REVISING ESTATE PLANS IN LIGHT OF THE RECENT NYS ESTATE TAX CHANGES. October 30, 2014

REVISING ESTATE PLANS IN LIGHT OF THE RECENT NYS ESTATE TAX CHANGES October 30, 2014 By: Stanley E. Bulua, Esq. ROBINSON BROG LEINWAND GREENE GENOVESE & GLUCK P.C. (212) 603-6311 (212) 956-2164 (fax) sbulua@robinsonbrog.com I. WHAT CHANGED? The 2014-2015 Executive Budget, enacted on March 31, 2014, as Chapter 59 of the Laws of 2014, brought significant changes to New York State s estate tax laws (Part X) and to certain income tax laws as they pertain to certain types of trusts and the New York resident beneficiaries thereof (Part I). Among other things, Chapter 59 amends the definitions of the New York State gross taxable estate for both resident and nonresident estates; increases the applicable estate tax basic exclusion amount effective April 1, 2014 (with increases each year thereafter); modifies the estate tax return filing requirement, especially when no federal estate tax return is required; closes the resident trust loophole ; modifies income taxes on New York resident beneficiaries of certain types of trusts; and changes the grantor trust status of incomplete gift non-grantor trusts. A. Definition of the New York State Taxable Estate. 1. Of a Resident: Under the new law, the New York State taxable estate of an individual who was a New York State resident at the time of his/her death is the New York gross estate: (a) reduced by any real or tangible property located outside of New York 1

State; (b) increased by the amount related to limited powers of appointment created prior to September 1, 1930; and (c) increased by the amount of any gift that would be taxable under Internal Revenue Code ( Code ) Section 2503 made within three years of the individual s death that was not otherwise included in the federal gross estate of the individual. However, excluded from the add-back in (c) are gifts of real or tangible personal property located outside of New York State and gifts made: (i) when the individual was a nonresident of New York State; (ii) before April 1, 2014; or (iii) on or after January 1, 2019. 1 2. Of a Non-Resident: The New York taxable estate of a New York State non-resident is now computed in the same manner as the New York taxable estate of a resident, except that it excludes: (a) the value of any intangible personal property otherwise includible in the deceased individual s New York gross estate, (b) the amount of any gift, otherwise includible in the New York gross estate of a resident, unless the gift was made: (i) while the nonresident individual was a resident of New York State; and (ii) it consisted of real or tangible personal property having a location in New York State; or (iii) it consisted of intangible personal property employed in a business, trade, or profession carried on in New York State; and (c) any works of art that are loaned to (or en route to or from) a public gallery or museum in New York State solely for exhibition purposes at the time of the individual s death, provided that no part of the net earnings for the public gallery or museum inure to the benefit of any private stockholder or individual. 2 However, a work of art that meets the conditions above is still considered located in 1 N.Y. Tax Law 954(a). 2 N.Y. Tax Law 960. 2

New York State and included in the federal gross estate, for purposes of determining whether a New York State non-resident estate must file an estate tax return. 3 B. Estate Tax Rates. The New York State estate tax is now computed based on the New York taxable estate of a resident or nonresident (as described above) using the following tax table: 4 If the New York taxable estate is: Not over $500,000 The tax is: 3.06% of taxable estate Over $500,000 but not over $1,000,000 $15,300 plus 5.0% of excess over $500,000 Over $1,000,00 but not over $1,500,000 $40,300 plus 5.5% of excess over $1,000,000 Over $1,500,000 but not over $2,100,000 $67,800 plus 6.5% of excess over $1,500,000 Over $2,100,000 but not over $2,600,000 $106,800 plus 8.0% of excess over $2,100,000 Over $2,600,000 but not over $3,100,000 $146,800 plus 8.8% of excess over $2,600,000 Over $3,100,000 but not over $3,600,000 $190,800 plus 9.6% of excess over $3,100,000 Over $3,600,000 but not over $4,100,000 $238,800 plus 10.4% of excess over $3,600,000 Over $4,100,000 but not over $5,100,000 $290,800 plus 11.2% of excess over $4,100,000 Over $5,100,000 but not over $6,100,000 $402,800 plus 12.0% of excess over $5,100,000 Over $6,100,000 but not over $7,100,000 $522,800 plus 12.8% of excess over $6,100,000 Over $7,100,000 but not over $8,100,000 $650,800 plus 13.6% of excess over $7,100,000 Over $8,100,000 but not over $9,100,000 $786,800 plus 14.4% of excess over $8,100,000 Over $9,100,000 but not over $10,100,000 $930,800 plus 15.2% of excess over $9,100,000 Over $10,100,000 $1,082,800 plus 16.0% of excess over $10,100,000 Interesting note: The 2014-2015 New York State Executive Budget Revenue Article VII Legislation (the Budget Bill ), before it became law, proposed an amendment to section 952(b) 3 N.Y. Tax Law 960(d). 4 N.Y. Tax Law 952. 3

