Advice to NYers hit by new estate tax glitch: 'Get out before you die'

Changes have some considering switching states - but be warned that that takes careful planning

By Darla Mercado

May 19, 2014 @ 12:01 am EST

Suddenly, for the wealthiest clients in the Empire State, leaving New York to avoid a new wrinkle in state estate taxes doesn't seem like such a bad idea.

Tax geeks may remember a story ran from March, detailing a possible overhaul of New York state's estate tax rules as a result of the state's budget. The new reality is here, and that estate tax tweak is here to stay.

For those who missed the memo, on April 1 the Empire State raised its estate tax exemption from $1 million to $2.062 million per person. The state estate tax exemption will rise each year until Jan. 1, 2019, when it will be on par with the inflation-adjusted federal estate tax exemption that's effective at that point.

Here's the problem: The exemption is phased out completely for those with a New York taxable estate whose value exceeds the New York estate exemption by 5%. This means the whole estate is subject to state estate taxes. For example, if a client dies between April 1, 2014 and March 31, 2015, there are no state estate taxes if the estate falls under the $2.062 million exemption limit. But if the estate is $2.165 million - 5% more than the $2.062 million exemption - then estate taxes are due on the entirety of the estate.

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Those tax levels are fairly steep. New York's estate tax rates have a top marginal rate of 16% for estates that are over $10.04 million.

Hank Leibowitz, a partner in Proskauer Rose's personal planning department, notes that there was a “cliff effect” back when the exemption was $1 million. Back then, estates over $1.093 million were subject to New York estate tax. Rather, this new law creates an extension of the previous cliff. “For the wealthy, it's no worse than the old law,” Mr. Leibowitz said. “It's always existed, at least for the last 15 years, but now it's calculated in a different way.”

To complicate things further, the law creates a three-year lookback period for federal taxable gifts that are made during the five-year period between April 1, 2014 and Jan. 1, 2019. Estates that are subject to that three-year lookback period are going to be included in the New York taxable estate and will face state estate taxes.

Go here for a handy chart depicting the estate tax exemption amounts.

Back in March, advisers and accountants were merely warning clients to be aware of upcoming potential change. Attorneys had come across experts who advised clients to make gifts prior to April 1 in order to get those assets out of their estate.

Primarily, it's the wealthiest of the wealthy who have something to worry about. “For the moderate to low-level of high net worth, there's less of a tax burden if you make it through the next few years - those who are staying under the federal exemption amount,” said Kate Cassidy, an advanced markets specialist with Barnum Financial Group's wealth strategies division.

“It's the people who exceed that number who have a more serious problem now,” she added.

Indeed, someone worth tens of millions would face not just the federal estate tax, but also the New York estate tax.

As far as mitigating the effects of the “cliff”, people with estates whose value is just over the New York estate exemption can add a formula clause that will donate the difference to charity at death, said Mr. Leibowitz. “If you can come up with a formula clause in your will - give to charity this amount that will lower your exemption and cause less taxes to be paid - then do so,” he said.

But others are willing to take more dramatic steps. For instance, Ted Sarenski, a CPA, personal financial specialist and CEO of Blue Ocean Strategic Capital, has encountered clients who are entertaining the idea of skipping town.

“For the wealthier clients, it's still 'Get out of New York before you die,'” he said.

Recently, Mr. Sarenski spoke with a group of physicians who are earning a sizable amount of money and socking away cash in their pension plans. Those physicians are now considering relocating to locations like Texas, Florida and Washington - jurisdictions that have no state income or estate taxes.

Moving is particularly appealing for those who want to retire. You collect your retirement income free of taxes. And when you pass away, your estate won't be subject to estate taxes.

Be warned, however. Pulling up roots in the Empire State is easier said than done. Mr. Sarenski noted that clients need to establish residence elsewhere by staying put in one place for more than 180 days. They have to change their address, driver's license and affiliations with religious organizations, plus other changes to show that they truly do live in the new place.

Those who own a business in New York will have a hard time fending off the state's attempt to collect its taxes. Business owners may have to consider selling their New York-based business and then move in order to show they've broken away from the Empire State.

“It's almost impossible to work here and establish yourself elsewhere,” said Mr. Sarenski. “New York will say that you're getting paid by a New York business, so you are a New York resident for tax purposes.”

“You really have to break ties,” he added.

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