Articles

NEW YORK ESTATE TAX AND ITS IMPACT ON ESTATE PLANNING FOR NEW YORK RESIDENTS

GENERAL PLANNING MEMORANDUM

Summary - New York imposes an estate tax on its residents, which is in addition to the federal estate tax. As a result, the overall estate tax burden for New York residents is greater than for residents of many other states, which can complicate estate planning for New Yorkers. This memorandum summarizes the New York estate tax, how it is connected to the federal estate tax, and estate planning issues for New York residents taking the New York estate tax into account. These issues are particularly important for: (1) married New Yorkers whose estate plans should provide flexibility to handle the separate New York and federal estate tax exemption amounts; and (2) any New Yorker who is considering moving out of New York (and changing domicile) to a state imposing less onerous taxes.

Background - In 2001, Congress enacted tax legislation making major changes affecting estate planning. The Economic Growth and Tax Reconciliation Act of 2001 (the "2001 tax act") substantially reduced the federal estate tax through 2009, with the federal estate tax repealed for decedents dying in 2010 but then reinstated (under "sunset" provisions) in 2011 and thereafter.

Since the 2001 tax act, it has been expected that further legislation by Congress would follow to amend the federal tax law, so as to create a climate of greater certainty and stability for long term estate planning. This has not occurred, in large part on account of substantial federal budget deficits and political polarization in Congress. More recently, there have been proposals in Congress to continue the federal estate tax with an exemption level in the range of $3,500,000 or higher, but Congress is not expected to address this until late 2008 or 2009.

State estate taxation was also affected by the 2001 tax act, because the act also eliminated the state death tax credit against federal estate tax. Before the 2001 tax act, the federal estate tax was reduced by a dollar for dollar credit for state estate taxes. The amount of this credit was limited by a federal table based on the size of the estate. Prior to the 2001 tax act, most states imposed a state estate tax tied to the structure of the federal estate tax. On account of the 2001 tax act, those states were confronted with potential for substantial loss of state revenues. Accordingly, many states reacted to this legislation with state estate tax laws enacted to prevent loss of state estate tax revenue.

New York Estate Tax - New York is among the many states which by legislation "decouple" their state estate tax from the federal estate tax system. The New York tax legislation has the effect of imposing substantial state tax on estates of New York residents. On account of pre-2001 New York law provisions, the New York estate tax is computed by reference to the federal state estate tax table in effect prior to the 2001 tax law. This causes taxable New York estates to pay a substantial New York estate tax but without receiving a federal estate tax credit for the state taxes paid. Under the 2001 tax law, estates may claim a deduction for state estate taxes paid; however, a deduction from federal estate tax provides less than one-half of the benefit which was provided by the credit.

The New York estate tax substantially increases the overall taxes imposed on estates of New York residents. While the exemption for federal estate tax is $2,000,000 in 2008 and then $3,500,000 in 2009, the New York estate tax applies to taxable estates that exceed $1,000,000. The chart below computes the total estate tax burden (federal and state taxes) for a New York decedent and a decedent in a state that has not decoupled, such as Florida. Each case assumes death in 2008 and is based on the value of the indicated taxable estate for federal estate tax purposes.

Tax Deferral for Married Persons - Estate plans of married persons typically defer the payment of estate tax until the death of the surviving spouse by taking advantage of the unlimited marital deduction. Accordingly, the New York estate tax generally will have more significant impact at the death of the surviving spouse. However, the New York estate tax also complicates estate planning for a married couple at the death of the first to die. This is because estate planning for married couples typically involves the creation of an "estate tax exemption trust" for the benefit of the survivor under the estate plan of the first to die so as to utilize the estate tax exemption of each spouse at his or her respective death. This planning is more straightforward for residents of states which are not decoupled. Typically, the estate plan of the first to die creates an estate tax exemption trust in the amount tied to the federal exemption -- $2,000,000 in 2008 -- and the balance of the estate passes to the survivor, either outright or in trust in a manner eligible for marital deduction treatment deferring estate tax until the death of the survivor. However, for residents of a "decoupled" state such as New York, planning along these lines typically involves greater complexity but can be even more important given the higher incidence of overall estate taxation because of the state estate tax.

New York's exemption amount of $1,000,000 is lower than the federal estate tax exemption amount, meaning that some New York estate tax will be payable on the death of the first spouse to die if the full federal estate tax exemption amount is then used. Accordingly, it is often appropriate for the estate planning documents to set the estate tax exemption trust amount at the lower New York exemption level and provide flexibility through additional trust provisions relating to the federal estate tax exemption level by post-mortem decision in connection with the estate administration.

Change of Residency - Many retired New York residents and residents of states which are decoupled from the federal estate tax may consider planning opportunities that may reduce or eliminate state estate taxation. One common technique is to change residency to a decoupled state, such as Florida. Florida only has a pick-up tax which imposes a state estate tax equal to the state estate tax credit and consequently no longer imposes a state estate tax. Change of residency is a serious matter, as the New York tax authorities in some cases vigorously audit tax returns where change of residency is claimed. Where a change of residence is effective, there is still a New York estate tax on New York real property owned by a former New York resident.

Lifetime Gift Strategies - There are a number of established techniques which a New York resident (without change of residency) may use during lifetime estate planning to reduce the long term estate tax burden under current law. These techniques include: full use of the annual per donee gift exclusion each year ($12,000 in 2008, which for a married couple is available to each spouse); irrevocable life insurance trust; qualified personal residence trust ("QPRT") for personal residence planning; and family limited partnership, LLC or grantor retained annuity trust ("GRAT") planning for marketable securities, closely held business interests, or other illiquid family assets. These techniques are available to residents of all states. There is an additional gifting option relating to the New York estate tax for a New York resident, particularly one who is of very advanced age or terminally ill. This involves making a substantial taxable gift (either outright or in trust) to family members, typically in excess of the federal gift tax exemptions ($1,000,000 under current law) thereby incurring federal gift tax. The benefit from this gift is that New York does not impose a gift tax, nor does New York take lifetime gifts into account in the New York estate tax transfer base at death. Depending on the size of the gift, a significant reduction of New York estate tax may be achieved. This gift does not produce adverse federal transfer tax consequences, because the federal estate tax is reduced by the gift tax paid.

Prospective New York Legislation - Legislation has previously been proposed in New York which would repeal the New York estate tax. A proposal endorsed by Governor Pataki in 2006 would have enacted a permanent repeal of the New York estate tax effective in 2010. The prospect for enactment of such legislation under the current climate is even more uncertain. Even if such legislation were enacted, properly drawn estate planning documents would need to take into account the possibility of death before the repeal of New York estate tax in 2010, as well as appropriate provisions applicable after the effective date relating to federal estate tax planning.

New York "GST" Tax - Another issue to consider is that the generation-skipping transfer ("GST") tax exemption for New York law purposes is lower than the federal -- $1,250,000 in 2007 and adjusted by an inflation factor in years going forward. The federal GST exemption amount is set at $2,000,000 through 2008, and $3,500,000 for 2009. Accordingly, separate New York GST tax may be applicable to federal GST exemption trust property at deaths of children with respect to any excess over the applicable lower GST exemption for New York estate tax purposes. 

Conclusion - Other planning opportunities and considerations may be applicable for specific client situations in addition to those outlined above. It is appropriate to review all estate plans periodically in light of today's federal and New York estate tax environment, the scheduled tax law changes in the coming years, and the prospect of significant future tax law legislation affecting estate planning.

Revised: January 2008