United States: New York Budget Law Dramatically Changes The Face Of New York Estate Planning

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 several significant 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 and more technically known as the federal "applicable exclusion amount"). However, the final version of the law does not match the federal exemption until 2019. Instead, starting April 1, 2014, the new law gradually phases in the amount exempt from New York estate tax, referred to as the New York "basic exclusion amount," over the next four years and nine months.

Certain other changes affect the income taxation of New York trusts, described below.

Increasing the Amount Exempt from NY Estate Tax

The New York basic exclusion amount is phased in as follows:

For a decedent dying:

For deaths occurring on or after January 1, 2019, the basic exclusion amount is $5,000,000 indexed for inflation to match the federal estate tax exemption.

The New York estate tax rate ranges from 3.06% for taxable estates not over $500,000 to a top marginal rate of 16% for estates exceeding $10,100,000.

The NY Estate Tax "Cliff"

Not everyone will be able to take advantage of the New York basic exclusion amount. The new law contains a "cliff" so that a taxable estate that exceeds 105% of the basic exclusion amount will be subject to New York estate tax, not just on the excess over the basic exclusion amount, but on the entire amount of the taxable estate.

To illustrate, assume a New York domiciliary dies in 2019 when the federal exemption will match New York's basic exclusion amount. We will estimate that amount to be $5,900,000.

If we assume that this decedent had a taxable estate of exactly $5,900,000, her estate would pay no federal or New York estate tax.

If the decedent's taxable estate was instead equal to $6,195,100 (which is $100 more than 105% of the exemption amount and which exceeds the basic exclusion amount by less than $300,000), the New York estate tax bill would come to $534,973.

After the basic exclusion amount is fully phased in to match the federal exemption, the new law will fully exempt the comparatively "small" estates of most New Yorkers (i.e., estates having a value equal to the federal exemption or less) from both federal and New York estate tax, but will continue to impose a rather substantial tax on estates that exceed the federal exemption amount by more than a small margin.

In addition, even those with comparatively "small" estates need to be aware of these changes. Many spouses whose combined estates are less than $10,680,000—twice the 2014 federal exemption amount—have simplified or plan to simplify their estate plans by taking advantage of the exemption portability provisions of the federal estate tax. In general terms, the federal portability provisions permit the surviving spouse to add to his federal exemption amount his deceased spouse's unused federal exemption amount. Spouses may be tempted to remove credit shelter trust planning from their wills and trusts (which would, at the first death, establish a flexible trust for the survivor that would not be part of the survivor's taxable estate) and instead allow the estate of the first spouse to die to pass outright to the surviving spouse. The unlimited marital deduction protects the first spouse's estate from estate tax. The survivor in this scenario would plan to rely on the combination of his own and his deceased spouse's unused federal exemption (which was carried to the survivor via the federal portability rules) to shield the combined estate from the federal estate tax at the survivor's death.

Following such a simplified federal plan in New York may not work so well. Again, the surviving spouse would not be affected: New York also has an unlimited marital deduction so no New York (or federal) estate tax would be due at the first death. New York, however, does not allow portability of exemption. As a result, this simple plan that works so well for federal purposes could easily push the survivor's estate above 105% of the New York basic exclusion amount, causing the survivor's estate to be fully subject to New York estate tax.

In contrast, two smaller uncombined estates, particularly where each one is at or under the New York basic exclusion amount, will fare better than one larger combined estate if the basic exclusion amount is properly utilized at the first death. For example, if each spouse has $3,000,000 of assets and one dies in April of 2015 and the other dies in that same year or later, there will be no New York estate tax payable at either death if the first spouse creates a credit shelter trust for the survivor. If instead the first spouse's assets pass outright to the survivor, creating a $6,000,000 combined estate for the survivor, there will be New York estate tax payable at the survivor's death if that occurs before 2019 and possibly even beyond, depending on the federal inflation adjustment and the basic exclusion amount then in effect.

Even individuals with larger estates will continue to benefit from credit shelter planning at the first death, since the sheltered amount is protected from federal and New York estate tax regardless of how large that trust may be at the survivor's death.

While each person's situation is different, these changes highlight the importance of careful planning to minimize one's exposure to the combined federal estate tax and New York estate tax.

Lifetime Gifts Added Back to the Taxable Estate

New York does not impose a gift tax at the time a gift is made, but the new law targets certain gifts for inclusion in a decedent's New York estate. Taxable gifts made within three years of death by a New York resident (while he or she is a New York resident) will be included in his or her estate at death. "Taxable gifts" has the same meaning as it does for federal purposes and does not, for example, include annual exclusion gifts (currently $14,000 per donee per year) or tuition or medical expenses paid directly to the service provider. This rule applies to gifts made on or after April 1, 2014 and before January 1, 2019.

Grantor Trust Treatment for Certain Resident Trusts; Throwback Tax

The new law also made some significant income tax changes that will impact certain resident trusts that currently avoid New York income tax.

A trust created and funded by a New York resident is technically a New York resident trust, but if its income is not taxable to the grantor under the grantor trust rules, such a trust had been able to avoid New York income tax on its accumulated income and gains so long as: (i) all the trustees are domiciled in a state other than New York, (ii) the entire corpus of the trust, including real and tangible property, is 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. (Intangible property, such as securities, is deemed located outside the state if the trustees are domiciled outside the state.) Such a resident trust is often referred to as an "exempt resident trust."

Under the new law, certain exempt resident trusts will no longer be able to avoid the imposition of New York income tax. An incomplete gift non-grantor trust (known as an ING trust) will now be treated as a grantor trust for New York income tax purposes, effectively subjecting the current net income of such a trust to New York income tax.

For New York exempt resident trusts that are not ING trusts, the new law enacted certain additional rules that will impose complexity and a tax, often referred to as the throwback tax, on certain beneficiaries. Under these new rules, generally speaking, if an exempt resident non-ING trust accumulates (i.e., does not distribute currently) income in years after 2013, tax may be imposed when a New York resident beneficiary receives a distribution from the trust.

Time for a Review

Certain planning opportunities are available under the new law and estate plans should be reviewed to determine if any changes are necessary or desirable to factor in these changes as well as significant changes to the federal estate tax in recent years.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.