New York’s recently passed legislation, effective April 1, 2014, significantly changes its estate tax regime and income tax regime for certain trusts. This Alert discusses the implications of this legislation.

Summary of Changes

There are five major changes in the newly passed New York legislation for personal tax planning purposes.

Increased Exclusion Amount. The New York estate tax exclusion amount — that is, the amount that may pass at death without incurring New York estate tax (previously $1,000,000 per person) — will be increased according to the following schedule:

New Cliff Tax. Although the legislation increases the New York estate tax exclusion amount, this benefit is phased out for taxable estates between 100 percent and 105 percent of the New York estate tax exclusion amount, and is completely eliminated for taxable estates that exceed 105 percent of the New York estate tax exclusion amount. This “cliff tax” means that the entire taxable estate of taxable estates exceeding 105 percent of the New York estate tax exclusion amount will be subject to New York estate tax, which will be applied at graduated rates.

New Three-Year Look-Back. If a New York resident dies within three years of making a taxable gift (made on or after April 1, 2014 and before January 1, 2019) while the decedent was a New York resident, the value of that gift will be included in the decedent’s estate for purposes of computing the New York estate tax.

Repeal of Generation-Skipping Transfer Tax. The new law repeals the New York generation-skipping transfer tax, the additional tax that was previously imposed on certain transfers to individuals (particularly, individuals who are more than one generation younger than the decedent).

Income Tax Changes. Income from Incomplete Non-Grantor (ING) trusts are now subject to income tax in New York on the personal income tax return of the New York resident grantor. In addition, the accumulated income of trusts with no New York trustees, source income or property, which was previously not subject to income tax in New York, will now be subject to New York income tax once that income is distributed to New York beneficiaries. This tax will be payable on the personal income tax return of the New York beneficiary.

Questions and Answers

This section addresses common questions regarding the recent New York tax changes applicable to New York residents.

Under the new rules, will my estate owe New York estate tax?

If at your death, your taxable estate does not exceed the applicable New York estate tax exclusion amount, it will not incur New York estate tax. If your taxable estate exceeds the applicable New York estate tax exclusion amount, New York estate tax will be due.

For example, a person who dies on January 1, 2015 with a taxable estate at or below $2,062,500 will not incur New York estate tax because it does not exceed the New York estate tax exclusion amount. If that same person has a taxable estate above $2,062,500, he or she will incur New York estate tax.

Will the “cliff tax” affect me?

Although the New York estate tax only affects estates valued at more than the applicable New York estate tax exclusion amount, the cliff tax particularly refers to estates valued at 105 percent or more of the applicable New York estate tax exclusion amount. These estates will be taxed on the full value of the estate (and will not benefit from any exclusion). This is called a cliff tax because a relatively small increase in the size of an estate can trigger significant New York estate tax liability.

For example, assume the person described in the example above dies on January 1, 2015 with a taxable estate of $2,170,000. The New York estate tax exclusion amount at that time will be $2,062,500. The individual’s estate exceeds 105 percent of the applicable New York estate tax exclusion amount ($2,062,500 x 105% = $2,165,625), and the estate will be subject to New York estate tax on the entire $2,170,000 (resulting in a New York estate tax bill of $112,400). In contrast, if an individual died with an estate worth $2,062,500, the estate would not be subject to New York estate tax at all. As a result, an increase in the taxable estate of $107,500 would result in an estate tax bill of $112,400.

Can I make gifts to reduce my estate?

Yes, but because of the new three-year look-back rule, you will need to survive three years after the date of the gift to ensure that the value of the gift is not included in your estate at your death (assuming that you’re a New York resident at the time the gift is made and the gift is made between April 1, 2014 and before January 1, 2019).

What doesn’t the new law change?

The new law retains the top rate of estate tax at 16 percent. The new law also does not adopt “portability” — that is, the option (for federal estate tax purposes) for a decedent to pass on his or her unused estate tax exclusion to the decedent’s surviving spouse.

I am married. What can I do to lessen the impact of the new law on my estate?

Due to the combination of the cliff tax and the absence of portability in New York, it is especially important for married individuals to make sure that each spouse dies with enough assets to fully utilize the applicable New York estate tax exclusion.