Avoid the Estate Tax Cliff with Proactive Planning

Introduction

On April 1, 2014, the New York State (“NYS”) legislature gave New Yorkers an estate tax gift by agreeing to increase the NYS estate tax exclusion amount over the next five years. This means that the value of an estate that can pass free of NYS estate tax will eventually increase until it matches the Federal exclusion amount.

Overview

This change in the NYS tax code will enable more individuals to transfer assets without having to face the specter of a forced sale of a business or real property to pay NYS estate tax.  Another benefit is that the exclusion amount will be indexed annually for inflation, rather than frozen in time, once it is finally aligned with the Federal exclusion, commencing January 1, 2019.

The increase in the NYS estate exclusion will be phased in as follows:

While this change could be beneficial  to many NYS residents, the legislature did play a few April Fool’s Day pranks on the ill-prepared. The first potential problem involves the inclusion of gifts made within three years prior to death in the decedent’s taxable estate.  The second could create an onerous NYS estate tax “cliff” for estates that are larger than the exclusion amount.

The amended NYS estate tax regime incorporates a three-year look-back to include gifts the decedent made in their New York gross estate, increasing the possibility that estate tax may be due. The look-back only applies to gifts made by a decedent who was a New York resident and made a gift between April 1, 2014 and December 31, 2018. If the decedent made gifts during this period, but prior to becoming a New York resident, the gifts will not be included in the look-back.

Strategic and Practical:  The Cliff

The potentially more troubling problem for NYS residents is the establishment of an estate tax “cliff” that could cause many NYS estates to plunge into a punitive tax situation. The same law that provides for an increased NYS estate tax exclusion also determines how estates greater than the exclusion amount are taxed.  The difficulty begins once an estate exceeds the NYS exclusion amount. 

If the value of an estate exceeds the NYS exclusion amount, then the amount of the estate subject to taxation increases. This does not work like conventional marginal tax brackets; both the exclusion amount and the tax rate are subject to a sliding scale.  Once an estate exceeds 105% of the new exclusion amount, the exclusion drops from the newly established amount to $1 million and the remainder of the estate is subject to the maximum 16% tax rate, up from 14.5%.

Illustration

The examples below demonstrate how the amended NYS estate tax currently operates. Please note that the examples presume a date of death after April 1, 2014, and before April 1, 2015, and illustrate what happens if the decedent’s taxable estate is valued at either: (A) 3% below the exclusion amount; (B) 3% over the exclusion amount; or (C) 193% over the exclusion amount.

The detrimental function of the “cliff” can best be seen in an estate that is 3% over the exemption limit (B). While the difference between the exemption amount and the gross value of the estate is only $61,875, the sliding scale provisions noted earlier strip away some of the exemption and subject the estate to a NYS estate tax of $67,005, which consumes the entire amount over the exclusion and forces the estate to dip into what otherwise would have been exempt assets.

While the exemption increase is a welcome relief, careful estate planning will be required to ensure that estates do not trip and fall over the cliff.

~ Michael L. Landsman, Esq.
  William P. Holm, Esq.

MORE READING FROM HOLM & O’HARA LLP

Posted on July 13th, 2014 in News Items, Newsletter, Trusts & Estates