Oct 14, 2024 - Get to Know Some Estate Tax Essentials
What is the Estate Tax Cliff?
Death and Taxes are famously the only guarantees in life; estate and inheritance taxes uniquely combine these items. Many people are aware there is a federal estate tax; however, many states also assess an estate tax that can create a significant tax liability. This risk can be mitigated with proper planning.
The Tax Cut and Jobs Act passed under former President Donald Trump ushered in many changes to the tax code, including an “exemption amount” increase that is excluded from determining federal estate tax owed. This increased exemption reduced the likelihood many people would be subject to the Federal Estate Tax. Unfortunately, many people are unaware of the potential for a State Estate tax liability. Further, certain states employ a “cliff” approach to assessing taxable estates, which can cause substantial challenges if not addressed. It may sound daunting, but we believe it can be managed with proper planning.
What exactly is the estate tax cliff, and how might it affect you? If this aspect is overlooked, the issue may cause significant financial stress for your heirs if left unchecked.
Understanding Estate Tax: Federal vs. State
When people discuss estate tax, they may be focused on the Federal Government’s rules on transferring property and possessions when one passes away. Inheritance tax, while similar, is assessed differently. In the case of estate tax, the deceased person’s estate is responsible for the tax, not the person inheriting assets. Certain states also have estate and inheritance tax systems.
Many may overlook these state-level liabilities because they focus only on federal estate taxes.
We believe there are two crucial factors when discussing estate taxes: the exemption amount and portability.
- Exemption Amount: This refers to how much of the estate is exempt from being taxed. For example, if there’s a $5 million exemption and the estate is worth $10 million, the first $5 million is tax-free, while the remaining $5 million is subject to taxation. Each individual has their own exemption amount.
- Portability: This is the ability to transfer an individual’s “unused” exemption to their spouse, increasing the exemption for married couples. It’s important to note that portability exists only at the federal level—many states do not offer it.
The Bush administration implemented major changes to the calculations of the estate tax in the 2001 Tax Cut Act. Before the tax cuts, the federal estate tax exemption was only $675,000, and there was no portability between spouses. In addition, the top marginal estate tax rate was 55%. Since then, these numbers have changed dramatically.
The New York estate tax exemption is much lower than the Federal system allows. The New York approach to estate tax liability contains an element that can result in a large tax liability even if a taxpayer’s net worth barely exceeds the exemption amount. This is the impact of the so-called tax “cliff.”
The Estate Tax Cliff in New York
Let’s talk about the feared estate tax cliff, particularly if you’re a New York resident. Many people might think that spending winters in Florida means they’re safe from New York taxes. However, New York has a very strict approach when determining residency for tax purposes.
We’ve seen clients in lengthy disputes with the state over this, so it’s important to clarify a few terms.
- Resident: For income tax purposes, you’re considered a New York resident if your permanent home (domicile) is in New York or if you maintain a residence there for more than 11 months and spend at least 184 days in the state during the tax year.
- Domicile: This is your permanent home. It is the place you return to after leaving for vacation, business engagements, military requirements, or school. You can only have one domicile, and you remain a New York resident until you establish a new domicile elsewhere by proving you have vacated New York.
- Permanent Place of Abode: This refers to a residence you maintain year-round, regardless of whether you own it. Even if your spouse owns or leases a residence for several years, it can qualify as a permanent place of abode.
New York’s estate tax system operates differently from the federal system, particularly with its so-called “cliff.” When the 2017 Tax Cuts and Jobs Act (TCJA) was passed, New York State removed the connection to the federal exemption amount. In 2024, New York’s estate tax exemption was $6.94 million—roughly half of the federal exemption. Moreover, New York doesn’t allow for portability, effectively cutting the estate tax exemption by 75% compared to federal rules.
In our opinion, the most important difference, though, lies in how New York calculates estate tax. In the federal system, only the value of assets above the exemption is taxed. For example, if a single person’s estate is worth $20 million, and the federal exemption is $13.61 million, only the $6.39 million excess is taxed. However, New York taxes the entire estate if the assets exceed 105% of the exemption threshold. In 2024, this exemption was $6.94 million. If an estate surpasses this amount, New York starts phasing in the estate tax, with rates reaching up to 16% for estates greater than $10.1 million.
Planning is Key
Facing a large estate tax liability can be alarming, but several strategies exist to help manage and reduce this burden. Solutions range from family-focused to charitable approaches that can help minimize or possibly eliminate estate tax. We think the key is to start planning early. The sooner you act, the more effective these strategies can be.
Disclosure
The content herein is for information purposes only and developed from sources believed to be providing accurate information. We make no representations as to its accuracy or completeness. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for services or the purchase or sale of any security.
Opinions expressed herein are solely those of the individual and may not be representative of SAX Wealth Advisors. Advisory services are offered by SAX Wealth Advisors, an SEC[1] Registered Investment Advisor.
[1] Registration does not imply a level of skill or expertise
About the Author
William (Bill) Connor, CFA, CFP®
Bill is a Partner and Wealth Advisor at SAX Wealth Advisors with over two decades of investment management and financial planning experience. Bill has a diversified skill set that focuses on risk management, investment analysis, and portfolio management. He works to develop comprehensive goal-based financial plans, including retirement, estate, tax, and concentrated equity planning. Bill has experience with private alternative investments, including hedge funds, private equity and real estate. Bill works in SAX’s New York office, serving the needs of domestic and international families.
Bill can be reached at wconnor@saxwa.com.