of the Tax Law to reduce the maximum New York State estate tax rate from 16% to 10%, to be phased in through April 1, 2017. However, such an amendment was not part of the new law. C. Estate Tax Exemption. Under the prior law, the threshold for filing a New York State resident decedent s estate New York State estate tax return was $1,000,000. Under the new law, the threshold, or the basic exclusion amount, is increased from $1,000,000 to $2,062,500 for dates of death on and after April 1, 2014. 5 The basic exclusion amount is used to determine the estate s filing threshold and also to determine the amount of the applicable estate tax credit (if any). A full summary of the changes to the basic exclusion amount, beginning April 1, 2014, is as follows: For decedent dying on or after: But before: The basic exclusion amount is: 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 Beginning January 1, 2019, the New York basic exclusion amount will be indexed for inflation so that it will equal the federal basic exclusion amount, as indexed for inflation. 6 Because the NYS basic exclusion amount is indexed using a different base year than the federal basic exclusion amount, it is possible that the NYS basic exclusion amount and the federal basic 5 N.Y. Tax Law 952(c). 6 N.Y. Tax Law 952(c)(2)(B). 4

exclusion amount may not be equal, although we can expect a legislative patch to fix this. For purposes of these materials, the New York State basic exclusion amount and/or the federal basic exclusion amount (or applicable exclusion amount, which is defined as the basic exclusion amount plus, in the case of a surviving spouse, the deceased spousal unused exclusion amount), as the case may be, shall be sometimes referred to as the estate tax exemption. D. The Cliff. An applicable credit is allowed against the New York State estate tax when a New York taxable estate (including gifts) is less than 105% of the basic exclusion amount. If the New York taxable estate is less than or equal to the basic exclusion amount, the applicable credit amount will be the amount of the New York State estate tax computed on the taxable estate (in other words, no New York estate tax will be imposed). If the New York taxable estate is greater than the basic exclusion amount, but not greater than 105% of the basic exclusion amount, then the applicable credit against the estate tax is phased out. The applicable credit is equal to the estate tax that would be due on an amount computed by multiplying the basic exclusion amount by one minus a fraction, the numerator of which equals the New York taxable estate minus the basic exclusion amount and the denominator of which equals five percent of the basic exclusion amount. Technical Memorandum, TSB-M-14(6)M, dated August 25, 2014, among other things, illustrates the application of the estate tax credit in two (2) situations: (1) for a taxable estate that is less than the basic exclusion amount, and (2) for a taxable estate that exceeds the basic exclusion amount by less than 5%. 5

