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Michael S. Kutzin

 

Gifts: Under the recent (2014) NY law, taxable gifts for Federal Gift Tax purposes made within 3 years of death will be added to the New York Taxable Estate in determining the New York Estate Tax, unless (1) the gift was made when the decedent was not a New York resident, (2) the gift was made before April 1, 2014, or (3) the gift was made on or after January 1, 2019.

            As discussed in The Estate Tax is Back, but with some Twists – And Opportunities, the increase in the exemption for Federal Estate and Gift Tax for $5 million per person (and $10 million for a husband and wife) for 2011 and 2012, presents people with a unique opportunity to make sizeable gifts to children while ensuring that any future growth in the value of those assets escape taxation in the parents’ estates.  In addition, if those gifts are made using estate planning devices such as GRATs, family limited partnerships, qualified personal residence trusts, or others, the ultimate tax savings can be substantially enhanced.

            An additional reason to consider making substantial gifts during this window of opportunity for individuals who intend to live in New York until their deaths is the potential savings on New York State Estate Tax.

            The following chart demonstrates how dramatically gifting during lifetime can reduce New York State Estate Tax.

NYS Taxable Estate               Tax if No Gift             Tax if ½ Gifted[1]         Tax if All

Before Gifts                                                                                                    Gifted             

 

$1 million                                           0                                  0                           0

 

$1.5 million                                        $64,400                       $20,400                0

 

$2 million                                           $99,600                       $33,200                0

 

$2.5 million                                        $138,800                     $48.400                0

 

$3 million                                           $182,000                     $64,400                0

 

$4 million                                           $280,400                     $99,600              0

 

$5 million                                           $391,600                     $138,800            0

 

            As is evident, gifting, even immediately before death, can substantially reduce or eliminate the New York State Estate Tax.  Since lifetime gifts of up to $5 million does not incur Federal Gift Taxes under the laws in effect through the end of 2012, New York state residents have an alternative to moving from New York to a state that does not impose an estate or inheritance tax, by simply gifting some or all of their wealth to children.  The full explanation of why this is so begins at Mechanics of New York State Estate Tax, below.

Caveat.  The benefit of gifting to reduce NYS Estate Tax must be weighed against other considerations, such as the loss of step up in basis of assets (see The Estate Tax is Back, but with some Twists – And Opportunities for discussion of step up in basis) and any immediate income tax consequences if retirement assets are gifted.  In addition, such transfers may also impact eligibility for Medicaid coverage of nursing home costs for persons, or their spouses, who may need such coverage at a later date (see New York Medicaid Article for a full discussion of the effects of asset transfers on Medicaid eligibility).

MECHANICS OF NEW YORK STATE ESTATE TAX

            New York State repealed its gift tax, but retained an estate tax that was based on the federal State Death Tax Credit in effect on July 22, 1998 (a so-called “sop tax”).[2]  Even though, under the Federal Estate Tax law in effect through 2012, there is no State Death Tax Credit (there is a deduction instead), New York State continues to use the State Death Tax Credit then in effect. 

            The maximum State Death Tax Credit (and thus the maximum tax) cannot exceed the Federal Estate Tax imposed under IRC § 2001 in effect on July 28, 1998, reduced by the unified credit against Federal Estate Tax in effect in 1998 as if it were $1 million.[3]

            The Federal Estate Tax is imposed on the “taxable estate” plus “adjusted taxable gifts, reduced by any gift taxes payable.”[4]  A unified credit against the tax is then applied.  The unified credit, had it been against the tax resulting from a combined taxable estate and adjusted taxable gifts (as reduced by gift taxes payable) of $1 million, would have been $345,800 in 1998.

            The State Death Tax is computed by multiplying the “adjusted taxable estate” by a rate that increases with the size of the estate.  The rates range from as low as 0.8% for adjusted taxable estates below $90,000 to as high as 16% for every dollar that the adjusted taxable estate exceeds $10,040,000.[5]  The “adjusted taxable estate” is the taxable estate less $60,000.[6] 

            The “taxable estate” is simply everything that is includible in the estate for Federal Estate Tax purposes less all permitted deductions.[7]  It does not include taxable gifts, which, as will be demonstrated in this article, is what provides the opportunity to reduce or eliminate NYS Estate Tax by making gifts.

