The following is a general discussion about the current law of estate taxes. It is meant to supplement a conversation with an attorney, and should not be used for specific estate planning without consulting an estate and/or tax planner.
YOUR “ESTATE” DEFINED:
The size of your estate. An estate consists of all assets you own when you die – whether the asset passes under your Will or passes directly to a surviving named beneficiary or passes to a surviving joint owner. Your estate includes, among other assets, real property, personal property, life insurance, retirements accounts. Your estate may include, in some cases, assets which you gave away during your lifetime if you retain some sorts of enjoyment and/or ownership interest. And your estate might also include prior taxable gifts.
To compute the amount of your estate, for federal tax purposes, the Internal Revenue Code (the IRC) adds in all prior taxable gifts a donor made in or after 1976. NYS does not have a separate gift tax, but NYS adds back in some prior taxable gifts for purposes of computing the amount of your estate for NYS estate tax purposes. NYS adds back in prior taxable gifts decedent made within 3 years of decedent’s date of death, but will not add back gifts made prior to April 1, 2019 or gifts made on or after January 1, 2026 (unless the law changes again).
Even if a prior taxable gift is added back in to compute estate tax, gifting often has beneficial income and estate tax effects. The estate planning benefits of gifting should not be overlooked.
The information provided in this Primer only relates to planning for US citizens. The tax rules for non-citizens and for non-citizen spouses are very different.
A gift is a transfer during lifetime for no consideration. The giver of a gift is called a donor. The recipient of a gift is called a donee.
Not all gifts are taxable. The IRC creates an annual gift tax exclusion in an amount which changes from year to year.
A person can make an unlimited number of gifts per year to anyone (friends, relatives, strangers), but some gifts have tax consequences. The general rule is that gifts equal to or less than the annual exclusion amount are not deemed to be taxable gifts. A donor can gift more than the annual exclusion amount, but gifts in excess of the federal exclusion amount should be reported to the IRS by filing form 709 and the excess amount above the annual exclusion amount will reduce the federal lifetime federal exclusion.
The annual gift tax exclusion amount is $17,000 per donor per donee per year for gifts made in 2023, increased from $16,000 in 2022.
There are exceptions to the general rule, that is, some gifts of any amount are not taxable. One exception is gifts for tuition, but to qualify for the unlimited exclusion, the gift must be made directly to the educational institution and must be allocated towards the donee’s tuition only. A second exception is gifts for medical-related expenses, but to qualify for the unlimited exclusion, the gift must be made directly to the medical provider and must be allocated for the donee’s unreimbursed medical expenses. Medical-related gifts may also be to pay donee’s health insurance premiums and/or donee’s long-term care insurance premiums, and these gifts must be made directly to the donee’s insurance providers.
The exclusion amount. The good news is that estate tax is not computed on the entire value of a decedent’s estate. When computing the estate tax, every taxpayer’s estate is entitled to exclude a certain amount – called an exclusion – which reduces the size of decedent’s taxable estate. The federal exclusion amount is different from the NYS exclusion amount. In addition to the exclusion amounts, an estate might also qualify for a marital deduction or a charitable deduction.
Some people mistakenly believe that the largest amount they can give is $10,000 per year, but they are thinking that the annual exclusion amount is the maximum gifting amount (which is not correct), and the exclusion amount hasn’t been $10,000 since 2001.
The federal estate tax exclusion.
The exclusion amount increased to $12,920,000 for decedents who die in 2023. Note however, that for decedents dying on or after January 1, 2026, the exclusion reverts to $5,000,000 (indexed for inflation) which will probably compute to approximately $6,000,000, unless Congress acts to change the exclusion amount. Assuming that a person has not made any taxable gifts during his or her lifetime which would reduce the exclusion amount, then a decedent’s estate would be eligible for the entire federal exclusion amount.
If a married couple is planning, when the second spouse dies, the second-dier’s estate may be able to use the survivor’s own exclusion amount plus any unused portion of the first-dier’s exclusion amount. This mechanism to carry over the first-dier’s unused exclusion amount is called “portability”. If both spouses die between 2023 and 2025, they could have a combined exclusion amount of $25,840,000. If one spouse dies between 2023 and 2025, and the other spouse dies after January 1, 2026, then they could have a combined exclusion amount of approximately $18,920,000 (unless Congress changes the exclusion amount). To elect portability, it is necessary to file an estate tax return in the first-dier’s estate. Again, even if no tax is due, the return must be filed.
If the taxable estate exceeds the exclusion amount, the excess will be taxed at a flat 40% rate.
The New York State estate tax exclusion.