Example 1: A taxable estate that is less than the basic exclusion amount (currently $2,062,500) will pay no tax because the applicable credit is equal to the amount of the tax. Example 2: 5% of the basic exclusion amount is $103,125. A taxable estate of $2,100,000 exceeds the basic exclusion amount but is less than 105% of the basic exclusion amount (or, $2,165,625), and is therefore subject to a credit phase-out. As described above, the numerator of the fraction is $37,500 ($2,100,000 $2,062,500) and the denominator is $103,125 (.05 x $2,062,500). The applicable credit equals the New York State estate tax on $1,312,575 [$2,062,500 x (1-37,500/103,125) = $2,062,500 x.6364 = $1,312,575] or $57,492. Accordingly, the estate tax due is computed as follows: Taxable estate $ 2,100,000 Tax computed $ 106,800 Applicable credit $ 57,492 Estate tax due $ 49,308 Because the taxable estate is more than the basic exclusion amount, but less than 105% of the basic exclusion amount, the applicable estate tax credit is merely phasedout, resulting in an applicable estate tax credit that is less than the estate tax due and a tax liability of $49,308. Not included in the examples from TSB-M-14(6)M is the taxable estate that exceeds 105% of the basic exclusion amount. Assume a person dies with a taxable estate of $2,300,000. The New York State basic exclusion amount is $2,062,500. Because the value of the estate exceeds 105% of the basic exclusion amount [$2,062,500 x 105% = $2,165,625], the estate will be subject to New York estate tax on the entire $2,300,000. NYS estate taxes are $122,800. Interestingly, this is the same amount that would have been due under the old law which provided for a basic exclusion amount of $1 million. So, for those New York State 6

residents whose taxable estates exceed 105% of the basic exclusion amount, the new estate tax changes do not give them any benefit. The elimination of the applicable credit when the taxable estate exceeds 105% of the basic exclusion amount is otherwise known as the cliff. The cliff becomes even more damaging as the basic exclusion amount increases. A decedent with a New York taxable estate of $5,512,500 in 2017 and 2018 (i.e., 5% more than the basic exclusion amount of $5,250,000 at such time) would pay New York State estate tax of $452,300. In effect, there is a New York estate tax of $452,300 on the extra $262,500, or the New York State estate tax is 172% of the excess over the basic exclusion amount. E. Gifts Before Death. New York has not had a gift tax since 2000 and still has no gift tax. With respect to the estate tax, under prior law, lifetime gifts were not subject to gift tax or included in the gross estate of a New York State resident. Under the new law, a New York State resident decedent s New York gross estate is now increased by the amount of any taxable gifts made within three years of death, thus potentially subjecting the resident decedent to higher New York State estate taxes in essence, the tax that would have applied had the decedent not made the lifetime gifts. However, the following gifts are excluded from the aforesaid add-back: (1) gifts made when the decedent was not a New York resident; (2) gifts made by a New York resident before April 1, 2014; (3) gifts made by a New York resident on or after January 1, 2019; and (4) 7

gifts that are otherwise includible in the decedent s estate under another provision of the federal estate tax law. 7 Although the new law eliminates the possibility of estate tax savings as a result of deathbed transfers, New York State residents should still consider making lifetime gifts that are not deathbed transfers to avoid New York State estate tax. After all, as described above, the addback is only for gifts made during the three years prior to the taxpayer s death. The following examples illustrate how deathbed transfers, and transfers of property outside of New York, affect the New York State estate taxes: Example 1: New York resident decedent dies with a taxable estate of $7,500,000. The New York State estate tax on $7,500,000 is $705,200. The federal estate tax on $7,500,000, including the federal deduction for New York State estate taxes, is $581,920. Combined, total estate taxes are $1,287,120. Example 2: New York resident decedent dies with a taxable estate of $6,500,000 because he/she made a deathbed transfer of $1,000,000. The New York State estate tax on $7,500,000 [$6,500,000 taxable estate plus $1,000,000 of deathbed transfers] is still $705,200. The federal estate tax not including a deduction for the NYS gift add-back (equal to $131,200), is $634,400. Combined, total estate taxes are $1,339,600. Example 3: New York resident decedent dies with a taxable estate of $6,500,000 because he/she made a deathbed transfer of a $1,000,000 home he owned in Florida. The New York State estate tax on $6,500,000 [the $1,000,000 deathbed transfer is not added back because it was a transfer of property outside of New York] is now $574,000. The federal estate tax is still $634,400. Combined, total estate taxes are $1,208,400. 7 See TSB-M-14(6)M. 8

