2018 Estate Tax Update

Crucial Recommendations Regarding New Estate Tax Law

While there is good news out of Washington regarding the Federal estate tax, it is important not to forget the bad news from Albany regarding the New York State estate tax.

Below we discuss the opportunities presented by the new Federal estate tax law and the crucial planning that is necessary to address New York State estate tax issues, which, if ignored, can be confiscatory.

1. New Federal Estate Tax Law

The Tax Cuts and Jobs Creation Act  doubled the amount of the exemption from Federal gift and estate tax from $5.5 million to $11 million (indexed for inflation) effective as of January 1, 2018 and continuing to December 31, 2025. The exemption will revert back to $5.5 million on January 1, 2026.

Required Review of Existing Plan

In light of the dramatic increase in the Federal estate tax exemption, we strongly recommend that all clients whose plans provide for bequests to beneficiaries tied to the amount of the exemption review their Wills immediately. Due to this increase, the bequests to these beneficiaries doubled overnight. This may not be what you intended and may inadvertently cause a substantial estate tax to be due to New York State even if the bequest was to a trust for your spouse.

Planning Opportunities

For clients who have made gifts to family members or trusts for their benefit utilizing the then current gift and estate tax exemption, the new law provides an ideal window within which to make significant additional gifts.  Not only will the value of the asset given away be removed from one’s taxable estate, but all of the subsequent appreciation in the value of such assets will also be removed and not subject to estate tax. In addition, such gifts also reduce one’s taxable estate for New York State estate tax purposes.

Given that the exemption will revert back to the pre-2018 exemption ($5.5 million) on January 1, 2026, this opportunity should not be wasted.

2. The NYS Estate Tax Exemption & the Dreaded “Cliff”

Under the Federal estate tax law, only the value of an estate in excess of the exemption ($11 million) is subject to tax.  However, the New York State estate tax exemption (which is $5,250,000 for deaths in 2018 ) works quite differently.

Exemption Cliff

The New York State exemption is phased out if a taxable estate exceeds 105% of the exemption amount ($5,512,500).  This is referred to as the New York State “exemption cliff”. If the estate exceeds $5,512,500, the estate gets no New York State exemption and is taxed on the first dollar of the estate. As a result, the tax liability to New York State on a $5,512,500 estate is a whopping $452,300 - - an effective marginal rate of 173%.  In other words, it is not simply the excess over the exemption that is subject to the tax, but the entire value of the estate that is taxed.

Fortunately, there is a solution known as the “Santa clause” for clients whose estates are slightly above the 105% cliff.

Believe it or not, if the Will includes a bequest to a charity (or charities) equal to the amount of the estate in excess of the New York State exemption, the family would “net” more funds than without this charitable bequest, and the family would also be “doing good” by giving to charity,  as illustrated by the below chart:

  Net to Family w/o Charitable Bequest Net to Family w/ Charitable Bequest
Gross Estate $5,512,500 $5,512,500
Bequest to Charity of amount over  Tax Exemption

-               0

-        262,500

Taxable Estate 5,512,500 5,250,000
NYS Estate Tax      452,300      0
Net to Family 5,060,200 5,250,000

Married Couples - No “Portability” for New York Estate Tax

As mentioned above, under the Federal estate tax law, the Federal estate tax exemption is now $11 million (indexed for inflation) per individual.  For married couples under the Federal law, spouses can combine their individual exemptions, so that a couple is able to leave $22 million (indexed for inflation) to their children without incurring any Federal estate tax.  If assets valued up to the exemption were not shielded from tax in the first spouse’s  estate, the unused exemption is able to be used in the second spouse’s estate to bring the total exempt amount up to $22 million. This is referred to as “portability”.

However, New York State is not so generous. It does not allow portability in calculating the New York State estate tax.  This means that if the first spouse’s exemption is not fully used to shield $5,250,000 in assets from estate tax upon that first spouse’s death, the unused exemption does not pass to and cannot be used by the surviving spouse’s estate.

Fortunately, once again, there is a solution with proper planning.  It is crucial that one’s estate plan be structured to ensure the maximum use of the New York State exemption upon the first spouse’s death in order to avoid it being wasted.

This can be accomplished by creating a trust upon the first spouse’s death for the benefit of the surviving spouse,  funded with assets in value up to the New York State exemption. The assets in this trust - - which is currently referred to as an “Exemption Trust” - - will not be taxable to the first spouse’s estate as it is shielded by his or her exemption, and more importantly, the assets in the trust (plus all subsequent appreciation in value) will not be counted as part of the surviving spouse’s taxable estate.

The following example demonstrates why proper estate planning is so important:

Let’s assume a married couple residing in New York State has assets valued at $10,500,000, but has only executed simple Wills leaving their estates outright to each other.  Keep in mind that amounts passing to a surviving spouse outright, in any amount, are not subject to estate tax, which is known as the “marital deduction”.

When the first spouse dies, there is no estate tax because the entire estate passes to the surviving spouse under the marital deduction.  However, the first spouse’s exemption was never used to shield any assets in that estate. The surviving spouse now has a $10,500,000 taxable estate under New York law.  While that second spouse’s estate has its own exemption of $5,250,000 (since portability is not allowed), there will still be a taxable estate of $5,250,000 and a New York State estate tax of $1,100,000.

If instead, the Wills provided for the creation of an Exemption Trust in the first estate having assets equal in value to the New York State exemption, the entire $10,500,000 would have been passed free of New York State estate tax. Upon the first spouse’s death, assets equal to the exemption would have been placed in the Exemption Trust, thereby utilizing the first spouse’s exemption. The key difference is that since the assets are in an Exemption Trust and not paid to  the surviving spouse outright, the assets in the Trust plus any appreciation in the value of the assets in that Trust, are not counted towards the surviving spouse’s estate. So instead of the surviving spouse having a $10,500,000 taxable estate, his/her taxable estate is only $5,250,000, which will be fully offset by the second spouse’s exemption, thereby resulting in a zero tax liability to New York State and saving $1,100,000.

As you can see, despite the new Federal estate tax law which significantly increases the exemption, it remains crucial to address New York State’s continuing estate tax provisions.  Please feel free to contact us to discuss the most effective ways for you to maximize estate tax savings and to address any additional estate planning issues that are important to you.