QTIP election. In making the decisions in “(i)” and “(ii)” above, consideration should also be given to the income tax rates vs. the estate tax rates and (particularly in the case of a first marriage) the benefits of outright dispositions to take advantage of income tax savings with portability, which could be costly in New York where there is no provision for portability.
To illustrate the interaction between the New York QTIP election and Portability, suppose a married New York resident dies with an estate of $4 Million at a time when the New York exemption is $2,062,500 and the decedent does not want assets to go outright to the surviving spouse. To avoid a New York tax, the credit shelter trust must be limited to the New York exemption amount. If no portability election is made, a New York QTIP election can be made for the balance of the estate. The entire $4 Million will be exempt from taxation in the survivor’s estate but, because no portability election was made, the balance of the decedent’s exemption ($5,340,000 less $4 Million) will be lost. Also, the assets in the credit shelter trust will not get a second tax basis step-up when the survivor dies. If, instead, a portability election is made, the full New York tax would be due on the decedent’s death, because the QTIP election would not be available, but the full $5,340,000 exemption would be available to the survivor and there would be a full tax basis step-up upon the survivor’s death.
Conclusion. As a result of the passage of the Executive Budget, estate planning for New Yorkers must still look to old tools, such as the credit shelter trust to achieve estate planning goals. In addition, gift planning must be carefully considered. Unless section 2058 of the Internal Revenue Code (the state death tax deduction) will be determined to include gifts added back under the new law (which is not likely), careful consideration will have to be given to the loss of the full deduction in determining the benefits of making large gifts (e.g., getting the income and appreciation on the gifted assets out of one’s estate). The timing of making gifts must also be considered if one is moving into or out of New York. Due to the cliff and New York’s keeping its top estate tax bracket at 16%, the wealthiest New Yorkers will be still incentivized to move out of the state to take advantage of more tax-favored jurisdictions.
 The authors gratefully acknowledge Jonathan Rikoon for all of his input and assistance.
 That is, a $103,125 increase in D’s taxable estate will result in an estate tax increase of $112,050 (or a marginal tax rate of 108.65%).
 The result here shows that an increase of only $61,875 in D’s taxable estate will result in an estate tax increase of $77,200 (or a marginal tax rate of 124.77%).
 The NYSBA Trusts and Estates Law Section, as well as the Estate and Gift Tax Committee and the Trusts, Estate and Surrogate’s Court Committee of the New York City Bar, submitted comments in response to the proposes budget bill in which each explained the tax issues with what had been essentially an unlimited add back of gifts subsequent to 3/31/14, urging that the pare back be limited to death bed gifts, if at all.