Today, many Americans are understandably concerned with the legacy they will leave their loved ones when they pass away. For people with businesses or for those who have accumulated a lot of wealth, the estate or death tax can be a significant burden. However, as of 2022, the federal estate tax exemption has increased to $12.06 million. If your estate is valued less than the 2022 tax exemption, this means that your estate would not be subject to estate tax.
Estate tax laws and your available options to avoid them can vary based on your state of residence. To reduce any tax consequences you may have and to ensure that you are abiding by the law, it is important to consult with an experienced Long Island estate planning attorney.
What Is the Estate or Death Tax? How Is It Different From the Inheritance Tax?
The IRS defines estate tax as a tax on your right to transfer property at your death. The value of the tax depends on the total fair market value of your assets at the time of death, not necessarily how much was paid to acquire those assets.
An inheritance tax is collected from the person who is inheriting the assets. The heir would have to pay a specified amount depending on the value of the assets they inherited. The inheritance tax differs from the estate tax in that the tax is collected after the estate has been divided amongst the heirs. An estate tax is calculated upon the collective value of the assets in the estate.
The state of New York does not impose the collection of inheritance tax. However, the state still has an estate tax on estates with a valuation of above $6.11 million (2022). You are considered exempt from the estate tax if the value of your assets is less than that amount.
Estate Tax Laws in New York
Estate tax rates under New York law range from 3.06 percent to 16 percent, based on the value of the estate. The federal tax rates range from 18 to 40 percent, as of 2021, based on the taxable estate value.
The New York estate tax laws are different from the federal estate tax law and those of other states in many ways. One of the most important distinctions in New York’s estate law is the “estate cliff”.
The New York Estate Tax Cliff
Federal estate tax laws and laws of most states that impose estate taxes only allow estates to be subject to taxation if they exceed a certain amount. The federal estate tax law, as well as the laws of most states that impose it, taxes only the amount above the triggering price. For example, if the state does not tax estates exceeding $1.5 million, then for an estate worth $2 million, the state will tax $500,000 or the portion above the triggering limit.
New York law also allows estates exceeding 105 percent of the exemption limit to estate taxes to “fall off the Cliff.” This means that the entire estate value is subjected to tax, not only the amount above the exemption limit. In certain cases, this could result in a tax bill that taxes more than 100 percent of the estate’s excess value beyond the exemption limit. In 2021, the exemption amount is $5.93 Million. This is adjusted annually to reflect inflation.
How can you avoid the estate tax?
The prospect of paying taxes on your estate and potentially diminishing the value your heirs will receive is not exciting. Still, some strategies and options you can explore would allow you to reduce the amount of estate tax you will have to pay, or completely avoid paying the estate tax.
Gift assets to your loved ones
Gifting your assets is a good way to reduce the value of your estate to below the exemption threshold. In New York, you can gift up to $16,000 per individual annually. Any more than that and your gift would be subject to taxes. However, there is no limit to how many people you can gift assets to.
Donate to charity
It’s possible to avoid estate taxes by donating assets to a charity. Charitable Lead Trusts (CLTs) and Charitable Remainder Trusts (CRTs) are two ways.
A CLT allows you to put assets into a trust, some of which would be donated to a tax-exempt charity. Through this, you can lower the value of your estate and also receive a tax break due to your charitable donation. After a predetermined time, or at the event of your passing, your beneficiaries can receive the rest of the assets left in the trust.
A CRT, on the other hand, is an irrevocable trust that can contain stocks or assets that appreciate in value. You can continue to collect the earnings from the assets in a CRT. When you pass away, any investment income goes to charity. This allows you to reduce your estate taxes while also receiving a tax deduction.
Create an irrevocable living trust for life insurance
Including a life insurance policy as part of your estate plan is a good idea to ensure that your loved ones will not be in a difficult financial position when you pass away. However, life insurance proceeds become part of your taxable estate at the time of your death.
An irrevocable living trust can help you avoid taxes on your life insurance payout. By putting your life insurance into a trust, any death benefits you get from the payout will not be considered part of your estate.
Early planning is important. Some states impose a condition that dictates that life insurance transfers are still part of an individual’s taxable estate if not completed within a given period.
Set up a Family Limited Partnership
A Family Limited Partnership or an FLP is a great way to protect your assets from creditors while still being able to manage your investments. An FLP is a kind of trust that allows you to pass assets to your ‘Limited Partners’. In an FLP, it is usually the parents who would serve as the General Partners. They would be the ones involved in managing the affairs of the trust and have unlimited liability when it comes to conducting the trust’s business.
The Limited Partners are typically the children or the would-be beneficiaries of the trust. They have limited liability in the FLP and do not have a stake in the management of the trust.
Assets are passed on through the transfer of partnership shares. Through this method, your ‘limited partners’ would be able to receive a tax break on gift taxes, income taxes, and estate taxes provided the transfers are made below the state’s tax exemption threshold.
Establish a Qualified Personal Residence Trust
For most Americans, the largest part of their estate comes from real property, meaning assets like houses or land titles. Given that these kinds of assets are likely to appreciate in value, it’s likely to add a large amount to the size of your estate. By using a Qualified Personal Residence Trust (QPRT), you can transfer the ownership of your home without worrying about the estate tax.
This doesn’t mean you have to immediately give up ownership. Depending on the trust’s terms, you can continue living in your house but once the terms of the trust end, your beneficiaries can take over the property. With a QPRT, the market value of your real estate will be frozen and you can avoid paying the gift tax provided you don’t exceed the lifetime limit for taxable gifts.
What is the best option to avoid the estate tax?
The easiest answer is: it depends. The best option to avoid the estate tax for one person might not necessarily apply to another. Mistakes can be costly when your estate is at stake. A well-structured financial strategy is essential in ensuring your assets pass on to your beneficiaries with the least amount of deductions possible.
A skilled Long Island estate planning attorney should be able to evaluate your financial situation and recommend the appropriate strategies to avoid estate taxes. Estate planning attorney Seth Schlessel has helped clients protect their estates and ensure that asset transfers go as smoothly as they can. At Schlessel Law, PLLC, Seth Schlessel and our team of qualified estate planning and trusts attorneys understand what it takes to avoid unnecessary complications and disputes. We can help you establish trusts to minimize the tax implications asset transfers would cause on your total estate.
Contact us today at (516) 574-9630 to schedule a consultation with Long Island estate planning attorney Seth Schlessel.