In the final month of 2017, President Trump and the Republicans in Congress agreed upon a massive change to the federal tax system. Amongst the changes was significant increase to the federal estate, gift and generation skipping transfer tax exemptions. Beginning in 2018 and continuing through the end of 2025, each individual receives a $11.2 million exemption (adjusted annually for inflation) and each married couple receives a collective $22.4 million exemption. This leaves the vast majority of estates able to pass free of federal estate tax.
In New York, however, this change brought about an end to the hope of both tax professionals and clients alike that the New York state and federal exemptions would once again be equal. This hope has now been extinguished as New York’s exemption will remain $5.25 million through the end of 2018. On January 1, 2019, the exemption will be determined based on a base exemption of $ 5 million adjusted for inflation over the course of the last ten years. Furthermore, two major differences from the federal estate tax system will complicate New York estate planning even further.
First, under federal estate tax law, if one spouse dies leaving a portion of their exemption unused, the surviving spouse may ‘inherit’ the remaining exemption through the concept of portability. New York, on the other hand, does not recognize portability and without additional planning, the unused exemption would not be preserved. Secondly, under federal estate tax law, the taxable portion of an estate is the value of the assets above the decedent’s exemption. This is also true in New York unless your estate exceeds 5% of the exemption. Once an estate exceeds this amount, the entirety of the estate is taxable, not just the excess amount.
The New York/Federal Exemptions historically
For many years, New York conformed it’s estate tax exemption to the state death tax credit under the federal estate tax system. In 2001, this changed due to the tax legislation passed by President George W. Bush which increased the federal estate exemption over the course of the next decade leading to a temporary repeal in 2010. In order to preserve the revenue that it was receiving from estate taxes, New York and other states which had a state-specific estate tax decoupled from the federal system and set their own exemptions. In New York, the exemption remaining $1 million for well over a decade.
In 2014, Governor Andrew Cuomo enacted legislation by which the New York exemption would progressively grow in size over a period of five years. By 2019, the New York exemption was scheduled to be tied to the same formula by which the federal estate tax exemption was determined. This, it was hoped, would reduce the estate tax burden on many New York families while reduces the disparity between state and federal tax regimes.
Planning for the new New York/Federal disparity
The large disparity between the two exemptions creates new complications and opportunities for New York residents with regard to their estate plans. Wills which utilized a mandatory credit shelter trust should be reviewed and changed to more flexible disclaimer trusts to give fiduciaries more room to determine how much and which tax to pay at a decedent’s death. Additionally, because New York does not have a state specific gift tax, New York residents with estates valued between the New York and Federal exemptions should consider gifting plans to lower their New York taxable estate and to avoid the estate tax cliff.
Gifting does not come without risks. For a taxable gift to be effective, the donor must live for three years after the gift is made. If they die in the interim, the gift is brought back into their estate for purposes of calculating their estate tax. In addition, given the partisan nature of the recent changes, it is not inconceivable that the current federal exemption may be repealed or lowered by a Democratic president and Congress. Finally, even if Republicans retain control over the presidency and Congress, the change to the estate tax will sunset. It is possible that any gifts made today may be subject to a future clawback by the IRS.
The Only Certainty Is Uncertainty.
In the sixteen plus years since New York first decoupled from the federal estate tax system, the federal exemption has changed twelve times and the New York exemption has changed five times. There is no reason to believe that these changes will suddenly end at the federal or state level. The best way to ensure that your plan reflects these changes is to remain in contact with your estate planning and tax professionals.
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