How to *Legally* Avoid the New York Estate Tax

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Paul Sundin, CPA

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To say that New York has high tax rates would be an understatement. I think most people agree it is a high taxing state.

But what about New York estate, inheritance, and gift taxes? In this article, we are going to address these taxes and try to give you an overall New York tax picture. 

New York estate tax rates and exemption amount

New York is one of only 12 states in the country that levies an estate tax. Clearly, most states don’t have one and try to keep their tax environment rather streamlined. But this is not the case for New York.

The current New York estate tax exemption amount is $5,930,000 for 2021. This amount is indexed by inflation and will grow in subsequent years.

The estate tax rate for New York is considered progressive or graduated. It begins at 3.06% and goes up to 16% for taxable estates worth more than $10.1 million.

For individuals who pass away in 2021 with a taxable estate between $5,930,000 and $6,504,587, the portion of the estate in excess of the New York estate tax exemption is taxed at rates over 100% and in some situations it can be in excess of 200%!

Financial planning puzzle piece

New York has what is called a “cliff” tax structure. New York has implemented a rule that limits certain estates from utilizing the exclusion. If the amount of the taxable estate is actually over 5% of the exclusion amount at date of death, you are restricted from using the New York’s exclusion amount.

That’s how you effectively “fall off the cliff” if your overall taxable estate is simply too high. In this situation, the estates are subject to estate tax in New York on their entire value – going back to dollar one.

Taking a look at an illustration, let’s assume a person passed away today when the exclusion amount is $5,930,000. If the person had a taxable estate of at least $6,226,500, the entire estate would be hit with the New York estate tax. This would result in a New York estate tax liability of over $538,000.

This is the case even though the amount by which the estate exceeds the exclusion was just $296,500. The result is a tax of over 100% on the amount by which the estate actually exceeded the exclusion amount. Doesn’t sound exactly “fair”, but who says that taxes will always be fair.

Fortunately, the estate tax exemption is high enough that 99% of New York citizens won’t have an issue with it.

Tax portability

When someone passes away, assets that pass to their spouse are not assessed estate tax in New York. However, when the surviving spouse dies, any amount of the estate exceeding $5,930,000 is subject to normal New York estate tax rules. What this means is that the estate tax exemption in New York is not portable between two spouses.

Some married couples can partially get around this by establishing a specific trust that is equal to the estate tax exemption. In this situation, these assets will not be taxed when the second spouse passes away.

Federal estate tax and exemption amount

The federal estate tax has been around for decades. But the exemption amount has certainly jumped around. Many people call it the “death” tax.

In theory, the calculation of federal estate tax is rather simple. But the complexity usually surrounds the valuation of the assets in the gross estate.

Taxes written on hanging tags

When someone passes away, the executor of the estate will aggregate all of the assets that the decedent owned. This would include investments like stocks, bonds and real estate. But it will also include business interests. This is usually where the complexity in valuation lies.

Once all assets are properly aggregated and valued, the estate can then deduct any liabilities of the decedent. This would include mortgages, loans and other liens, and even credit card debts and medical bills.

The final step is to reduce the estate by deducting administrative costs like tax and legal fees. You can also reduce it by funeral costs. The net amount is considered the net estate.

Inheritance tax & gift tax

But I’ve got some good new for you. New York does not have an inheritance tax. If you are receiving money or assets from a relative, you do not have to remit anything to New York.

However, many states do impose an estate tax. So If the person who died lived in another state, make sure to verify the inheritance tax requirements in that state to see if they apply.

More good news for you. New York does not assess a gift tax. So if you wanted to avoid the estate tax then just gift away assets before you pass away.

However, any gifts made within three years prior to the person passing away are counted as part of the person’s estate. So make sure to plan in advance and don’t just gift away all your assets on your deathbed. The federal gift tax applies to gifts of more than $15,000 for 2021.

Strategies to Avoid or Eliminate the New York Estate Tax

You may be in the lucky 99% without an estate tax headache. But that could change quickly. Make sure you consider a variety of planning ideas. The following are some of our favorites:

  • Qualified Personal Residence Trusts (QPRTs) 
  • Grantor Retained Annuity Trusts (GRATs) 
  • Grantor Retained Income Trusts (GRIT)
  • Intentionally Defective Grantor Trust (IDGT)
  • Irrevocable Life Insurance Trust (ILIT)
  • Charitable Gift Annuity
  • Minor Trusts 
  • Direct Tuition Payments
  • Family Limited Partnerships (FLPs)
  • Charitable Remainder Trusts (CRUT)
  • Crummey Trusts 
  • Special Valuation of Farms and Businesses
  • Gifts Below Annual Exemption
  • Revocable Grantor Trusts
  • Donor-Advised Funds
  • 529 Plans
  • Direct Medical & Healthcare Payments 
  • Grantor Retained Unitrusts (GRUTs)
  • Qualified Terminable Interest Property (QTIP)
  • Dynasty Trusts

Estate Tax Return Requirements, Rules & Limits

Now that you have calculated all the numbers it is time to file the tax return. The estate tax return is Form 706. Make sure to consider the following:

  • If the net estate is below the exemption, you are not required to file Form 706 (except for the portability election).
  • You are required to file the tax return within nine months from the date of the death. If you cannot file by the deadline, don’t worry. You can request an extension. Just complete Form 4768 to apply for a 6-month extension of time. 
  • Regarding the portability concept, the executor may only transfer the “DSUE” amount to a surviving spouse when Form 706 is filed timely. 

Who needs estate planning?

While everybody should consider some form of estate planning, it is imperative for certain people. If you fall into one of the following categories, you may need to get started immediately:

  • Retirement plan assets over $1 million
  • Significant real estate (rental property) holdings
  • Large stock, bond, or mutual fund holdings
  • Life insurance policies over $1 million
  • Stand to inherit large sums of money
  • Own a business or are an entrepreneur
  • Professional occupation and high-earner

New York tax structure

New York is not exactly the most tax friendly state. Income taxes range from 4% to almost 9%. New York City also assesses a local income tax. If you reside in the five boroughs, make sure you consider this.

Real estate taxes are a little high at around 1.5% of value. Property taxes are actually the lowest in New York City. They average around .8% there. The state assesses a sales tax rate of 4%. But many local cities tack on an assessment that brings the average overall sales tax rate to around 8%.

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