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An Overview of the Federal Estate Tax and the New York Estate Tax and the Use of Disclaimer Credit Shelter Trusts

July 7, 2011 • Posted By Moira E. Casey • Complex Litigation

Under the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010”, the federal estate exemption is $5 million for decedents passing away in 2011 and 2012.  Amounts in excess of $5 million will be taxed at a rate of 35%.  Estates of individuals who pass away in 2011 and 2012 will be entitled to a full step-up in basis, so no capital gains taxes will be owed on inherited assets.  This eliminates 2010’s carry-over basis regime and the accounting nightmare of calculating basis on assets purchased decades ago.

New York State residents must still deal with and plan for tax on estates in excess of $1 million.    In addition, the $5 million federal exemption is temporary.  It is currently scheduled to sunset on December 31, 2012.  As a result, the estate, gift and generation skipping transfer tax exemptions will revert to $1 million and the tax rate will revert to 55%.

 Couples with assets in excess of $1 million should consider implementing credit shelter trusts as part of their estate planning.  This will prevent loss of the New York State exemption for the first spouse to die.  Just because each spouse has a $1 million credit does not mean that the credits automatically combine to shelter the entire estate up to $2 million.  There is no portability for purposes of New York estate tax.  Everyone, at all wealth levels, should at least take advantage of the $1 million New York exclusion.

 If, for example, a couple has a combined estate of $1.5 million and they have simple wills leaving everything to the surviving spouse and the remainder to the children, a bad tax consequence will ensue.  This is because the unlimited marital deduction prevents the imposition of tax on transfers between spouses.  Without any tax liability on the first death, there is no opportunity to utilize the first credit.  It, in essence, dies with the first decedent.  Upon the death of the second spouse, her estate can only apply her $1 million New York State credit.  The result in this example is that $500,000 will be subject to New York estate tax.  This is especially important now that the New York estate tax is becoming more onerous as the marginal New York State estate tax rate increases to 16%.

 Estates that we have handled in the past where a New York State resident died with a taxable estate of $2million, $99,600 in New York estate taxes was paid.  A taxable estate of $3.5 million incurred $229,200 in New York estate taxes.  These are examples only and depend on the New York tax rate staying the same.  An estate worth $1,500,000 incurred $64,400 of New York estate taxes. 

 In order to avoid this result, the wills or revocable trusts should contain credit shelter trusts which can operate as follows:  husband and wife leave everything to each other with the exceptions of whatever amount the surviving spouse chooses to disclaim into the credit shelter trust of the first decedent.  The survivor has nine months to execute the disclaimer.

There are several different ways to fund the credit shelter trust but we believe that the “disclaimer” method above is the most flexible.  The family has the luxury of waiting until the first death to make a good decision based upon the survivor’s age, health, expenses, as well as the estate tax laws at that future point in time.

Further, the usual benefits of a trust to provide investment management, beneficiary protection against creditors and insulation from inheritance by others, divorcing spouses, claims by right of election and asset protection which would not exist if the assets were in the direct name of the spouse, are among these.  If the surviving spouse has a judgment against him or her, the assets in the trust will generally be protected from creditors.

 Flexibility continues to be important in drafting documents where there is a surviving spouse.  The use of disclaimers should be considered in most situations.

French & Casey, LLP stands ready to advise our clients based on the latest tax laws and interpretations of New York law in estate planning, probate and estate litigation.  Please feel free to call us if you need to create an estate plan or update an existing plan.