As part of Tax Cut and Jobs Act of 2017, the U.S. federal estate tax exemption amount increased to approximately $11.7 million per individual or $23.4 million per couple (for 2021). As a result, many families are no longer subject to this federal estate tax due to the high estate tax exemption amounts. However, several individual states impose their own estate or death taxes, and many have much lower estate tax exemption thresholds.
New York is one of the states that administers their own NY estate tax and has a relatively low NY estate tax exemption amount. Even if a deceased’s estate is not large enough to owe federal estate tax, individuals may still owe an estate tax to the state of New York. The New York estate tax exemption amount is currently $5,930,000 (for 2021).
Early estate planning is recommended to avoid a diminished legacy due to the NY estate tax. One reason to plan early is that part of New York’s estate tax law includes a drastic provision commonly referred to as the “NY estate tax cliff” that can lead to significantly increased taxation when estates pass a certain threshold. This article reviews the basics of the NY estate tax law and discusses estate planning strategies that can be used to reduce the NY estate tax and avoid “falling off the NY estate tax cliff.”
Review of New York Estate Exclusion, NY Estate Tax Rate, & NY Spousal Exemption
There are many unique aspects to calculating an estate tax on a decedent’s estate. To make things more complicated, New York has laws that are considerably different from the federal estate tax and other state estate taxes.
What is the New York Estate Tax Exclusion? – The basic exclusion amount for New York’s estate tax for deaths in 2021 is $5,930,000. The estate of a New York resident must file a New York State estate tax return if the amount of the NY resident’s federal gross estate, plus the amount of any includible gifts, exceeds the current NY exclusion amount at the date of death. Each year this NY estate tax exclusion amount is adjusted slightly for inflation. For example, the NY basic exclusion amount was previously $5,850,000 for deaths in 2020.
What is the New York Estate Tax Rate? – The New York estate tax rate is much lower than the federal estate tax rate (40%). Specifically, the NY estate tax rate starts at 5% and goes up to a 16% maximum rate. Calculating the New York estate tax is done by using the tax tables provided on NY Form ET-706. Executors must file and pay the tax to the New York Department of Taxation and Finance within nine months after the decedent’s death.
Does the NY Estate Tax Have a Spousal Exemption? – Any amount of property left to a surviving spouse is exempt from both federal and NY estate tax (this is referred to as the “marital deduction”). There is a big distinction here between NY and federal law. The federal estate tax exclusion amount left unused is transferrable (or “portable”) between spouses. However, any unused amount of the New York estate exclusion may not be transferred and later used by the surviving spouse.
This means that if the deceased spouse’s exclusion is not used by passing gifts to non-spouse beneficiaries or a trust, it cannot be used in the future. For example, this may happen when a spouse directs that their entire estate pass outright to the surviving spouse. When the surviving spouse passes, that spouse will only have their own NY estate tax exclusion amount available, but no additional amount from the predeceased spouse (under federal law the deceased spouse’s unused exemption amount may be carried over and added to the surviving spouse’s exemption). By not passing the first spouse’s NY exemption amount to non-spouse beneficiaries or a trust, the family could face significant future NY estate taxes.
Are there any Special Considerations for Non-NY Residents with NY Property? – If the decedent is a NY non-resident owning real property or tangible personal property in New York State, the NY property is subject to the NY estate tax above the exemption amount. The decedent’s other assets are not. This could occur when a non-NY resident owns real estate valued over the exemption amount. However, there are many planning techniques that may be used to mitigate a NY estate tax on property owned by non-NY residents.
What is the New York Estate Tax Cliff? How does an Individual Fall Off the Cliff?
One distinctive part of the NY estate tax law that catches many families by surprise is known as the NY estate tax cliff. The NY estate tax cliff law is unique compared to the federal estate tax. Under federal law, only the amount above the exemption amount is subject to estate tax. For example, if the exemption amount is $11.7m, and the taxable estate is $12.7m, then only the excess $1m above the exemption amount would be subject to federal estate tax.
The operation New York’s estate tax law is very different. When a NYS estate exceeds the exemption amount by greater than 5%, the entire estate is subject to NY estate tax (under 5% only the excess amount is taxed). This can lead to interesting outcomes.
For example, if someone dies in January 2021, leaving a taxable estate of $6,250,000, the estate exceeds the New York estate exemption of $5,930,000 by $320,000. Since this amount exceeds $6,226,500 (5% of the basic exclusion amount), the entire $6,250,000 estate is subject to NY estate tax with an amount payable of $542,000 (calculated on Form ET-706). In other states or at the federal level, the estate would pay tax on the excess amount ($320,000 in this case for NY). However, in New York, a tax is now owed on the entire estate. The heirs in this example would avoid paying $542,000 in estate tax and have a better financial outcome if the estate were valued only $25,000 less!