F. Changes to Income Taxation of Non-Resident Trusts. Beginning in 2014, the new law also imposes income tax on income accumulated in a New York State resident trust (that is currently exempted from income taxation) if the accumulated income is subsequently distributed to a New York State resident trust beneficiary. With respect to income taxation of non-resident trusts, the new law specifically includes the income of an incomplete gift non-grantor trust (known as an ING Trust ) in the taxable income of the trust grantor. As a result, New York State resident taxpayers can no longer use ING Trusts to avoid New York State income taxes on the income earned by assets within the ING Trust. 1. Resident Trust Loophole Closed. New York State income tax is not imposed on a New York State resident trust that is, an irrevocable trust created by a New York State resident or a testamentary trust created by a New York State resident decedent if all of the following conditions are met: (1) all the trustees are domiciled outside of New York State; (2) no real property or tangible personal property is located in New York State; and (3) all income and gains are from derived from sources outside of New York. 8 Under the new law, New York now will impose a throwback tax on the accumulated income of such exempt resident trusts earned after January 1, 2014 at the time of a distribution to a New York beneficiary. Distributions of accumulated income by such exempt resident trusts made before June 1, 2014 are excluded from the throwback tax. 9 2. ING Trusts Treated as Grantor Trusts. Under the prior law, a New York State resident could have established an ING Trust and structured the trust as a nongrantor trust under the grantor trust rules of Sections 671 through 678 the Code and as a 8 N.Y. Tax Law 605(b)(3)(D). 9

defective trust for gift and estate tax purposes so that the grantor s transfer of assets to the ING Trust was an incomplete gift for gift and estate tax purposes and the grantor was not treated as the owner of the income or principal of the ING Trust. In that case, if the ING trust was administered in a state with no income tax such as Delaware and if the ING Trust was a New York exempt resident trust (detailed above), the income was not subject to New York State income tax. No longer. Under the new law, a New York State resident must now include the net income from the ING Trust in his/her taxable income for New York State purposes. 10 In essence, such an ING Trust may still be a defective non-grantor trust for federal purposes, but not a non-grantor trust for New York income tax purposes. Distributions of income by such ING Trusts made before June 1, 2014 are excluded from this tax treatment. II. DO WE NEED TO REVISE OUR ESTATE PLANNING? One might think that with the passage of the new laws, less estate taxes would mean less estate tax planning. But, as described below, that is not necessarily true. Yes... if estate taxes are to be paid, then those estate taxes may be less, because of the changes to the estate tax rates, but only if the client s estate planning documents are properly prepared and the client s estate tax situation is appropriately managed to result in estate tax savings. For example, one could do a basic Last Will and Testament whereby one spouse leaves everything to the surviving spouse, and if there is no surviving spouse, then to the children. That is a basic Will that contemplates the most minimal level of estate tax planning. Assuming an all-probate estate, the estate of the first deceased spouse will be completely estate tax free because it will all go to the surviving spouse 9 N.Y. Tax Law 612(b)(40). 10

and the estate tax will be fully offset by the unlimited marital deduction. But, upon the surviving spouse s death, his/her estate will be taxed fully. This is due to the fact that the estate plan failed to contemplate the portability of the first deceased spouse s unused estate tax exemption, or the use of a credit shelter trust to preserve the first deceased spouse s estate tax exemption. Just because the estate tax laws have changed does not mean there is no longer a need to do estate tax planning. A. Credit Shelter Trust Planning. The federal estate tax exemption is currently $5,340,000. 11 The New York State estate tax exemption is currently $2,062,500. 12 These are the respective credits that we wish to preserve or shelter when contemplating estate tax planning. The planning technique is to create a trust in the first deceased spouse s estate into which an amount of money gets funded, either up to the New York State exemption or up to the federal exemption. 13 The surviving spouse is typically given all of the income from the Credit Shelter Trust, although other loved ones/beneficiaries could also be included. The Trustees are typically given discretion to invade the principal for the surviving spouse s benefit, although other loved ones/beneficiaries could also be included. The Trustees discretion could be limited to certain standards or guidelines, or it could be more broad, depending on the factual situation. Instructions are also typically given for what triggers the termination of the Credit Shelter Trust. 10 N.Y. Tax Law 612(b)(41). 11 IRC 2010. 12 N.Y. Tax Law 952(c). 13 Because of indexing, beginning in 2019, each of these exemptions is intended to be the same. 11

