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Estate Tax Misconception

Many believe estate taxes are unavoidable upon death, but this isn't usually the case. In 2024, New York State has an exemption of up to $6,940,000, while the federal government's exemption is $13,610,000. Estates valued below these thresholds are not subject to estate tax.
March 7, 2024
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Many believe estate taxes are unavoidable upon death, but this isn’t usually the case. In 2024, New York State has an exemption of up to $6,940,000, while the federal government’s exemption is $13,610,000. Estates valued below these thresholds are not subject to estate tax.

Often, clients are anxious to make annual gifts with the mistaken belief that their heirs will pay a tax at their death if they don’t. First, any amount given to a spouse is tax free – either during life or at death. Second, any gift amount under the federal threshold is also tax free. This is because the federal estate tax exemption is a combined lifetime gift and “death tax,” called the unified tax credit. Nevertheless, for estates over the exemption amounts, either the New York or federal, additional planning is necessary.

How to Calculate Your Taxable Estate

Before we consider estate tax, let’s be clear about what comprises your taxable estate. All assets that you own at your death are counted toward your taxable estate, including:

  • IRA’s
  • Annuities
  • Bank accounts
  • Real estate
  • Some jointly held accounts
  • Life insurance owned by you or for which you have the power to change the beneficiary

New York Taxable Estate

In New York, estates valued below this threshold amount ($6.94 million) will not incur any tax. For any estate that is over the threshold by no more than 5%, the estate is only taxed on the overage. However, for any estate valued at more than 5% over the threshold amount, ($7.287 million) the entire estate is taxed, and there is no exemption available.

To illustrate:

  • For decedents dying in 2024, consider an estate valued at $6.0 million. This is under the threshold amount and no tax is due.
  • For an estate valued at $7.1 million, which is $160,000 over the threshold amount, there will be a tax for the $160,000 overage, to wit: the taxable estate is $397,444. This is because $7.1 million is not more than 5% of exemptible amount.
  • For an estate valued at $7.3 million ($13,000 over the 5%), the value of the estate is above the threshold by more than 5% and the estate tax rises sharply, and your taxable estate is $678,000. This commonly known as the “cliff.”

Avoiding New York Estate Tax

Estate tax planning for New York residents is often focused on keeping assets under this cliff. There are several techniques that can be used to avoid the cliff:

  1. Annual Gifting: Everyone can make tax free annual gifts in the sum of $18,000 per person in 2024. Annual gifts can be utilized during lifetime to bring the value of an estate under the cliff, and maybe even under the threshold.
  2. Disclaimer to Charity: A Disclaimer provision can be placed in a Will or Trust in case there is a taxable estate to reduce the taxable estate with gifts to charities. This is a savings provision that provides for a charity to receive any amounts disclaimed by the beneficiaries. Where the decedent dies and the estate is over the threshold, the beneficiaries have up to 9 months after the decedent’s death to file a qualified disclaimer, renouncing any such overage and having the disclaimed amount pass to the named charity. The beneficiaries can disclaim any amount necessary to bring the estate under the threshold and reduce the estate tax to zero.
  3. Large Gifts 3 Years Before Death: Another technique is to make a large gift more than 3 years prior to death. Since New York State does not have a gift tax, only an estate tax, this works quite well. Clients often limit annual gifts to the annual exclusion amount, currently $18,000, because they mistakenly believe they would owe taxes if they gifted more. However, neither the donor nor donee pay tax on a gift over $18,000 – the donor will only owe gift tax if they exceed the federal exemption of $13,610,000 over their lifetime. However, they need to make sure any larger gifts do not get “clawed back” into the estate.

Take the example of an individual with $8.94 million in assets, which is $2.0 million over then threshold. If they transfer the $2.0 million to their heirs directly or to a properly drawn trust for heirs, and survives the gift by three years, then they still have a full New York State exemption, and the lifetime gift is essentially transferred estate tax free. If they die before the three years, the gift would come back into the estate for the purposes of calculating the estate tax.

Federal Taxable Estate

Avoiding federal estate tax

The above large gifting technique would not work for federal estate tax purposes. This is because any lifetime gift over the annual gift amount reduces the lifetime applicable credit (the federal exemption). The applicable credit amount is currently $13.61 million. This amount is indexed for inflation and will increase again in 2025. However, the credit amount will be reduced when the law “sunsets” in 2026. Most experts believe the new federal exemption will be somewhere between $6.5 and $7.0 million as of January 1, 2026. The federal estate tax imposed on estates over the threshold is a hefty 40%.

For clients with estates over that amount, it is necessary to plan early and reduce their taxable estates before the federal applicable credit is reduced. This is usually done with sophisticated trust planning which moves assets “over the tax fence” and uses the credit before they lose it. It is important to contact an experienced estate planning attorney to discuss how to take advantage of this historically high federal exemption before it disappears.