The exclusion amount increased to $6,580,000 for decedents who die in 2023. If the decedent’s taxable estate is below the exclusion amount, then there is no NYS estate tax. NYS does not recognize portability to capture the unused exclusion amount of the first-spouse to die. When computing a decedent’s taxable estate, NYS does include some prior taxable gifts, but NYS does not include real or tangible property located outside of NYS.
If the taxable estate is below the exclusion amount, then there is no NYS estate tax. NYS has added a “phase out” amount. If the taxable estate is between the exclusion amount and in the phase out amount (referred to by some as a “black hole”), then the estate tax could be higher than the amount by which the estate is larger than the exclusion amount. The phase out amount ends when the taxable estate is approximately 110% of the exclusion amount.
Here are some examples of the NYS estate tax in the phase out amount. Again, these are based on NYS estate tax law if Decedent dies on or after January 1,
2023, but prior to January 1, 2024.
If Decedent dies with a taxable estate of $6,580,000 – which is the Exclusion amount – there is no NYS estate tax. The beneficiaries inherit $6,580,000.
If Decedent dies with a taxable estate of $6,600,000: The value of decedent’s taxable estate exceeds the Exclusion Amount by $20,000 (“the excess”). The estate tax is $53,760, but the excess was only $20,000. The beneficiaries inherit $6,546,240, less than the Exclusion Amount. If Decedent dies with a taxable estate of $6,909,000: The value of decedent’s taxable estate exceeds the Exclusion Amount by $329,000 (“the excess”). The estate tax is $626,352, but the excess is $329,000. The beneficiaires inherit $6,282,648, again, less than the Exclusion Amount.
If Decedent dies with a taxable estate of $7,000,000: The value of decedent’s taxable estate exceeds the Exclusion Amount by $420,000 (“the excess”). The estate tax is $638,000, but the excess is $420,000. The beneficiaires inherit $6,362,000, again, less than the Exclusion Amount.
In each of these examples, the NYS estate tax is more than 100% of the excess and the beneficiaries inherit less than the Exclusion Amount. This result flips when the Decedent dies with a taxable estate of $7,251,389. The excess is $671,389 and the estate tax is $671,389. For people dying in 2023, if the taxable estate exceeds the Exclusion Amount, then the entire taxable estate is taxed (starting at dollar one). Therefore, there is a distinct penalty if a decedent’s taxable estate is between $6,580,000 and $7,251,389. There are however some ways to reduce the tax impact if a taxable estate falls within the black hole. We can discuss options if appropriate for you.
THE MARITAL DEDUCTION.
In addition to the exclusion amounts, neither the IRS nor NYS impose any gift or estate tax consequence when married couples (who are both US citizens) pass property between them during their lifetimes and at the death of the first spouse, provided the assets pass to the surviving spouse. This is called the marital deduction which reduces the taxable estate dollar-for-dollar to the extent assets pass to the surviving spouse outright. In some cases the deduction is available.
ATTORNEY ADVERTISING: The information provided in this Primer is general information. It is not intended to be specific legal advice or to be followed without individualized, professional guidance and assistance. Please speak with a tax professional and/or estate planning professional before acting upon any of this information.
THE CHARITABLE DEDUCTION.
In addition to the exclusion amounts and the marital deduction, both the IRS and NYS permit each decedent’s estate to take an estate tax charitable deduction which reduces the taxable estate dollar-for-dollar to the extent of the decedent’s bequests to IRC-approved charities.
STEP-UP IN BASIS RULES.
Unrelated to the exclusions and deductions, but also important for estate and income tax planning, is an asset’s cost basis. Simplistically you can think of cost basis as the asset’s original value.
The value of decedent’s property is stepped-up to its value on the date of decedent’s death. This is called a step-up in basis. The date-of-death value becomes the new cost basis for the person inheriting the property. Basis will have an impact on the amount of gains tax (income tax) due when the property is sold.
The donee of the gift treats the gifted property at its cost basis (donor’s purchase price) when determining the amount of gain or loss if the donee sells the gifted property. But, the inheritor of property treats the inherited property at its stepped-up basis when determining the amount of gain or loss if the inheritor sells the inherited property. Note that property which is gifted away by donor during his or her lifetime does not get a step up to the date-of-gift value. It is possible though for decedent to make a gift during donor’s lifetime and retain some sort of interest for his or her lifetime (as defined by law) such as a life estate. If the donor retained (the correct) interest, then the value of the property is included in donor/decedent’s estate. Yes, this increases the value of decedent’s estate and an estate tax might be owing, but it is possible that no estate tax will be owing or that the estate tax might be lower
than the income tax which would be imposed.
It is always necessary to weigh the impact of estate tax vs income tax when contemplating gifting.