Federal Transfer Tax Updates and New York State Estate Tax Planning Strategies and Pitfalls
Important Changes Regarding Federal Estate, Gift and Generation-Skipping Transfer Tax
On December 22, 2017, the “Tax Cuts and Jobs Act” was signed into law, making the following changes to federal estate, gift and generation-skipping transfer tax exemptions:
Federal Estate and Gift Tax:
- The federal unified exemption (applicable toward federal estate and gift taxes) was increased to $11,580,000 per person, but this increase is scheduled to expire after December 31, 2025, and revert to a $5,000,000 basic exemption, indexed for inflation.
Note: The Internal Revenue Service (IRS) has issued regulations confirming that gifts made by a taxpayer prior to December 31, 2025 are subject to the federal unified exemption available at the time of the gift – not the federal unified exemption available at the time of the taxpayer’s death. In other words, taxpayers who take advantage of the increased federal unified exemption amount will not be penalized if they die after the federal unified exemption reverts to a lower amount on December 31, 2025.
Note: Portability of a decedent’s unused federal unified exemption continues. That is to say, if a decedent does not
use his or her full available federal unified exemption, the decedent’s spouse may generally use the decedent’s unused federal unified exemption.
Federal Generation-Skipping Transfer Tax:
- The federal generation-skipping transfer tax exemption increased to $11,580,000 per person, but this increase is scheduled to expire after December 31, 2025, and revert to a $5,000,000 basic exemption, indexed for inflation.
While the changes described above may provide certain federal estate tax planning advantages, New York State estate tax considerations remain important as New York State does not offer a “portable” estate tax exemption. In addition, the New York State estate tax exemption (currently $5,850,000) is lower than the current federal unified exemption, and the New York State estate tax exemption will only increase each year thereafter based on a cost of living adjustment tied to inflation. Therefore, allocating assets between spouses and creating trusts for surviving spouses remain important planning strategies. See the following sections for details on a potential New York State estate tax planning pitfall and strategy.
Pitfall of the Federal Unified Exemption Sprinkle Trust
Many wills include a provision to fund a trust with an amount equal to the federal unified exemption and allow the trustees to “sprinkle” distributions of principal for the benefit of the decedent’s spouse and descendants (“federal exemption sprinkle trust”). With the increase in the federal unified exemption amount over the New York State estate tax exemption amount, these types of trusts will cause the decedent’s estate to incur New York State estate tax because some of the assets in the trust, while exempt from federal estate tax, will not be exempt from New York State estate tax.
For example, if a decedent passes away in 2020 with a gross estate of $10,000,000 that funds a federal exemption sprinkle trust, the decedent’s estate will not incur federal estate tax, but it will incur $1,067,600 of New York State estate tax.
This problem can be solved by restructuring the estate plan to limit the funding of the sprinkle trust to the greatest amount that can qualify for both the federal and New York State estate tax exemptions. The balance of the estate, which otherwise would have caused the estate to incur New York State estate tax, passes to the decedent’s spouse by outright bequest or by funding a second trust for the benefit of the decedent’s spouse only. This bequest or trust saves New York State estate tax in the decedent’s estate because it qualifies for a federal and New York State marital estate tax deduction. Therefore, the decedent’s estate incurs no federal or New York State estate tax.
Santa Clause Strategy for Minimizing New York State Estate Tax
Since 2014, in calculating the estate tax due, New York State provides a credit against the estate tax owed. However, the credit comes with a catch – it is only fully available to taxable estates equal to or less than the exemption from New York State estate tax (“NYS exemption”). See the chart below for the NYS exemption.
The credit is gradually phased out for taxable estates greater than the NYS exemption and less than 105% of the NYS exemption. The credit is disallowed in its entirety for taxable estates that exceed 105% of the NYS exemption (“phase-out point”). Because of the aggressive phase-out point of the NYS exemption, there is a range of taxable estates that will pay a greater amount in New York State estate tax than the amount which exceeds the NYS exemption (“overtax range”), ultimately leaving the beneficiaries of such estates with less of an inheritance, despite the estate having a greater value.
The table below illustrates the varying available credit, phase-out point and overtax range.
|For Decedents with |
Dates of Death
|NYS Exemption||Phase-Out Point||Overtax Range|
|January 2, 2020 –|
December 31, 2020
|On and After|
January 1, 2021
Base Exemption, Indexed
for Inflation from 2010
|105% of the|
|To Be Determined|
Based on the Value of the
One potential solution is to include a provision in your Will that leaves a deductible bequest to one or more charities in the amount necessary to reduce your taxable estate to the NYS exemption, thereby taking full advantage of the credit (commonly known as the “Santa Clause”). While we are not aware of New York State having yet accepted the Santa Clause, we believe that it should, as formula clauses are commonly used when drafting Wills in order to minimize estate taxes. The Santa Clause applies if:
- Your estate is subject to New York State estate tax; and
- The savings in New York State estate tax owed equals or exceeds the value of the bequest to the charity.
The Santa Clause favors benefitting charity over the payment of estate tax when doing so will either increase your beneficiaries’ inheritance or have no effect on it.
Below is an example of a Santa Clause provision:
If my spouse does not survive me, and in the event my estate is taxable for New York State Estate Tax purposes, then, and in that event, I give, devise and bequest to the following charities – [Names of Charities] – an amount equal to the maximum portion of my estate that will result in a reduction of my net New York State estate tax, which equals or exceeds the amount so distributed. Such amount shall be distributed in equal shares to the foregoing named charities to be used for their general charitable purposes.
Below is an example of the effect of the Santa Clause:
|Hypothetical: Decedent passes away in 2020, and decedent’s estate is valued at $6,050,000,|
which is to be distributed equally among decedent’s three children.
|Without Santa Clause||With Santa Clause|
|Charitable Bequest||$0.00||Charitable Bequest (Santa Clause)||$200,000|
|NYS Estate Tax Due||$426,250||NYS Estate Tax Due||$0.00|
|Federal Estate Tax Due||$0.00||Federal Estate Tax Due||$0.00|
|Balance to Be Distributed||$5,623,750||Balance to Be Distributed||$5,850,000|
|1/3 of Balance for Each Child||$1,874,583||1/3 of Balance for Each Child||$1,950,000|
Extension of New York State Estate Tax “Clawback” on Gifts
New York State estate tax law includes in a decedent’s gross estate any taxable gifts made within three years of the decedent’s date of death (“clawback rule”). The clawback rule was to expire on January 1, 2019; however, the 2020 New York State Executive Budget, adopted on March 31, 2019, extended the clawback rule until January 2, 2026, with one exception – gifts made between January 1, 2019 and January 15, 2019 are not subject to the clawback.
If your current estate plan is affected by any of the foregoing, or if you would like us to review and assist you in updating your plan, please contact a member of our Family Wealth Planning Practice Team or the Phillips Lytle attorney with whom you have a relationship.