The excess of the estate over the Credit Shelter Trust is the marital share. The marital share may be transferred outright to the surviving spouse or held in a QTIP trust for the surviving spouse s benefit (discussed below). B. Disclaimer Trust Planning. In situations (like we have now) where the federal estate tax exemption is more than the New York State estate tax exemption, the first deceased spouse s Will will typically utilize disclaimer provisions. In Disclaimer Trust planning, the surviving spouse has the right to disclaim any assets coming to him/her, in whole or in part. By the terms of the first deceased spouse s Will, such disclaimed assets will be distributed to the Trustees of the Credit Shelter Trust (or which may otherwise be known as a Disclaimer Trust ). The disclaimer is made, usually, to maximize the lower of the available estate tax exemptions, knowing that more wealth will be included in the marital share, which means more wealth in the surviving spouse s estate and subject to the surviving spouse s estate tax. The alternative is more New York State estate taxes paid on an over-funded Credit Shelter Trust. Take, as an example, the $3,500,000 taxable estate of a first deceased spouse. The first deceased spouse s New York State estate tax exemption is $2,062,500. The federal estate tax exemption is $5,340,000. The first deceased spouse s Will provides that the entirety of the taxable estate is to be distributed to the surviving spouse. However, if the surviving spouse disclaims any amount, the amount disclaimed is to be distributed to the Trustees of the Credit Shelter Trust for the surviving spouse s benefit. If the surviving spouse disclaims $2,062,500 (i.e., the New York State estate tax exemption), then the Credit Shelter Trust will be funded with the first $2,062,500. In that case, the marital share will be equal to $1,437,500 (the excess of taxable estate over the Credit Shelter Trust), which will be included in the surviving spouse s 12

estate when he/she dies. As a result, there would be no federal or state estate tax on the first deceased spouse s estate because of the combined use of the first deceased spouse s New York State estate tax exemption and the unlimited marital deduction. However, the marital deduction merely provides for the deferral, rather than the elimination, of estate taxes because, at the surviving spouse s death, all property owned by him/her will be subject to estate taxes. On the other hand, if the surviving spouse disclaims the entire taxable estate, the Credit Shelter Trust will be funded with the entire $3,500,000. There will be no marital share. The first deceased spouse s estate would pay (in 2014) $229,200 in unnecessary New York State estate taxes [(($3,500,000 - $3,100,000) x 9.6%) + $190,800 = $229,200]. C. QTIP Planning. Both the federal estate tax laws and the New York State estate tax laws provide for an unlimited deduction for certain transfers to a decedent s surviving spouse. The unlimited marital deduction was originally intended for outright transfers to the surviving spouse, but sometimes the deceased spouse prefers to bequeath assets in a trust for the benefit of the surviving spouse. To protect the assets against creditors, to protect the assets from the spouse s spendthrift ways, to protect the assets from the spouse s gambling, drug, or other addictions, to protect the assets from the spouse s new romantic relationship, or to ensure that the trust assets remain for the benefit of the couple s children in the event the surviving spouse has new children, are just some of the reasons why the first deceased spouse may want to leave the marital share in a trust. However, while outright transfers to a surviving spouse qualify for the unlimited marital deduction, transfers to a trust for the benefit of the surviving spouse will 13

qualify for the unlimited marital deduction only if the trust meets certain qualifications, one set of which is that the trust be a qualified terminable interest property trust, or QTIP trust 14. Under federal law, a QTIP election can only be made on a filed federal estate tax return. Under the prior New York State law, if a federal return was filed and a federal QTIP election was made, then a New York QTIP election was also deemed to have been made. In other words, there could be no New York QTIP election if a federal estate tax return was not filed. Under the new law, a New York QTIP election can be made if no federal estate tax return is filed. Take, for example, the aforesaid scenario: $3,500,000 taxable estate, New York State estate tax exemption of $2,062,500, and federal estate tax exemption of $5,340,000. There is no need to file a federal estate tax return because the taxable estate is below the federal exemption. Assume the first deceased spouse s Will creates a Credit Shelter Trust for the $2,062,500, and the excess of $1,437,500 is payable to a trust for the benefit of the surviving spouse which qualifies for QTIP treatment. Under the prior law, the first deceased spouse could not make a NY QTIP election for this trust in the amount of $1,437,500 because if a federal return is not filed and the QTIP election is therefore not made, a New York QTIP election could not be made. 15 However, under the new law, the first deceased spouse s estate could make the QTIP election for New York purposes even if no federal estate tax return is filed. In other words, the first deceased spouse s estate could create the Credit Shelter Trust for the first $2,062,500, then a New York QTIP trust for the balance of the estate of $1,437,500. Based on 14 In order to qualify as a QTIP trust, the surviving spouse must be entitled to all of the net income from the trust for his/her life and no other individual may be entitled to anything from the QTIP trust while the spouse is alive. 15 Rev. Proc. 2001-38 provides that a QTIP election is void if made on a federal estate tax that is not required but filed only to make the QTIP election. 14