            As will be demonstrated in the following examples, if the taxable estate is $100,000 or less, the New York State Estate Tax is zero, even if substantial taxable gifts were made for Federal Estate and Gift Tax purposes.  Moreover, in most cases, the New York State Estate Tax can be reduced if taxable gifts are made, even if Federal Gift Tax is imposed on the total amount of gifts made.

            Here are some examples of how making gifts can result in substantial New York State Estate Tax savings.  The examples assume that all property is located in New York, and that all of the people are New York residents at the time of their deaths.  Unless stated otherwise, all of these people are unmarried.

           

Example #1:   Jane dies with a taxable estate of $1 million, and she has not made any taxable gifts during her lifetime.  In this case, the NYS Estate Tax will be zero.  The maximum State Death Tax Credit would be $33,200, but the hypothetical Federal Estate Tax on a taxable estate of $1 million in 1998 would have been $345,800 (the tentative tax), which when the assumed credit of $345,800 is applied against it, amounts to zero. Since the State Death Tax Credit cannot exceed the hypothetical Federal Estate Tax as reduced by the hypothetical unified credit, the NYS Estate Tax is zero.

Example #2:  Jane’s sister, Jean, died with a taxable estate of $2 million.  She never made any taxable gifts during her lifetime.  Based on a $2 million taxable estate, the maximum State Death Tax Credit would be $99,600.  The tentative tax would, just as for Joan in Example #2, be $780,800, less the $345,800 unified credit, for a hypothetical Federal Estate Tax of $435,000.  Since the maximum State Death Tax Credit of $99,600 does not exceed this hypothetical tax, the NYS Estate Tax is $99,600.

            Example #3:   Jane’s cousin, Joan, made a taxable gift of $1 million to her children, leaving her with a taxable estate of $1 million at the time of her death.  As her taxable estate was $1 million, the maximum State Death Tax Credit would be $33,200.  The tentative tax, computed on the basis of both Joan’s taxable estate and adjusted taxable gifts, would be $780,800, less the $345,800 unified credit, for a hypothetical Federal Estate Tax of $435,000.  Since the maximum State Death Tax Credit of $33,200 does not exceed this hypothetical tax, the NYS Estate Tax is $33,200.

            As is illustrated in Examples #2 and #3, even where the wealth transferred is the same, there is a substantial reduction in the NYS Estate Tax where a portion of it was transferred during the person’s lifetime instead of at death.

           

Example #4:   Jane’s wealthy niece, JoAnn, died in 2011 leaving a husband (a U.S. citizen) and children.  She left the children $5 million, and left the rest of her estate to her husband outright.  Her gross estate was worth $7 million.  The $2 million that is left to JoAnn’s husband qualifies for the marital deduction, so her taxable estate (gross estate less deductions) is $5 million.  There will be no Federal Estate Tax on the $5 million that she leaves to her children, but there will be a NYS Estate Tax.  The maximum State Death Tax Credit would be $391,600.  The tentative tax would be $2,390,800, less the $345,800 unified credit, for a hypothetical Federal Estate Tax of $2,045,000. Since the maximum State Death Tax Credit is less than this hypothetical Federal Estate Tax, the NYS Estate Tax would be $391,600.

            Example #5:  JoAnn’s cousin, Jackie, also died in 2011 leaving a U.S. citizen husband and children.  Shortly before her death, in 2011, Jackie gave her children taxable gifts of $5 million, and left everything else to her surviving husband.  Just as in Example #4 for JoAnn, there was no Federal Estate Tax.  However, because Jackie transferred the $5 million during her lifetime to the children instead of at death, the NYS Estate Tax is zero because her taxable estate was zero (taxable gifts are not included in computing the maximum State Death Tax Credit).

            For someone willing to make substantial lifetime gifts (or for whom someone with the authority to make gifts can do so using a power of attorney), substantial sums of money can be saved on the NYS Estate Tax.

           

Example #6:   Jennifer dies leaving a taxable estate of $1,013,000.  The maximum State Death Tax Credit is $33,928.  The tentative tax is $351,130, less the unified credit of $345,800, for a hypothetical Federal Estate Tax of $5,330.  In this case, the hypothetical Federal Estate Tax is less than the maximum State Death Tax Credit, so the NYS Estate Tax is $5,330. 

