Over the course of my career, I’ve found that there are really two parts to being an estate planning attorney. The first part is to actually create and execute a plan for my clients. The plan usually consists of a Will or a trust, along with a Power of Attorney, Health Care Proxy and Living Will. This is to ensure that whatever is in your estate gets to pass to who you want, when you want and who gets to control this passing of assets.
The second part is what’s commonly referred to as asset protection. This simply means making sure that your estate plan actually has assets to pass. Otherwise it’s an exercise in futility.
But who are we protecting our assets from? There are two main entities that are trying to greatly reduce our estate. The first is the government in the form of taxes. The other is the cost of long term care. The latter, in New York, can cost anywhere from $6,000 per month for home care to $15,000 per month for nursing care.
This month I’m going to concentrate on discussing (and ways of reducing) various taxes and next month I’ll discuss how to protect at least some of our assets from the high cost of care.
The potentially biggest type of tax on our assets is estate tax. There is both federal and New York estate tax. With the federal tax, it’s actually what they call a uniform gift and estate tax and currently has a $5,340,000 exemption. The exemption amount goes up every year as it is indexed for inflation. This means that there is no tax for the first $5 million, whether you give it away over the course of your lifetime or upon your death. But the tax cranks to 40% very quickly after that. There is also this thing that has been dubbed “portability” between spouses. Simply put, whatever the first spouse hasn’t used of his or her exemption can be “ported” over to the surviving spouse. So the surviving spouse could therefore, potentially have up to a $10 million exemption.
Prior to April 1, 2014, New York had a $1 million dollar exemption before any estate tax kicked in. As I’m sure many of you have heard, Governor Cuomo has changed all of that. Now, if you died after that date, your exemption doubled to $2,062,500 and an additional $1,062,500 is being added each year until 2017 when it gets to $5,025,000. After that New York should then match the federal exemption. This is great news if you are only “upper middle class” as you should now be exempt.
But, like so many other areas in New York, this is another buyer beware. The problem comes in when you exceed the exemption. After that you rapidly lose the exemption. And if you have over 105% of the exempted amount, you lose the entire exemption with a maximum tax rate of 16%. As an example, if you die this year with $2,062,500 you pay no New York estate tax. But if you die with $2,100,000, you will now pay over $49,000 in taxes. Under the old tax laws you would only pay about $18,000. As the exemption grows over the next few years, that loss of the exemption becomes even more Draconian.
So, how can we reduce this tax? Remember portability with the federal tax? Not so with New York estate tax. So, if you have a spouse, it becomes even more imperative to set up some type of credit shelter trust within your Wills or trusts. This will allow you to take advantage of both spouses’ exemptions. I prefer using disclaimers as this gives the surviving spouse the most flexibility.
Another way to reduce the taxes is by the use of gifting. Prior to April 2014, New York had no gift tax. So if you gave away assets prior to your death, you only had to worry about the federal estate tax. Technically New York still doesn’t. But now they have what they call an “add-back” provision. Between April 1, 2014 and January 1, 2019, any asset that you’ve gifted within three years of your death will be added back into your estate for tax purposes.
The options here are to either try to discount the gift or give the gift to charity. There are various ways of discounting a gift, depending on the type of asset. If you give away a $500,000 asset (say into a trust for your kids), there are ways of discounting the gift and making it look like a $200,000 gift for tax purposes. Gifting to charity may actually be less expensive than the tax. For example, as noted above, if you have $2,100,000 and die this year your estate will pay over $49,000 in taxes. But if you gift $40,000 to charity, you now are under the $2,062,500 and will have no estate tax. That’s a net savings of over $9,000.
My only advice with methods such as above is to be very careful when doing things like this. You don’t want to trade one type of tax for another. You may have just gotten rid of a 16% estate tax and now have a 20% capital gains tax. Or you may have triggered an income taxable event and all the gift may now be additional income to you or your children. I suggest that you speak to a professional when trying to protect your assets while setting up your estate plan.