Governor Cuomo Proposes Massive Overhaul of New York s Tax System Sharon L. Klein i Governor Cuomo's budget bill, released Jan. 21, 2014 includes significant proposed changes to New York tax law. The proposals, which are based on two State Tax Commission Reports issued in 2013, potentially set the basis for a major overhaul of New York s transfer and fiduciary income tax regimes. New York State Tax Reform and Fairness Commission Report The New York State Tax Reform and Fairness Commission, a body established by Governor Andrew M. Cuomo in December 2012 to conduct a comprehensive and objective review of the State s tax structure, issued its final report on Nov. 11, 2013. ii The Commission was charged with developing revenue neutral policy options to modernize the current tax system with the goals of increasing its simplicity, fairness, economic competitiveness and affordability. Among the Commission's findings with respect to estate and gift tax were the following: New York s estate tax, currently based on federal law as it existed in 1998, is outdated. The current exemption threshold of $1 million has been criticized as too low given significant increases in the value of assets. In addition, there are concerns that it may serve as a factor in taxpayer migration from New York to other states (e.g. Florida) that do not impose any estate tax. Under the new federal scheme, gift giving has increased substantially, which will result in smaller estates and an erosion of the State s estate tax revenue. The Commission made the following recommendations: Reform the Estate Tax and Raise the Estate Tax Exemption to $3 Million The Commission recommended raising the threshold from $1 million to $3 million, thereby eliminating almost three quarters of all estates from estate tax. The exemption for estates valued in excess of $3 million was proposed be phased out gradually, to prevent any steep jumps in marginal tax rates. Eliminate the Generation Skipping Transfer (GST) Tax The Commission recommended eliminating New York s GST tax. According to the Report, the GST tax was enacted in 1999 but is not a major source of revenue. On average, fewer than 50 GST tax returns are filed and the tax generates less than $500,000 annually. 1
Reinstate the Gift Tax: New York repealed its gift tax in 2000. According to the Commission, because New York no longer has a gift tax, the increase in gifting driven by the $5.25 million (2013) federal gift tax exemption will result in a reduction in the size of New York taxable estates, with a corresponding loss of estate tax revenue. The Commission proposed two options to address the impact of the federal change on New York estate tax revenues: Under the preferred option, New York could reinstate a gift tax, which would subject gifts above a certain threshold to tax rates in line with the New York estate tax. Alternatively, New York could require estates to add back the value of any gifts above a certain threshold before determining the value of an estate. Either option was stated to have the potential to generate revenue of approximately $150 million annually. Close the Resident Trust Loophole Under New York Tax Law 605(b)(3), a New York resident trust is not subject to tax if all three of the following conditions are met: All trustees are domiciled outside the State; All real and tangible trust property is located outside the State; and All trust income and gain is derived from sources outside the State. One option suggested by the Commission to close this loophole is to treat these trusts as grantor trusts for New York income tax purposes so the trust income would be included in the taxable income of the grantor. In addition, the Commission suggested that New York could adopt California s approach, which creates an addition modification equal to distributions to resident beneficiaries by trusts not subject to California tax. Impact on Revenue The proposed changes were estimated to be revenue neutral because an increase in the estate tax exemption was predicted to decrease revenues by $300 million and reinstating the gift tax and closing the resident trust loophole were each estimated to increase revenues by $150 million. The Fairness Commission Report was sent to another commission, the New York State Tax Relief Commission (co-chaired by H. Carl McCall and Governor George Pataki), to review and provide recommendations for consideration in the Governor s 2014 State of the State message. 2
New York State Tax Relief Commission Report The Tax Relief Commission, which issued its report on December 6, iii made the following recommendations: Link New York Estate Tax Exemption with Federal Exemption, with Top Estate Tax Rate of 10% Tax Relief Commission recommended equalizing the state exemption threshold with the 2013 federal level of $5.25 million, with indexing. It also recommended lowering the top estate tax rate from 16 percent to 10 percent. Gift Tax/Resident Trust Proposals Not Mentioned The proposals in the Fairness Commission Report regarding reinstituting the gift tax, closing the resident trust loophole and eliminating the GST tax were not mentioned in the Tax Relief Commission Report. As noted, however, that the Fairness Commission had a revenue-neutral mandate. It does not seem that the Tax Relief Commission was so constrained. Governor Accepts Final Report of New York State Tax Relief Commission On Dec. 10, 2013, Cuomo announced that he accepted the Final Report of the Tax Relief Commission. Although that Report did not mention a phase-in approach, a press release issued by the Governor on Jan. 6, 2014 did propose phasing in the changes: New York is one of only 15 states that impose an estate tax, and the current estate tax level is badly in need of reform. While the federal government exempts the first $5.25 million of an individual s estate, New York only exempts estates valued below $1 million. To end this unnecessary incentive for elderly New Yorkers to leave the state, Governor Cuomo proposes increasing the New York estate tax threshold to $5.25 million and lowering the top rate to 10 percent over four years. Beginning in 2019, the State estate tax exemption would equal the Federal exemption, which is indexed to inflation. This change 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. In his Jan. 8, 2014 State of the State address, the Governor 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. The Budget Bill Governor Cuomo's budget bill, iv released Jan. 21, incorporates the Commission proposals as follows: 3
