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New York State Estate and Gift Tax Law Highlights Effective April 1, 2014

Effective April 1, 2014, the New York State 2014-2015 budget legislation (the “Executive Budget”) makes significant changes to New York’s estate tax and the income taxation of certain trusts. A brief summary follows:

Estate Tax Exclusion Increased but Includes a Cliff
New York has increased its basic exclusion amount (from $1,000,000 per decedent prior to April 1, 2014) to $2,062,500 per decedent as of April 1, 2014, with gradual increases annually as follows:

Date of Death Exclusion Amount
April 1, 2014 to March 31, 2015 $2,062,500
April 1, 2015 to March 31, 2016 $3,125,000
April 1, 2016 to March 31, 2017 $4,187,500
April 1, 2017 to December 31, 2018 $5,250,000

Thereafter, the New York State basic exclusion amount will be indexed for inflation, which should link New York’s basic exclusion amount to the federal basic exclusion amount (currently $5,340,000, indexed for inflation).

It is important to note that the New York exclusion is a “cliff” because it is phased out if the New York taxable estate exceeds the amount of the exclusion by up to 5% and no exclusion is allowed if the taxable estate exceeds 105% of the amount of the exclusion.

For a decedent dying on or after April 1, 2014 and before April 1, 2015, the top estate tax bracket is still 16%.

Gifts within Three Years of Death

Effective for gifts made by New York residents between April 1, 2014 and December 31, 2018, taxable gifts made within three (3) years of death will be added back to the gross taxable estate for New York estate tax purposes. Gifts made while the decedent was a nonresident of New York State and gifts made prior to April 1, 2014 or on or after January 1, 2019 are not included.

GST Taxes Repealed

New York repealed its Generation Skipping Transfer tax. There is still GST tax at the federal level.

Throwback Tax for Exempt Resident Trusts

Under prior law, a so-called “Exempt Resident Trust” (an irrevocable trust created by a New York resident) was not subject to New York income tax if all (1) all trustees were domiciled in a state other than New York; (2) the entire corpus of the trust, including real and tangible personal property, was located outside New York; and (3) all income and gains of the trust were derived from or connected with sources outside of New York.

Under the new law, a New York beneficiary of such an “ Exempt Resident Trust” (other than an Incomplete Gift Non-Grantor Trust described below), is now subject to a New York “throwback tax,” or an income tax imposed on accumulated income which is distributed to the beneficiary. This applies to the extent the income is earned in a taxable year starting on or after January 1, 2014, but does not apply to income paid to a beneficiary before June 1, 2014.

Incomplete Gift Non-Grantor Trusts Treated as Grantor Trusts.

Under the prior law, a New York resident could establish an Incomplete Gift Non-Grantor (“ING”) Trust and structure the trust so that the grantor’s transfer of property to the trust is an incomplete gift for gift and estate tax purposes and the grantor is not treated as the owner of the income or principal of the trust under the “grantor trust rules” of the Internal Revenue Code. If the ING trust was established in a state with no income tax and if the ING trust met the “Exempt Resident Trust” requirements (detailed above), the income would not be subject to New York State income tax.

Under the new law, a New York resident who transferred property to an ING Trust must now include the income of the trust, less any deductions, as personal income for New York purposes. For New York purposes, it is now as if the ING Trust was a “grantor trust” for New York State income tax purposes. This is effective for taxable years beginning on or after January 1, 2014, but does not apply to income from a trust that is liquidated before June 1, 2014.

Estate and Gift Tax Highlights for 2014

Inflation adjustments increase the ability to make tax free transfer as of January 1, 2014.

Estate, Gift & Generation-Skipping Tax Transfers
The exemptions for federal estate, gift and generation-skipping tax (“GST”) transfers are set at $5,000,000, indexed for inflation. Due to the inflation adjustment, the exemption for 2014 transfers (during life and at death) is $5,340,000 (or $10,680,000 per married couple), reduced by any portion of the exemption used in prior years. Taxable transfers beyond the available exemption will still be subject to a 40% tax rate.

New York still sets its estate tax exemption at $1,000,000. However, New York does not have a gift tax, which means lifetime gifts continue to be particularly advantageous for New York residents.

Annual Exclusion

The annual exclusion will remain at $14,000 per donee (or $28,000 per donee for a married couple). However, as of January 1, 2014, the annual exclusion for gifts to non-citizen spouses will be increased to $145,000 (from $143,000 for 2013 gifts).