this framework, the estate tax plan optimizes the first deceased spouse s use of the estate tax exemption and the unlimited marital deduction, which results in no federal estate taxes at the first deceased spouse s death. However, as stated above, the marital deduction merely provides for the deferral, rather than the elimination, of estate taxes because, at the surviving spouse s death, all property owned by him/her will be subject to estate taxes. A Clayton QTIP allows the creation of the QTIP trust to be contingent on the fiduciary s (e.g., an executor or trustee of a revocable trust) election to treat the marital share as QTIP property under Code section 2056(b)(7). The property elected for QTIP treatment remains in the QTIP trust, while the non-elected portion of the QTIP trust generally passes to a Credit Shelter Trust in which the surviving spouse does not have a right to income. This technique comes from Estate of Clayton v. Comm. 16, wherein the decedent s estate attempted to give the executor the authority to determine what portion of the marital share to elect QTIP status for, which allowed for the non-elected portion to be subject to estate taxes. IRS argued that if the creation of the QTIP Trust was dependent upon an executor making a QTIP election, then the QTIP trust would not qualify for the marital deduction. The Fifth Circuit rejected the IRS s argument and allowed the marital deduction. While other federal circuit courts may or may not follow the Fifth Circuit s ruling, the IRS has acquiesced and conceded the issue in the Treasury Regulations. D. Disclaimer Trust Planning versus Clayton QTIPs. The Clayton QTIP election permits the estate of the first deceased spouse an incredible amount of flexibility. A fiduciary may make the Clayton QTIP election at any time on or before the decedent s estate tax 16 976 F2d 1486 (CA 5 1992). 15

return must be filed, which may be at least 15 months from the decedent s date of death (9 months from the decedent s date of death to file the return, plus a 6-month automatic extension). Contrast this with Disclaimer Trust planning, which relies on the surviving spouse s qualified disclaimer, which disclaimer must be made within 9 months of the decedent s date of death. Also, the Clayton QTIP election is made by a fiduciary, who may be in a better position to understand and appreciate the tax consequences of the Clayton QTIP election, whereas the disclaimer is made by the surviving spouse, who may be approaching the decision from a more emotional, and, frankly, more self-interested, point-of-view. E. Portability. As stated above, the federal estate tax exemption is currently $5,340,000. The New York State exemption is currently $2,062,500. Under federal estate tax rules, with a proper election on the federal estate tax return, the surviving spouse can elect to use his/her deceased spouse s unused federal estate tax exemption, or Deceased Spousal Unused Exclusion Amount (or, DSUE ), pursuant to the American Taxpayer Relief Act of 2012. However, although many practitioners hoped the new New York State estate tax laws would provide otherwise, New York still does not provide for portability of a deceased New York resident s unused New York estate tax exemption. To illustrate the interplay between the New York QTIP election and portability, please consider the following example. Example: In 2014 a deceased married New York resident s taxable estate is equal to $4,000,000. The New York State estate tax exemption is $2,062,500. The decedent s Will contemplates Disclaimer Trust planning. The surviving spouse disclaims the New York State estate tax exemption amount, which is funded into the Credit Shelter Trust under the first deceased spouse s Will. Because of the changes to the estate tax laws, the 16

