Demystifying Estate Taxes: Federal and New York State Exemptions and Effective Estate Planning Techniques

Planning for the future is essential, and that includes ensuring your loved ones are taken care of even after you’re gone. However, the prospect of estate taxes can be intimidating. The good news is that both the federal government and the state of New York offer exemptions to reduce or eliminate potential estate taxes. In this article, we’ll break down the basics of these exemptions and explore some practical estate planning techniques to help you navigate this complex landscape.

Federal Estate Tax Exemption:

Let’s start with the federal estate tax, which is a tax levied on the transfer of wealth after someone’s passing. Currently, the federal estate tax exemption stands at $12.92 million per individual (as of 2023). This means that if the value of your estate falls below this threshold, no federal estate tax will be imposed. But if the value of your estate is above the threshold, the excess is taxed at an alarming 40% or so rate! For married couples, the exemption is portable, allowing the surviving spouse to utilize any unused portion of their deceased partner’s exemption.

To illustrate, let’s consider an example. John and Lisa are a married couple with a combined estate valued at $20 million. John passes away first. At the time of his death, the federal estate tax exemption is $12.90 million. Due to the spousal marital deduction, when John passes away, his entire estate can pass to Lisa without incurring any federal estate tax. This is because the marital deduction allows for unlimited transfers of assets between spouses without triggering estate tax.

Now, let’s fast forward to when Lisa eventually passes away. At the time of her death, the federal estate tax exemption has increased to $14.06 million due to inflation adjustments. Lisa’s estate, including the assets inherited from John, is valued at $15 million.

In this scenario, Lisa can take advantage of portability. Portability allows the surviving spouse to utilize any unused portion of their deceased spouse’s federal estate tax exemption. Since John’s estate did not fully utilize his exemption, there is an unused exemption amount that can be transferred to Lisa.

Let’s say John’s estate utilized $5 million of his exemption, leaving $7.90 million unused. Lisa can claim this unused exemption and combine it with her own exemption.

By combining her own exemption of $14.06 million with the $7.90 million unused exemption from John, Lisa can effectively shield a total of $21.96 million from federal estate tax. As a result, Lisa’s estate of $15 million remains well below the combined exemption, and no federal estate tax will be imposed.

In this example, by utilizing the spousal marital deduction and portability, John and Lisa maximize their federal estate tax exemptions, ensuring that their estate remains protected from federal estate tax liabilities.

Remember, estate planning can be complex, and the specific details of each individual’s situation may vary. It’s crucial to consult with an estate planning attorney or financial advisor to assess your unique circumstances, stay up to date with the latest tax regulations, and develop a comprehensive estate plan that aligns with your goals and objectives.

New York State Estate Tax Exemption:

In addition to federal estate taxes, New York state imposes its own estate tax with different rules and thresholds. New York has what is known as a “cliff” system, meaning that if your estate exceeds the exemption threshold even by a dollar, the entire estate becomes subject to tax. As of 2023, the New York state estate tax exemption is $6.58 million.

Let’s look at an example to understand how this works. Suppose Sarah’s estate is valued at $7.5 million. Since it exceeds the New York state exemption threshold, the entire estate will be subject to tax, not just the portion exceeding the threshold. Therefore, it’s important to be mindful of the state-specific exemption when planning your estate.

Estate Planning Techniques to Reduce or Eliminate Taxes:

Now that we understand the exemptions, let’s explore some estate planning techniques that can help reduce or eliminate potential estate taxes:

Lifetime Gifts: Gifting assets to your loved ones during your lifetime can be an effective way to reduce the overall value of your estate. The annual gift tax exclusion allows you to gift up to $16,000 per recipient (as of 2023) without incurring gift tax or reducing your lifetime exemption. By strategically gifting assets, you can lower the value of your taxable estate.

For instance, if George has three children, he can gift $16,000 each to them every year. Over time, this can significantly reduce the overall value of his estate, bringing it below the exemption threshold.

Irrevocable Life Insurance Trust (ILIT): Life insurance policies are commonly included in estate plans to provide for beneficiaries. However, the death benefit from a life insurance policy is still included in your taxable estate. By establishing an ILIT and transferring ownership of the policy to the trust, you effectively remove the proceeds from your estate. As a result, the value of your estate is reduced, potentially keeping it within the exemption threshold.
Charitable Bequests: Leaving a portion of your estate to a charitable organization not only supports a cause you believe in but can also reduce your estate tax liability. Charitable bequests are deductible from your taxable estate, effectively lowering the overall value subject to estate taxes. This can be accomplished through a specific dollar amount, a percentage of your estate, or even a remainder interest.
Shelter or Bypass Trust: Another effective estate planning technique to reduce or eliminate potential estate taxes is the use of shelter or bypass trusts. These trusts are designed to maximize the use of both federal and state exemptions while still providing for your loved ones. With a shelter or bypass trust, you allocate the amount exceeding the exemption threshold to the trust, effectively “sheltering” it from estate taxes. The assets in the trust can continue to grow and benefit your beneficiaries without being subject to estate taxes.

By utilizing a combination of these estate planning techniques, you can optimize your estate plan, minimize estate taxes, and ensure the smooth transfer of your assets to your loved ones. However, keep in mind that estate planning is a complex area, and the effectiveness of these techniques may depend on various factors, including changes in tax laws. It’s crucial to consult with a knowledgeable estate planning attorney or financial advisor to tailor a strategy that aligns with your specific goals and circumstances.

Remember, with careful planning, you can protect your wealth and ensure a smooth transition for your loved ones. The Law Offices of Irina Yadgarova PLLC is equipped to give you professional guidance and ensure your estate plan is structured properly, remaining up to date with the latest tax regulations and exemptions.