Estate Taxes

There are two types of death taxes that you should be concerned about:  the federal estate tax and NY estate tax.  The federal and NYS estate taxes are computed as a percentage of your net estate.  Your net estate comprises all assets you own or control minus certain deductions.  Such deductions can be for funeral expenses, decedent’s debts, professional’s fees, charitable donations, and gifts for spouses.  The federal estate tax is currently (2023) taxes estates with assets of $12,920,000 or above. Even if you believe that you may not be affected by the federal estate tax, you still need to determine whether you may be subject to taxes from NYS  Estate tax calculator is provided on this site.  NYS currently taxes estates with assets of $6,850,000. These numbers typically change annually.

Your taxable estate comprises of the total value of your assets including your home, other real estate, business interests, your share of joint accounts, retirement accounts, and life insurance policies – minus liabilities and deductions such as funeral expenses paid out of the estate, debts owed by you at the time of death, bequests to charities and value of the assets passed on to your U.S. citizen spouse. The taxes imposed on the taxable portion of the estate are then paid out of the estate itself before distribution to your beneficiaries.

The federal government and NYS allows every married individual to give an unlimited amount of assets either by gift or bequest, to his or her spouse without the imposition of any federal gift or estate taxes.  In effect, the unlimited marital deduction allows married couples to delay the payment of estate taxes at the passing of the first spouse because at the death of the surviving spouse, all assets in the estate over the applicable exclusion amount ($5,000,000 in 2011 through 2012) will be included in the survivor’s taxable estate.  It is important to keep in mind that the unlimited marital deduction is only available to surviving spouses who are United States citizens.

A Credit Shelter Trust, also known as a Bypass or A/B Trust is used to eliminate or reduce federal estate taxes and is typically used by a married couple whose estate exceeds the amount exempt from federal estate tax.  For example, in 2011, every individual is entitled to an estate tax exemption on the first $5 million of their assets.

Because of the Unlimited Marital Deduction, a married person may leave an unlimited amount of assets to his or her spouse, free of federal estate taxes and without using up any of his or her estate tax exemption. However, for individuals with substantial assets, the Unlimited Marital Deduction does not eliminate estate taxes, but simply works to delay them.  This is because when the second spouse dies with an estate worth more than the exemption amount, his or her estate is then subject to estate tax on the amount exceeding the exemption.  Meanwhile, the first spouse’s estate tax credit was unused and, in effect, wasted.  The purpose of a Credit Shelter Trust is to prevent this scenario.  Upon the death of the first spouse, the Credit Shelter Trust establishes a separate, irrevocable trust with the deceased spouse’s share of the trust’s assets. The surviving spouse is the beneficiary of this trust, with the children as beneficiaries of the remaining interest.  This irrevocable trust is funded to the extent of the first spouse’s exemption. Thus, the amount in the irrevocable trust is not subject to estate taxes on the death of the first spouse, and the trust takes full advantage of the first spouse’s estate tax credit.  Special language in the trust provides limited control of the trust assets to the surviving spouse which prevents the assets in that trust from becoming subject to federal estate taxation, even if the value of the trust goes on to exceed the exemption amount by the time the surviving spouse dies.

Just like U.S. citizens, permanent legal residents are taxed on assets they own anywhere in the world. In 2011 and 2012, they get an estate tax exemption on the first $5 million of their estate after they die. Unlike citizen spouses, however, non-citizens spouses cannot qualify for the “unlimited marital deduction.” This means if you die first, you won’t be able to leave an unlimited amount of assets to your non-citizen spouse without the imposition of estate taxes.   The Qualified Domestic Trust, or QDOT was established as a means allow some benefits of the unlimited marital deduction for bequests to a non-citizen spouse and essentially results in a deferral of estate taxes until the death of the surviving spouse.  Your resident-alien spouse is entitled to all the income generated by the assets in the QDOT, but the trustee must be a United States citizen or corporation.

Our homes are often our most valuable assets and hence one of the largest components of our taxable estate.  A Qualified Personal Residence Trust, or a QPRT (pronounced “cue-pert”) allows you to give away your house or vacation home at a great discount, freeze its value for estate tax purposes, and still continue to live in it.  Here is how it works: You transfer the title to your house to the QPRT (usually for the benefit of your family members), reserving the right to live in the house for a specified number of years. If you live to the end of the specified period, the house (as well as any appreciation in its value since the transfer) passes to your children or other beneficiaries free of any additional estate or gift taxes.  After the end of the specified period, you may continue to live in the home but you must pay rent to your family or designated beneficiary in order to avoid inclusion of the residence in your estate.  This is may be an added benefit as it serves to further reduce the value of your taxable estate, though the rent income does have income tax consequences for your family.  If you die before the end of the period, the full value of the house will be included in your estate for estate tax purposes, though in most cases you are no worse off than you would have been had you not established a QPRT.  An added benefit of the QPRT is that it also serves as an excellent asset/creditor protection vehicle since you no longer technically own the property once the trust is established.

There is a common misconception that life insurance proceeds are not subject to estate tax.  While the proceeds are received by your loved ones free of any income taxes, they are countable as part of your taxable estate and therefore your loved ones can lose over forty percent of its value to federal estate taxes.  An Irrevocable Life Insurance Trust keeps the death benefits of your life insurance policy outside your estate so that they are not subject to estate taxes.  There are many options available when setting up an ILIT.  For example, ILITs can be structured to provide income to a surviving spouse with the remainder going to your children from a previous marriage.  You can also provide for distribution of a limited amount of the insurance proceeds over a period of time to a financially irresponsible child.

A Family Limited Partnership (FLP) is simply a form of a limited partnership among members of a family. A limited partnership is one which has both general partners (who control management) and limited partners (who are passive investors). General partners bear unlimited personal liability for partnership obligations, while limited partners have no liability beyond their capital contributions. Typically, the partnership is formed by the older generation family members who contribute assets to the partnership in return for a small general partnership interest and a large limited partnership interest. Then the limited partnership interests are transferred to their children and/or grandchildren, while retaining the general partnership interests that control the partnership.

The FLP has a number of benefits: Transferring limited partnership interests to family members reduces the taxable estate of the older family members while they retain control over the decisions and distributions of the investment. Since the limited partners cannot control investments or distributions, they can be eligible for valuation discounts at the time of transfer which reduces the value of their holdings for gift and estate tax purposes.  Lastly, a properly structured FLP can have creditor protection characteristics since the general partners are not obligated to distribute earnings of the partnership.