decedent s estate can fund the Credit Shelter with the New York exemption amount and create a New York QTIP for the balance of the estate no federal estate tax return is required to be filed, which means that the decedent s estate did not elect federal portability. The entire $4,000,000 will be exempt from federal and New York State estate tax, but the surviving spouse will lose the benefit of the DSUE the Deceased Spousal Unused Exclusion Amount or $1,340,000 ($5,340,000 minus $4,000,000) because no portability election was made. Also, whereas the assets in the Credit Shelter Trust got a step-up in basis when the first deceased spouse died, the assets in the Credit Shelter Trust will not get a second step-up in tax basis when the surviving spouse dies. If, instead, a portability election is made, a New York QTIP election cannot be made. Therefore the full New York tax would be due on the decedent s death, but the full federal exemption would be available to the survivor. F. Equalize the Estates of a Married Couple. A married couple should consider equalizing their estates re-titling their combined assets so that each spouse has a roughly equal amount of assets in his/her name if doing so (a) would leave each spouse with assets at or below the New York State estate tax exemption and/or the federal estate tax exemption, and (b) would not subject assets unnecessarily and dangerously to creditors or ruin already existing and necessary creditor protection. In those situations where equalizing the estates is unwanted or dangerous, creating a Lifetime QTIP may help. Rather than shuffling title registrations or moving money from one spouse to another, and risking creditor attack, or simply because one spouse does not want to 17

give his/her assets to the other spouse, the higher asset-rich spouse could create a Lifetime QTIP Trust for the other spouse s benefit. The Lifetime QTIP Trust would be fully included in the donee spouse s taxable estate, so it increases the value of the donee spouse s estate to take advantage of both estate tax exemptions. With the proper protections, the Lifetime QTIP Trust would also protect the trust assets from claims of future, unknown creditors, as well as in the event of the non-property spouse s remarriage or in the event the non-property spouse has additional children with a new paramour. As such, the Lifetime QTIP Trust accomplishes the goal of balancing the assets between spouses. And, it serves as a marital planning agreement to prevent the surviving spouse s new paramour/children from gaining access to the trust assets. G. Generation-Skipping Transfer Tax Planning. The new law repeals the New York State generation-skipping transfer ( GST ) tax, which was previously imposed on taxable distributions to skip persons and taxable termination of trusts. H. Planning for Surviving Non-Citizen Spouses. United States citizens and resident aliens are subject to federal gift and estate tax on their worldwide assets. 17 Nonresident aliens are subject to federal gift and estate tax on their property situated in the United States. 18 Under federal law, an estate tax marital deduction is denied for bequests to noncitizen spouses unless the property is transferred into a qualified domestic trust ( QDOT ). 19 17 IRC 2001(a), 2501 18 IRC 2101(a), 2103, 2511(a) 18

The new New York State law allows a marital deduction for bequests to non-citizen spouses, without the requirement of a QDOT, when a federal estate tax return is not required to be filed. 20 D. Use of Alternate Valuation Date Where no Federal Estate Tax Return is Filed. The new law creates an alternate valuation date (ordinarily six months after the date of death as opposed to the date of the decedent s death) for a New York estate where a federal estate tax return is not required. 21 The new law provides that the alternate valuation date may be used, provided that (1) a federal estate tax return is filed and the alternate valuation date is used, or (2) a federal estate tax return is not required to be filed because the federal gross estate is below the threshold for filing a federal estate tax return. Like federal law, the alternate valuation may be used only if it decreases the size of the decedent s New York State gross estate and reduces the amount of New York State estate tax due. 19 IRC 2056(d). 20 N.Y. Tax Law 951(c). 21 N.Y. Tax Law 954(b)(2). 19

