Issues AND INSIGHTS May 2014 Dramatic Changes for Trusts & Estates Laws in New York State What you should know as a New York resident IN THIS ARTICLE Passage of the Executive Budget for 2014 2015 by the New York State legislature brings substantial changes for New York residents It includes an increased estate tax exclusion amount, a potential estate tax cliff, a gift add-back after death, and income tax changes Plans should be carefully reviewed in light of these changes Sharon L. Klein, Managing Director of Family Office Services & Wealth Strategies, Wilmington Trust, N.A., New York On March 31, 2014, the New York State legislature passed the Executive Budget for 2014 2015. The budget brought with it very substantial changes to New York law, from increases to the estate tax exclusion amount, to an estate tax cliff, to a gift add-back after death, to changes to the income taxation of resident trusts. Estate Tax The new law increases New York s estate tax exclusion amount, which up to this point was $1 million (see Figure 1). figure 1 New York Estate Tax Exclusion For individuals dying on or after And before Exclusion amount 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 1, 2019 $5,250,000 2014 Wilmington Trust Corporation. All rights reserved. page 1 of 6
After January 1, 2019, the basic exclusion amount will be indexed for inflation with a cost-of-living adjustment pegged from 2010. That should link the state exclusion amount to the federal exclusion amount by 2019, and going forward. For 2014, the federal exclusion amount is $5.34 million, and projected to be $5.9 million in 2019 ($5 million, indexed for inflation since 2010). The current top estate tax rate of 16% remains in effect. Although Governor Andrew Cuomo originally proposed reducing the top rate to 10%, that proposal was eliminated from the final version of the budget bill. It s interesting to note that the new estate tax rate schedule applies to individuals dying between April 1, 2014 and March 31, 2015. There is no rate schedule for individuals dying after March 31, 2015. While possibly an error, this omission may have the effect of eliminating the estate tax for those dying outside the expressed timeframe, potentially signaling that the intent was to force the rate schedule to be revisited as part of next year s budget bill negotiations. Beware the Estate Tax Cliff Governor Cuomo criticized New York s tax system for having estate tax rates among the highest in the country, with exemption levels among the lowest. He advocated reform of what he called the move to die tax by increasing the tax threshold and reducing the tax rates to put New York in line with other states. In his January press release, the Governor proposed to restore fairness and eliminate the incentive for older middle-class and wealthy New Yorkers to leave the state. However, the increase in the New York estate tax exclusion amount fully benefits only those estates equal to or below the exclusion amount in effect on the date of death. This creates a cliff effect: New York taxable estates that are less than or equal to the applicable New York estate tax exclusion amount on the date of death will pay no tax; The increase in the New York estate tax exclusion amount fully benefits only those estates equal to or below the exclusion amount in effect on the date of death. This creates a cliff effect. New York taxable estates that are between 100% and 105% of the applicable exclusion amount will rapidly lose the benefit of the exclusion due to a phase-out computation; and New York taxable estates that exceed 105% of the applicable exclusion amount will lose the benefit of the exclusion amount entirely. As a result, if a resident decedent s taxable estate exceeds the exclusion amount by more than 5%, the entire taxable estate will be subject to New York estate tax. This cliff effect can be very dramatic: Example: Assume an individual dies on May 1, 2017, when the New York exclusion amount is $5.25 million. If that individual dies with an estate valued at $5.25 million, the estate will owe no New York tax. If instead that individual s New York taxable estate is $5,512,500, the estate would pay New York estate tax of $452,300. Why? An estate of $5,512,500 exceeds the $5.25 million exclusion amount by 5% ($262,000) and therefore loses the benefit of the tax exemption entirely. In other words, there is a New York estate tax differential of over $450,000 (or a marginal New York estate tax rate of over 170%) on the additional New York taxable estate of $262,500 in excess of the basic exclusion amount of $5.25 million: an arguably confiscatory result. Ironically, reducing the taxable estate with a $262,500 charitable bequest 2014 Wilmington Trust Corporation. All rights reserved. page 2 of 6
