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Making Sense of the Basic Exclusion and Applicable Credit Amount

Effective April 1, 2014, the New York State 2014-2015 Executive Budget (the “Budget”) includes legislation that makes significant changes to the New York State estate tax laws.  The changes will have a positive impact on New Yorkers with estates valued between $1million and $5.25 million over the next few years.  Wealthier New Yorkers will not experience any difference in the taxation of their estates due to the new changes.

Under the Budget legislation, the New York State Basic Exclusion Amount (the “Basic Exclusion”) increased from $1 million to $2.0625 million for decedents dying on April 1, 2014 through March 31, 2015.  Therefore, estates that are less than or equal to $2.0625 million will not be subject to New York State estate taxation.  Previously, only those estates that were less than or equal to $1 million were not subject to the New York State estate tax.

The Basic Exclusion will increase each year – to $3.125 million on April 1, 2015 and $4.1875 million on April 1, 2016 – until April 1, 2017, when the Basic Exclusion will reach $5.25 million.  The Basic Exclusion will remain at $5.25 million until January 1, 2019, and will thereafter be indexed for inflation, linking it to the federal exclusion amount, which is currently $5.34 million.

If an estate is greater than the Basic Exclusion (currently $2.0625 million), then it is a taxable estate.  The New York Applicable Credit Amount (the “Credit”) can be applied to certain taxable estates to reduce the tax owed.

The Credit can only be applied to estates that exceed the Basic Exclusion amount by up to 5% (currently this would be an estate that is less than $2,165,625).  Applying the Credit will result in a decrease of the amount of tax owed on estates valued between $2.0625 million and $2,165,625.   As the value of the taxable estate increases the Credit phases out.

Once an estate reaches 5% of the Basic Exclusion amount, the Credit is phased out to zero and cannot be applied to the taxable estate.  This phenomenon is referred to as the estate tax “cliff,” since once the estate reaches the 5% threshold there will be no Credit available to reduce the tax owed.  Such estates will pay the same amount of estate taxes as they would have under the old law.

The maximum marginal New York estate tax bracket for 2014 remains at 16%.

The Add Back Gift Provision Under the New Executive Budget

The New York legislature repealed the New York State gift tax in 2000 and New York has not had a gift tax since then.

As a result, New Yorkers have been using gifting strategies (while taking into consideration the federal gift tax limits) as a way to reduce the size of their estates.  Under the old law, so long as the person making the gift did not retain any control over the assets, the value of the gift would not have been included in the estate for New York State estate tax purposes.

New York still does not have a gift tax, but the Budget includes an “add back” provision which adds certain gifts back to the gross estate.  The value of any taxable lifetime gift will be included in the New York gross estate if the gift was (i) made by a New York resident, (ii) within 3 years of death, (iii) on or after April 1, 2014 and (iv) on or before December 31, 2018.

If the decedent is a New York resident, a gift of real property or personal property that is located outside of New York presumably will not be added back to the decedent’s gross estate.  This provision may make it desirable for New York residents to give lifetime gifts of property located outside of New York.

Taxable gifts are those that exceed $14,000, the current federal annual exclusion amount.

How These Changes Impact Your Planning

The recent changes give rise to several planning strategies that should be considered.  Individuals with assets in excess of the current Basic Exclusion Amount can utilize estate planning strategies that can protect their assets from exposure to the New York State estate tax, which would be significant.

The new laws, while providing a more generous Basic Exclusion, do nothing to minimize the taxation of estates that exceed the then current Basic Exclusion by 5%.  Therefore, credit shelter trusts, charitable gifting and other planning tools should be used in order to utilize the Basic Exclusion.

Married couples may continue to benefit from the use of credit shelter and marital trust planning. Unlike the federal law, New York does not allow portability for spouses, so the unused portion of the New York State Basic Exclusion amount of the first spouse to die cannot be transferred to the surviving spouse to be used at the death of the surviving spouse.

Unmarried individuals with assets in excess of the Basic Exclusion amount may want to consider making charitable bequests to reduce the New York State estate to less than the Basic Exemption Amount and thereby avoid estate tax completely.  Gifting real property or tangible property that is outside of New York should also be considered.

In light of these changes you should review your current estate planning documents with your attorney, to be sure that they are properly structured to enable you to minimize your exposure to New York State estate tax, and, at the same time, are not imposing unnecessary restrictions on your beneficiaries.

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