III. STEPS TO AVOID THE NYS ESTATE TAX CLIFF. A. Who Does the Cliff Truly Hurt? The increase in the New York State estate tax exemption is a fiction for wealthier New Yorkers. Remember that if the New York State taxable estate is less than or equal to the basic exclusion amount, the applicable credit will be the amount of tax that is computed on the taxable estate. If the New York State taxable estate is greater than the basic exclusion amount, but not greater than 105% of the basic exclusion amount, then the applicable credit is phased out as the New York taxable estate approaches 105% of the basic exclusion amount. If the New York taxable estate exceeds 105% of the basic exclusion amount, then the applicable credit is lost altogether. What this means is that a New York State resident decedent whose taxable estate exceeds 105% of the basic exclusion amount will lose the benefit of the higher exemption under the new law and his/her estate will still be taxed effectively under the old law, with a basic exclusion amount of $1,000,000. Here is an example: Assume a New York resident dies in 2019 with a taxable estate of $6,100,000. Assume further that the federal exclusion amount (currently, $5,340,000) in 2019, indexed for inflation, is $5,790,000. Because the value of the estate exceeds 105% of the basic exclusion amount [$5,790,000 x 105% = $6,079,500], the estate will be subject to New York estate tax on the entire $6,100,000. NYS estate taxes are $522,800 (which is the same amount of tax imposed on a $6,100,000 taxable estate prior to enactment of the new law). An estate of $5,790,000 (assuming the assumption of inflation-indexing is correct) or less would owe no New York State estate tax in 2019. A difference of $310,000 in the two New York State taxable estates results in a New York State estate tax of $522,800. 20

B. Will Tax-Conscious NYS Residents Still Flee the State? In the Memorandum in Support of the Budget Bill, 22 Governor Cuomo stated that [The estate] tax is woefully out of date. It is tied to a federal law that no longer exists in practical effect, because the [Code] has undergone significant amendments over the last 15 years that have not been adopted by New York. For example, the credit for state estate taxes the base of New York s estate tax no longer exists in federal law. Moreover, when the current State exclusion amount of $1 million was set, it was not indexed to inflation or tied to the periodic increases in the federal estate tax exclusion amount. The federal estate tax exclusion amount has been raised to $5.25 million and indexed to inflation, leaving New York significantly out of sync. New York is one of only 15 states with an estate tax and only two states currently have a lower exemption. Consistent with Governor Cuomo s Tax Relief Commission Report, this bill would increase the New York exclusion amount to the federal amount of $5.25 million over four years, with the exclusion indexed to inflation thereafter. Many estates of middle class individuals (including small business owners and family farmers) will no longer be subject to the tax as a result of increasing the exclusion amount. The bill would also phase down the top tax rate from 16 percent to 10 percent by State Fiscal Year 2017-18. This will address an incentive for wealthy New Yorkers to leave the State. (emphasis added). Moreover, the Governor s message on the Budget Bill, dated January 6, 2014, stated that The change [to estate taxes] would exempt nearly 90 percent of all estates from the tax, restore fairness and eliminate the incentive for older middle-class and wealthy New Yorkers to leave the State. 23 Clearly, the Governor s message, prior to the passing of the new law, was that his aim was to make the New York State estate tax such that New Yorkers do not have an incentive to leave the state. Yet, the practical effect of the new law may, in fact, still create the incentive for the wealthiest New Yorkers to leave New York. 22 http://publications.budget.ny.gov/ebudget1415/fy1415artviibills/revenue_articlevii_ms.pdf. 21

C. To Avoid the Cliff, Make Charitable Bequests of Assets in Excess of the State Basic Exclusion. Charitably inclined New York residents with taxable estates more than the basic exclusion amount may want to provide in their estate planning documents for a charitable bequest equal to the value by which their taxable estate exceeds the basic exclusion amount (or exceeds 105% of the basic exclusion amount, thus bringing their taxable estates at or below the basic exclusion amount. Example: 5% of the basic exclusion amount is $103,125. A taxable estate of $2,500,000 exceeds 105% of the basic exclusion amount. The estate tax due is $138,800. If the decedent s Will provides for a charitable bequest equal to the difference between the precharitable-bequest-taxable-estate (i.e., $2,500,000) and the basic exclusion amount (i.e., $2,062,500), or $437,500, the taxable estate would be reduced by the charitable bequest to equal the basic exclusion amount and the estate would pay no New York State estate taxes. Even though the charitable bequest exceeds the amount of the New York State estate tax the taxpayer would otherwise have to pay, by including charitable bequests in the his/her estate tax planning, the taxpayer was able to eliminate the estate taxes his/her estate would have to pay and benefit a worthwhile charity while doing so. 23 http://www.governor.ny.gov/press/01062014-tax-relief-proposal. 22