          Example #7:  Shortly before her death, Justine gives her son, Jack, a $13,000 gift.  Because the gift qualifies as an annual exclusion gift, it is not a “taxable gift”[8].  She has not made any taxable gifts during her lifetime.  As a result, at her death, her taxable estate is $1,000,000.  Her NYS Estate Tax is zero.  See Example #1 for the computation.

            Example #8:   Shortly before her death, Jolene gives her son, John, $13,000 in a trust without “Crummey powers”, so the gift does not qualify as an annual exclusion gift.  If her taxable estate is $1 million, then the maximum State Death Tax Credit is $33,200.  The tentative tax, just as in Example #6, is $351,130, because the taxable gift of $13,000 is added to the $1 million, and when the unified credit of $345,800 is applied against the tentative tax, the hypothetical Federal Estate Tax is $5,330.  Just as in Example #6, the hypothetical Federal Estate Tax is less than the maximum State Death Tax Credit, so the NYS Estate Tax is $5,330.

 

            As is demonstrated by Examples #6 and #7, annual exclusion gifts can be used to bring the taxable estate down to $1 million, and because they are not “taxable gifts”, they are not included in the computation for the hypothetical Federal Estate Tax.  Example #8 demonstrates an unusual situation where the gift did not lower the NYS Estate Tax from the situation where the gift was not made (Example #6).  However, for individuals with just a bit more money, gifting in any manner can reduce the NYS Estate Tax, as is demonstrated below.

           

Example #9:  Jessica dies with a taxable estate of $1.5 million.  The maximum State Death Tax Credit is $64,400.  The tentative tax is $555,800 and after the unified credit of $345,800 is applied against it, the hypothetical Federal Estate Tax is $210,000.  Since the maximum State Death Tax Credit is less than the hypothetical Federal Estate Tax, the NYS Estate Tax is $64,400.

            Example #10:  Joely makes taxable gifts of $500,000 immediately before she dies, leaving her with a taxable estate of $1,000,000.  The maximum State Death Tax Credit is $33,200.  The tentative tax on a taxable estate of $1 million plus adjusted taxable gifts of $500,000 is $555,800, and after the unified credit of $345,800 is applied against it, the hypothetical Federal Estate Tax, as it was in Example #9, is $210,000.  Since the maximum State Death Tax Credit is less than the hypothetical Federal Estate Tax, the NYS Estate Tax is $33,200.

            Example #11:  Jerome makes a series of annual exclusion gifts totaling $500,000, leaving him with a taxable estate of $1 million at death.  Jerome made no taxable gifts.  As in Example #10, the maximum State Death Tax Credit is $33,200.  The tentative tax on a taxable estate (note that there are no taxable gifts to be added, as the gifts were all annual exclusion gifts), is $345,800 and after the unified credit of $345,800 is applied, the hypothetical Federal Estate Tax is zero.  Since the hypothetical Federal Estate Tax is less than the maximum State Death Tax Credit, the hypothetical Federal Estate Tax is the NYS Estate Tax – namely a tax of zero.

            Examples #9-11 demonstrate how gifting, whether taxable gifts or excluded gifts, reduce the NYS Estate Tax once the size of the estate substantially exceeds $1 million, and how if the taxable estate can be reduced below $1 million without making any taxable gifts, the NYS estate tax can be eliminated altogether.  In Example #11, a tax of $64,400 that was incurred in Example #9 was saved merely by making annual exclusion gifts.

            Qualified transfers for medical and educational expenses can also be used for this purpose,[9]  as well as gifts to minor’s trusts that qualify under IRC §2503(c).

            Conclusion.  If anyone needed the additional incentive to consider making gifts through 2012 to take advantage of the $5 million lifetime gift tax exemption, the potential savings on New York State Estate Tax should provide it.  Gifting programs, however, have multiple considerations (see Caveat, above), and should be discussed with your Estate Planning and tax professionals.



[1] For simplicity’s sake, all gifts are assumed to be taxable gifts rather than gifts qualifying for the annual exclusion from taxable gifts for Federal Gift Tax purposes. 

[2]   NY Tax Law § 951(a); NY Tax Law § 952(a), IRC § 2011 as in effect on July 22, 1998.

[3]   IRC §2011(f); IRC §2001; IRC §2010; NY Tax Law § 951(a).

[4]   IRC §2001(b).

[5]   Id. 

[6]   Id.

[7]   IRC §2051.

[8] IRC §2503(b).

[9]  IRC §2503(b).