Although New York estate taxes are generally deductible against the federal estate tax liability, the estate tax attributable to the gift add-back does not seem to be deductible. The result is that gifts added back will potentially be subject to the full maximum 16% estate tax rate, without any offsetting federal deduction. (or even squandering that amount) would result in a tax saving of $452,300: the tax saving is greater than the amount of the bequest by pushing the estate value down to the exclusion level. Note, however, that due to modifications to the new bracket structure, if an estate does exceed the New York exclusion amount by more than 5% and is fully subject to New York estate tax, the estate tax owed will be the same amount that was owed under prior law. The end result: Under prior law, only estates under $1 million were exempt from New York tax. The new law exempts from tax estates that are less than or equal to the increased exclusion amount ($2,062,500 currently and rising to an estimated $5.9 million in 2019 when linked to the federal exclusion amount); There is no change to the estate tax consequences for estates under $1 million (not taxable under prior or current law); and There is no change to the estate tax consequences for estates that exceed the New York exclusion amount by 5% (same tax payable under prior and current law). Gift Add-Back The original budget bill also included a proposal to increase the New York gross estate of a deceased resident by the amount of any taxable gift made on or after April 1, 2014, if the decedent was a New York resident at the time the gift was made. In other words, although a current gift tax was not proposed, the value of taxable gifts made during lifetime was to be added back at death to increase the size of the estate, potentially subjecting those amounts to New York estate tax at a maximum rate of 16%. The stated intent behind the proposal was to close a loophole by preventing deathbed gifts from escaping the estate tax: a deathbed gift would otherwise not be subject to gift tax in New York since New York does not impose a gift tax, and the gifted assets would reduce the size of the estate for the purposes of computing the New York estate tax. Although the add-back for taxable gifts remains in the final budget, its application has been significantly narrowed: the add-back applies only to gifts made within three years of death. In other words, if an individual makes a gift and survives at least three years, the value of the gift will not be added back to the value of the estate. In addition, this three-year look-back applies only to gifts made on or after April 1, 2014 and before January 1, 2019 (although it could be extended). The add-back also only applies if an individual was a New York resident at both the time of making the gift and at the time of death. The final budget is not entirely clear on whether gifts of out-of-state tangible or real property are added back to the estate, although out-of-state tangible and real property are specifically excluded from the estate for New York estate tax purposes. For example, if a New York resident gifted a vacation home in Florida, the value of that gift may be added back to the value of the 2014 Wilmington Trust Corporation. All rights reserved. page 3 of 6
estate, but if an individual died owning a vacation home in Florida, that real property would not be included in the value of the estate. A clarification may be necessary to confirm parity. Note also that, although New York estate taxes are generally deductible against the federal estate tax liability, the estate tax attributable to the gift addback does not seem to be deductible. The result is that gifts added back will potentially be subject to the full maximum 16% estate tax rate, without any offsetting federal deduction. Annual exclusion gifts ($14,000 for 2014) are not added back. Portability Absent Portability refers to the ability of a surviving spouse to utilize the federal unused gift and estate tax exclusion of the first spouse to die ($5.34 million for 2014), to the extent that the first spouse had not used the full amount. Portability has been permitted for federal purposes since 2011. Although many had advocated for state-level portability to match the federal regime and facilitate planning, portability is absent from the new budget legislation. As a result, New York individuals cannot rely on portability to access any unused New York exemption amount from the first spouse to die (it will be lost). Planning for New York Residents is Critical Planning to utilize the New York exclusion amount is critical. With a married couple, for example, considering how each spouse can each use his or her New York exclusion amount bears close examination. Example: If spouses each own assets worth $3 million and the first spouse to die leaves everything to the survivor, that will push the survivor s estate of $6 million over the cliff. Assuming that the survivor dies on May 1, 2017 when the New York exclusion amount is $5.25 million, the $6 million estate will have fallen off the cliff, and New York estate taxes of $510,800 will be payable. Structuring the estate plan to take advantage of the exclusion amount at the first death with trust planning, for example, so that each estate is under the cliff threshold, could potentially result in estate tax savings to heirs of $510,800. If one spouse held the bulk of the $6 million assets, retitling assets might be considered in order to leave each spouse with assets below the exclusion level. As noted previously, charitable planning to reduce an estate below the cliff threshold can also result in substantial tax savings ironically, savings which are potentially greater than the amount of the charitable bequest. Additionally, because the new law regarding gifts is structured as an add-back as opposed to a current gift tax, gifting up to the federal exclusion amount ($5.34 million in 2014, or $10.68 million per married couple) merits consideration. In order to determine if a gift will save overall taxes, a number