New Estate and Gift Tax Law Highlights (2013)

On January 1, 2013, Congress passed new law known as the American Taxpayer Relief Act of 2012, or “ATRA.”  ATRA makes many important changes to the Internal Revenue Code. The following are some notable highlights:

 

Estate, Gift & Generation-Skipping Tax Transfers  

The exemptions for federal estate, gift and generation-skipping tax (“GST”) transfers are set at $5,000,000, indexed for inflation. For 2013, the exemption is $5,250,000 (or $10,500,000 per couple), reduced by any portion of the exemption used in prior years. Taxable transfers beyond the available exemption will be subject to a 40% tax rate. This law sets so-called permanent exemptions because, unlike the prior law, the exemptions and rates do not automatically adjust or sunset. However permanent, the law is still subject to future legislation.

 

New York still does not have a gift tax, which means lifetime gifts continue to be particularly advantageous for New York residents.

 

Portability

ATRA makes portability permanent. Portability allows a surviving spouse to inherit the unused federal (not state) exemption amount of the deceased spouse, if the executor files an estate tax return for the deceased spouse and makes an affirmative election. The unused GST exemption of a predeceased spouse is still not portable to the surviving spouse.

 

Income Taxes 

ATRA increased the top Federal income tax bracket from 35% to 39.6%, effective for this year.  In addition, there is a new 3.8% Medicare Tax that applies to most dividends, interest, rents, royalties, certain annuities and capital gain.  Although the 39.6% and 3.8% tax rates apply only to individuals with relatively high levels of income, these rates of tax apply to trusts with about $12,000 of income. One immediate reaction is that the use of trusts should be curtailed.  However, I believe a flexible trust will continue, in most cases, to be beneficial for asset protection and generational wealth preservation.

 

Annual Exclusion 

ATRA does not change the annual exclusion from the federal gift tax. The annual exclusion was already indexed for inflation, and, for 2013, the exclusion has increased from $13,000 to $14,000 per donee (or $28,000 per donee for a couple).

 

Not Included in ATRA

It is important to note that ATRA did not include many proposals to limit certain estate planning techniques that, if enacted, would have dramatically effected estate planning. These include the restriction the of the term for Grantor Retained Annuity Trusts, disallowing minority discounts for many family owned entities, consistent valuation requirements for estate tax and basis for capital gains, limiting the duration of generation-skipping trusts, and providing consistent treatment of grantor trusts with respect to income, estate and gift tax.  These techniques are still effective, however, subject to future legislation.

 

Estate and Gift Tax Law Highlights (2012)

Startlingly, Congress passed a very favorable gift and estate tax law which not only applies in 2011 and 2012 but can be retroactive for estates of decedents who died before December 17, 2010.  A brief summary follows:

Gifts
Beginning January 1, 2011, individuals can give up to $5 million (or $10 million per couple) free of gift tax, reduced by any portion of the exemption used in prior years.  Gifts over $5 million will be subject to a 35% tax rate.  New York still does not have a gift tax.

Estates
Beginning January 1, 2010, the estate tax is reinstated with a 35% rate, a $5 million exemption and stepped-up basis for all assets included in the estate for estate tax purposes.  However, for the estates of decedents who in 2010, before the date of enactment, the Executor can elect out of estate tax in favor of the carryover basis rules, with an allocation of $1.3 million of basis step-up and an additional $3 million for assets passing to a surviving spouse.

Portability
This is new and is currently applicable only to decedents dying after January 1, 2011 and before December 31, 2012. If an estate tax return is filed for a decedent and an election is made, the surviving spouse can use the unused estate tax exemption amount of the deceased spouse.  Unless the law is extended, both spouses must die within the two year period (2011 and 2012) for this provision to apply.  Also, note that any unused GST exemption of a predeceased spouse is not portable to the surviving spouse.

GST Taxes
The GST tax is reinstated effective January 2010, with a $5 million exemption.  However, the tax rate is 0% for 2010 transfers.  The rate increases to 35% effective January 1, 2011.  The historically low rate is an opportunity if you are interested in GST planning, specifically direct gifts or gifts in trust for grandchildren.

Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional

On June 26, 2013, the United States Supreme Court, in U.S. v. Windsor, ruled that Section 3 of the Defense of Marriage Act (DOMA) is unconstitutional under the Due Process Clause of the Fifth Amendment.

Under DOMA, the federal government had defined “marriage” as between one man and one woman. As a result, same-sex marriages that were legally recognized in many states did not enjoy full rights and responsibilities under federal law. The Windsor case marks a monumental shift: the federal government will recognize “marriage” as defined by each state.

