New York to Drastically Change "Gift Tax" Rule

by Holland & Knight LLP

  • Currently, there is no gift tax in New York, and although the amount of lifetime taxable gifts made by a New Yorker may cause the estate tax rate to increase, there is no additional estate tax paid on those gifts.
  • New York individuals who have significant estates should consider making taxable gifts before April 1, 2014 – especially if the individual has not used up the federal exclusion amount.

Gov. Cuomo has proposed a change to New York's estate and gift tax law that will require all taxable gifts made by a New York resident after March 31, 2014, to be included as part of the gross estate for purposes of calculating the New York estate tax.

Avoid Paying Estate Tax by Making Taxable Gifts Before April 1, 2014

Currently, there is no gift tax in New York, and although the amount of lifetime taxable gifts made by a New Yorker may cause the estate tax rate to increase, there is no additional estate tax due on those gifts. While not changing the gift tax, the net effect of this proposed change would be to cause New Yorkers who make taxable gifts after March 31, 2014, to pay more tax by requiring estate tax to be paid on those gifts.

In essence, when all of the New York rate adjustments are made, the new provision will cause any taxable gift made by a New York resident after March 31, 2014, to incur an additional net estate tax of anywhere from 6.5 percent to 12 percent, if the New York gross estate, including taxable gifts, exceeds the New York exclusion amount (the actual net rate is impacted by the amount of the New York exclusion amount and the federal exclusion amount). The governor's proposal also gradually increases the New York estate tax exclusion amount over the next five years from $1.0 million to $5.25 million, with CPI adjustments thereafter, while lowering the top rate from 16 percent to 10 percent.

New York individuals who have significant estates should consider making taxable gifts before April 1, 2014 – especially if the individual has not used up the federal exclusion amount.

The following is an example of the potential savings by making taxable gifts before April 1, 2014.

A New York resident has a taxable estate valued at $15.34 million. (For this purpose, no deductions other than the deduction for state estate taxes are being considered). If, before April 1, 2014, she makes a gift of the full federal estate tax exclusion ($5,340,000) and dies in 2014 after that date, her combined federal and New York estate tax would be $4,628,780. If the gift were made after March 31, 2014, her combined federal and New York estate tax would be $5,356,720 or a $720,176 increase (over a 15 percent increase in the estate tax). On the other hand if no taxable gift was made and the New York resident died before April 1, 2014, her combined federal and New York estate tax would be $5,144,720; if she died after March 31 in 2014, without making gifts, the combined federal and New York estate tax would be $5,101,360. So the New York reduction in rate and increase in exclusion provides only a $43,360 savings. By making the gift before April 1, 2004, there is a potential savings of $472,580; even if she survives until the New York estate tax exclusion is in parity with the federal estate tax exclusion, which will occur in 2019, the potential savings on making a gift before April 1, 2014, would be approximately $320,000.

The sizable increase in the combined estate tax noted above if the taxable gift is made after March 31, 2014, is caused not just by the inclusion of the taxable gifts in calculating the New York estate tax, but also by the fact that the tax attributable to the New York taxable gifts will more than likely not be deductible from the federal gross estate under §2058 of the Internal Revenue Code. That section provides that the amount of state death taxes paid "in respect of any property included in the gross estate" shall be deducted from the taxable estate. For federal purposes, taxable gifts are not included in the gross estate. While there are no cases which have been decided on this issue under §2058 (which was added by EGTRRA of 2001), there are two cases which were decided when the Code allowed a credit for state death taxes: Second National Bank of New Haven v. United States, 442 F. 2d 40 (2d Civ. 1970); Estate of Owen v. Commissioner, 104 T.C. 498 (1995). Both cases held that the phrase "included in the gross estate" required that the property upon which the state tax is levied must be included in the calculation of the federal gross estate. Since New York taxable gifts are not part of the federal gross estate, there will be no deduction available for the state death tax attributable. The result of this denial of deduction will be to increase the cost of making New York taxable gifts to the full amount of the estate tax attributable to the taxable gift.

There is an additional interesting aspect to the New York estate tax on taxable gifts, namely, who will be responsible for paying it. Under §975 of the New York Tax Law, the executor of a decedent's estate is liable for paying the tax, who must then apportion and collect the estate tax paid in accordance with the rules of §2-1.8 of the New York Estates, Powers and Trusts Law. That statute requires the tax to be "equitably apportioned among the persons interested in the gross tax estate (emphasis added)" unless the decedent otherwise directed. Section 975 of the Tax Law also provides that if the executor fails to pay the estate tax, the transferee shall be personally liable for the tax due.

There are a number of issues that arise. One is that a decedent may inadvertently wipe out the assets which pass through his probate estate if his will directs that all estate taxes are to be paid from the probate assets. For example, take an individual who has an estate of $12.8 million and makes taxable gifts of $10.0 million on April 1, 2014 (leaving him with $944,000 after paying federal gift tax of $1.856 million), and dies in 2019 with the $944,000 remaining. If he provides in his will that all taxes are paid from his probate estate, the estate would owe $124,202 federal estate tax (only the New York estate tax applicable to the $944,000 gross estate can be deducted for purposes of the federal estate tax) and $973,200 for New York estate taxes. The result is that not only would all of the probate assets be used up, but the transferee would be required to pay the balance of $153,402. Alternatively, if New York EPTL §2-1.8 applied, the transferee would owe $889,254 for the New York estate tax (the equitable share of $10.0 million over $10.944 million) with the probate assets charged with the balance of $83,946 of New York estate tax and $124,202 federal estate tax. In either event the executor would need to seek reimbursement from the transferee.

Another issue is whether this new tax law creates the concept of a net gift, which would have the effect of lowering the value of the gift for federal gift tax purposes. The recent Tax Court decision in Steinberg v. Commissioner, 141 T.C. No 8. (September 30, 2013) may be applicable to the value of the original taxable gift, which will now be subject to New York estate tax. At the very least, the donor and donees should be advised to enter into an agreement similar to the one used in Steinberg in order to avail themselves of the net gift valuation.

To ensure compliance with Treasury Regulations (31 CFR Part 10, §10.35), we inform you that any tax advice contained in this correspondence was not intended or written by us to be used, and cannot be used by you or anyone else, for the purpose of avoiding penalties imposed by the Internal Revenue Code.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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