Close the Resident Trust Loophole The bill would tax distributions of accumulated trust income to New York beneficiaries of (1) exempt resident trusts and additionally (2) non-resident trusts. These "throwback" rules are perceived as a constitutionally permissible mechanism to tax accumulated income that is distributed to New York resident trust beneficiaries: the tax is imposed on the resident beneficiary and not the trust. Changes are also proposed with respect to the taxation of incomplete gift, non-grantor trusts (so-called DINGs or NINGs ), which would be decoupled from federal income tax treatment and treated as grantor trusts for New York purposes. According to the Governor s memorandum in support of the budget, in general, from an income tax perspective, income that is earned by a trust may be included in the income of the grantor, the trust, or the beneficiaries of the trust. Under the Tax Law, however, the accumulated income (i.e. the income of a trust that is not distributed to a beneficiary) of several types of trusts is not subject to any New York tax at the grantor level, the trust level, or the beneficiary level. These categories of trusts include: (1) non-resident trusts (i.e. a trust whose grantor is not domiciled in New York at the time the trust became irrevocable); (2) exempt resident trusts (i.e. trusts that are exempt from New York income taxation because three conditions in Tax Law 605(b)(3) are satisfied: there are no New York trustees, assets or source income); and (3) incomplete gift, non-grantor or ING trusts (i.e. certain trusts that are specifically structured (i) so that the settlor s transfer of property to the trust is an incomplete gift and (ii) to avoid grantor trust status under Sections 671 through 678 of the Internal Revenue Code). Accordingly, this bill would (1) tax New York beneficiaries of non-resident trusts and exempt resident trusts on the accumulated income of the trusts when the income is distributed to the beneficiary and (2) include the income of an ING trust established by a New York resident in the current income of its grantor. Subsequent amendments (discussed below) modify the operation of this proposal. The bill would also provide a credit for non-resident trust and exempt resident trust beneficiaries for taxes paid to other jurisdictions and require non-resident trusts and exempt resident trusts to file information returns, including the identity of the resident beneficiary and the amount of the accumulation distribution. The bill would be effective immediately and be applicable to tax years beginning on or after Jan. 1, 2014. To mitigate transition issues, however, the section excludes from tax: (1) distributions of accumulated income by exempt resident trusts (except ING trusts) made before June 1, 2014; and (2) income earned by ING trusts that are liquidated on or before June 1, 2014. 4
Increase Estate Tax Exemption and Decrease Rates Over four years (by April 1, 2017), the bill would phase-in an increase to the New York estate tax exemption amount to the 2013 federal unified credit amount of $5.25 million. The exemption amount would be indexed for inflation from January 1, 2019, although with the consumer price indexing mechanism utilized, it was unclear whether there would be precise parity with the federal exemption amount. Subsequent amendments (discussed below) attempt to clarify this. The top tax rate would be reduced from 16 percent to 10 percent over the same four-year period. These changes would phase-in beginning on April 1, 2014 and would apply to estates of individuals dying on or after that date. Increase Gross Estate by Taxable Gifts The New York gross estate of a deceased resident would be increased 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. The stated intent behind this change is to close a loophole by preventing deathbed gifts from escaping the estate tax. The way the proposal is currently drafted, there is a lack of parity with the estate tax regime: gifts by a New York resident of out-of-state real property or tangible personal property are not specifically excluded from the proposed add back, but out-of-state real and tangible property are specifically excluded from the New York gross estate for New York estate tax purposes. Repeal GST Tax: New York's GST tax would be repealed. Budget Bill Updated 21-Day Amendments Released February 11, 2014 On Feb. 11, the Governor released so-called 21-day amendments to his original budget proposal. The State constitution gives the Governor 30 days to makes changes to the proposed budget, so additional amendments could be released by Feb. 20. Among the changes made by the 21-day amendments are the following: While the original bill would have taxed New York beneficiaries of non-resident trusts and exempt resident trusts generally on the accumulated income of the trusts when the income was distributed, the amendments provide that: o distributions of income accumulated from nonresident trusts and exempt resident trusts prior to tax year 2011 are not taxable; and o distributions of income accumulated by a trust prior to the beneficiary first becoming a resident of the State are not taxable. Amendments are intended to clarify that the State exclusion threshold is indexed to the Federal exemption amount for tax years on and after January 1, 2019. Final Budget The budget is supposed to be finalized by April 1, 2014. 5
i Sharon L. Klein, Managing Director of Family Office Services & Wealth Strategies, Wilmington Trust, NA, 520 Madison Avenue, New York, New York 10022. Phone Number: 212-415-0531. E-Mail: sklein@wilmingtontrust.com. www.wilmingtontrust.com ii http://www.governor.ny.gov/assets/documents/greenislandandreportandappendicies.pdf iii http://www.governor.ny.gov/assets/documents/commission_report.pdf iv http://publications.budget.ny.gov/ebudget1415/fy1415artviibills/revenuearticlevii.pdf Copyright @ 2014. All rights reserved. ABOUT WILMINGTON TRUST Wilmington Trust s Wealth Advisory offers a comprehensive array of personal trust, financial planning, fiduciary, asset management, and family office services that help high-net-worth individuals and families grow, preserve, and transfer wealth. Wilmington Trust has offices throughout the United States and internationally in London, Luxembourg, Frankfurt, Dublin, Amsterdam, Cayman Islands, and Channel Islands. Wilmington Trust focuses on serving families with whom it can build long-term relationships, many of which span multiple generations. Wilmington Trust also provides Institutional Client Services for clients throughout the world. Wilmington Trust is an M&T company. For more information, visit www.wilmingtontrust.com. IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, please be advised that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This material is for informational purposes only and is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances; nor does it represent any undertaking to keep recipients advised of all relevant legal and regulatory developments. If professional advice is needed, the services of a professional advisor should be sought. The application and impact of relevant laws will vary from jurisdiction to jurisdiction and should be based on information from professional advisors. Information and opinions presented have been obtained or derived from sources believed to be reliable. No representation is made as to their accuracy or completeness. All opinions expressed herein are as of the date of this presentation and are subject to change. 6