As one can see, the NY estate tax can quickly become a large taxable event for many families and often surprises individuals. Many practitioners call this the NY estate tax cliff due to the harsh tax treatment triggered by only exceeding 5% of the exemption limit. Fortunately, there are advanced NY estate planning techniques that individuals approaching or anticipating being near these NY exemption amounts should consider that require taking early action. If properly implemented ahead of death, these may successfully mitigate the negative effects of the NY estate tax cliff and leave larger post-tax legacy.
New York Estate Tax Planning Techniques to Avoid Falling off the NY Estate Tax Cliff
Given these NY estate tax limits and the unique operation of the NY estate tax cliff, there are strategic options when positioning investment strategies and other financial planning considerations. The New York state legislature is intent on not matching the federal estate tax exclusion amount or adopt the federal rule on portability between spouses. Thus, planning is vital to minimize possible NY estate taxation as this law will be around for the foreseeable future.
Lifetime Gifting to Reduce NY Taxable Estate – Lifetime gifting is a great way to plan a legacy and move gifts outside of the reach of both the federal and the NY estate tax. New York does not currently have a gift tax for lifetime transfers. However, federal gift tax laws and reporting must still be considered. Further, NY has a provision that includes gifts made within three years of death includible in the NY taxable estate (same as federal law).
Certain gifts will also not be subject to NY estate tax. This includes:
- Gifts made when the decedent was not a resident of New York.
- Gifts of real property or tangible personal property located outside New York at the time the gift was made.
- Gifts made to charity (never taxable to an estate).
Properly Using Life Insurance Trusts – Younger families with growing balance sheets may not think much about estate tax planning or death, but they may own significant life insurance policies. An unexpected life insurance payout not structured properly may push one spouse well over the NY estate tax cliff. Properly transferring existing policies to or purchasing new life insurance policies by a life insurance trust (ILIT) to hold insurance proceeds is essential for families who may be near or above the NY estate tax emption amounts when considering current life insurance coverage as an asset of the overall estate.
“Santa Clause” Provision in a Will and Charitable Giving – Commonly known as a “Santa Clause” provision amongst estate planning practitioners, it is a possible to make a conditional bequest in a will or revocable trust to a charity that will happen only if an estate is valued over a certain amount (most commonly the NY estate tax cliff number) This may be a great way to plan for an unexpected increase in asset size before death and is often used in conjunction with other NY estate tax planning methods. Families would rather have the excess money go to a charity of their choice rather than the state of New York.
Preserve NY State Estate Tax Exclusion Amount with an Exemption Trust – As discussed above, the NY estate tax exemption is not portable between spouses (“use it or lose it”). One way to preserve this amount is by establishing a trust equal to the estate tax exemption (federal or NY). Transfers to these trusts leave an individual’s estate and are technically subject to the estate tax (or gift tax). This ensures that the remaining money and growth will not be taxed again when the second spouse dies.
These special trusts are also known as credit shelter trusts, A/B trusts or bypass trusts. There are many ways to structure these trusts to provide flexibility to the grantor, surviving spouse and family at death. This may include setting up a spousal lifetime access trust (SLAT) which is one type of can in certain circumstances provide the ability to retain some ability to access the funds during the life of the Grantor. Ultimately, the goal is for assets in the trust to avoid taxation at the deaths of both spouses to maximize a wealth transfer to other estate beneficiaries.
Breaking Domicile with New York – Some individuals are motivated to leave the state of New York before death to avoid estate tax. This may be an effective strategy to mitigate the NY estate tax, as well as the NY income tax. However, careful planning is needed to demonstrate that sufficient ties are broken to escape taxation (see our article on residency vs. domicile for more information on leaving high tax states).
Moving Assets into Non-NY Tangible Property – Increasing assets that are not NY situs may be another strategy to consider (most often real estate). This can be part of a broader strategy using IRC §1031 like-kind exchanges or opportunity zones. Using a properly structured like-kind exchange, NY investment property may be exchanged into other non-NY investment property with no federal tax liability.
It is important to note that cooperative apartments are considered an intangible asset that are not subject to NY estate tax for non-NY residents. Non-NY residents can essentially copy this legal structure for other property by creating a special residence trust or LLC for their NY property. These structures convert the NY tangible property to intangible property and avoid the imposition of the NY estate tax for non-NY residents.
Integrating New York Estate Planning into a Family’s Financial Plan
An integrated financial plan will not only consider New York legal and estate tax rules, but also the subjective needs of the individual family. Families may feel uncomfortable gifting assets to their spouse/children, setting up irrevocable trusts, or engaging in other more permanent planning strategies. A strategy that works for one family might not be suitable for another family with different goals and values.
Considering changing laws and potential changes in personal circumstances, maintaining flexibility in your estate plan is important. One thing is certain, laws and planning needs will change. Families must develop a plan that not only is tax efficient and compliant, but also suits the goals and circumstances of their relationship to protect and build the family’s wealth for current and future generations. Working together with an experienced financial advisor, attorney, and accountant are essential for families. Round Table Wealth Management can also help you integrate your investment strategy with your estate plan for longer-term peace of mind.