As a result, same-sex couples legally married under state law will now have many federal income and estate planning opportunities that were previously unavailable to same-sex couples. Some such benefits include the option to file federal income taxes jointly or individually, eligibility for the marital deduction for lifetime and testamentary transfers whether made outright or in a marital trust, the option to elect to split gifts on federal tax returns, the ability to elect portability of a deceased spouse’s unused applicable exclusion amount, spousal IRA rollovers, entitlement to Social Security benefits or other spousal survivorship benefits available under many federal programs, and immigration protections.

The Windsor case did not challenge Section 2 of DOMA. Section 2 affords all states and territories the right to deny recognition of the marriage of same-sex couples that originated in states where they are legally recognized. This will continue to cause complexity for same-sex couples that reside in or move to a state that does not recognize same-same marriage. The Marriage Equality Act has been in effect in New York since 2011.

Use of a Life Estate for Personal and Charitable Benefit

A homeowner or the homeowner’s family is often faced with the prospect that the homeowner’s estate will have to sell the property to raise the money to pay the estate taxes due if the property is included in the owner’s estate.  By making a gift of the property to a qualified charity with a reserved “life estate,” the owner of a personal residence or family farm can preserve the use of a property for the owner, spouse and/or children for an extended period of time.  In addition, by making a transfer to a qualified charity during your life, rather than waiting until your death, you may be entitled to take an income tax deduction that you can enjoy while you are alive, yet still retain the ability to use the property throughout your life.

The estate tax is based on the fair market value of the property as of the owner’s date of death (or the 6-month anniversary date), currently at a tax rate of up to 50%.  Because it may not be possible to pay the estate taxes due from the other estate assets, it may become necessary to sell the home to pay the taxes.  Although it may be financially impossibly to keep the property, it may also be psychologically impossible to part with the property, whether it be the historic family farm or a beloved home.

A person who wants to leave their home to a favorite charity can, or course, do so under the person’s Will.  But, by making the contribution under the person’s Will rather than making the contribution while the person is alive, the person will lose the opportunity to enjoy an income tax deduction and may never know the pleasure that the gift has given to the charitable beneficiaries.

For persons who wish to make a charitable contribution of their property to a nonprofit organization, wish to retain the use of the property during their lifetime, and would benefit from an income tax charitable deduction, the use of a life estate can be the perfect tool.

A life estate is created when a property owner gives the property away but reserves the right to reside in the property for the owner’s life or for the lifetimes of the owner and the owner’s spouse and possibly even children’s lives.  By making a gift of the remainder interest in your personal residence or family farm to a qualified charity and holding onto a life estate, the homeowner is entitled to take a current income tax deduction in the year of the gift (subject to certain limitations); and the value of the property will not be taxed in the owner’s estate at death.

For example, assume a 75-year old signs a deed to the home transferring the property to a qualified charity, but retains a life estate.  In this case, the homeowner would be entitled to an income tax deduction for some or all of the value of the remainder interest, and no estate taxes would be due at the owner’s death:

 

Full Value of property $2,000,000

Actuarial value of life estate created for owner, age 75 $800,000

Maximum current income tax deduction $1,200,000

Estate tax on value of home $0

Estate tax saved $1,000,000

The income tax benefit can be substantial and will benefit a charitably inclined donor during life, while the donor can experience the tax savings.

 

The life-estate can extend to the second generation, as well.

For example:

Full value of property $2,000,000

Estate tax at death of second parent to die if no life estate is created $1,000,000

* * * * *

Life estate created for owner, spouse and

2 children ages 80, 75, 57, 55 respectively.

Full value of the property $2,000,000

Estate tax at death of second parents to die if life estate is created $787,500

Maximum current income tax deduction $425,000

Estate tax savings $212,500

Potential total income and estate/gift tax savings $637,500

 

If the life estate extends to a second generation, the parents may be making a taxable gift at the time the life estate is created.  In the above example, if the parents have not made any other significant lifetime gifts, the parents will not have to pay a gift tax because the first $1,000,000 of gifts by each parent will be shielded from the gift tax.

The longer the period of the life estate (e.g., children’s or grandchildren’s lives) the greater the value of the property in the parent’s estate and the greater the estate tax.  Incorporating life insurance in the planning can provide a source of payment of the increased estate taxes resulting from the extended life estate.  Moreover, if insurance is purchased on the lives of the children, it could provide funds to purchase back the property from the charity for the benefit of the grandchildren.  The cycle can begin again.

The issue of management of the property during the period of the life estate should be addressed and a Management Agreement among the family members is recommended.  If the property is of large acreage, a portion could be sold or donated or a combination thereof, and the life estate can be created on the reserved residence portion.

In summary, the use of a life estate is an effective tool to significantly extend the period the family can enjoy the use of a personal residence or farm while at the same time fulfilling a charitable interest.

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