of factors need to be weighed, including the life expectancy of the donor and the cost basis of the gifted assets for capital gains tax purposes. Since gifted assets will not receive an increased basis (or step-up ) upon death, the donor should consider potential estate tax savings through gifting versus potential future capital gains tax cost on the sale of the gifted assets. For New York residents in particular, if an individual survives three years after making a gift, the gift will reduce the size of the New York estate and may also lower the value of the estate to below the cliff threshold. Individuals can utilize the federal exclusion amount to create dynasty trusts in Delaware, for example, which if properly structured, can benefit successive generations of their issue in perpetuity, without any gift or estate tax consequences. 2014 Wilmington Trust Corporation. All rights reserved. page 4 of 6
Another possibility is a so-called spousal limited access trust or SLAT, which is typically a trust created for the ultimate benefit of descendants, but to which a spouse can have access. This might be an attractive option for those who wish to make a gift, but reserve the possibility that a spouse could have access to the trust funds if needed. Income Tax Changes for Certain Trusts Under existing New York Tax Law, an income tax is imposed on the income of a resident trust, which includes a trust created by a New York domiciliary. However, prior law provided that a resident trust would be exempt from tax if three conditions were met: 1) there were no New York trustees, 2) there was no trust property located in New York, and 3) there was no New York source income. The Executive Budget includes changes to the taxation of resident trusts. While it does not impose a tax at the trust level, the new law does tax distributions of accumulated trust income to New York beneficiaries of these exempt resident trusts. In addition, changes are also made to the taxation of so called INGs incomplete gift, non-grantor trusts. These trusts were structured as incomplete gifts for gift tax purposes so that no gift tax was payable, but as separate taxpayers for income tax purposes. What Should You Do in Light of the New Laws? Planning should be carefully reviewed in order to ensure that the impact of the new laws is incorporated, and that existing plans are structured for maximum efficiency and flexibility. The new laws generally were effective as of April 1, 2014, so prompt action is advisable. Wilmington Trust has been serving as a corporate trustee for more than a century, helping individuals and families translate their success into meaningful and lasting legacies. We understand that there is much more to managing wealth than simply managing money, and we are committed to helping you develop and implement the most effective wealth transfer plan for your unique situation. Please do not hesitate to contact your relationship manager, call us at 866 627.7853, or visit our website at wilmingtontrust.com if you have any questions or would like additional information. Under the new law, ING trusts will be treated as grantor trusts for New York purposes. That is, the income and gains of the ING trust will be includible in the income of the New York grantor, although the trust will remain a separate taxpayer for federal purposes. The law is effective immediately and applicable to tax years beginning on or after January 1, 2014, but does not apply to income earned by ING trusts that are liquidated on or before June 1, 2014. 2014 Wilmington Trust Corporation. All rights reserved. page 5 of 6
Renowned Expertise: About our Author Sharon L. Klein Managing Director of Family Office Services & Wealth Strategies Wilmington Trust, N.A., New York Sharon is responsible for providing comprehensive wealth management advice to high-net-worth individuals and families, entrepreneurs, business owners, and foundations and endowments throughout the New York Metro Region. She joined Wilmington Trust in 2013 with more than twenty years of experience in the area of trusts and estates. Sharon holds a Master of Laws degree from Boalt Hall School of Law at the University of California, Berkeley and a Bachelor s of Law from the University of New South Wales, Australia. She is a nationally recognized speaker and author on trust and estate issues and has spoken for many professional organizations. Sharon serves as chair of the Trusts, Estates and Surrogate s Court Committee for the New York City Bar Association, and holds leadership positions on several other estate and trust related committees. This publication is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. This publication is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought. Wilmington Trust is a registered service mark. Wilmington Trust Corporation is a wholly owned subsidiary of M&T Bank Corporation. Investment management and fiduciary services are provided by Wilmington Trust Company, operated in Delaware only, and Wilmington Trust, N.A., a national bank. Loans, retail and business deposits, and other personal and business banking services and products are offered by M&T Bank, member FDIC. This version was adapted from a longer article first appearing in the April 22, 2014 edition of the NEW YORK LAW JOURNAL 2014 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. 2014 Wilmington Trust Corporation. All rights reserved. page 6 of 6 CS5378