The New York (and other states) death tax trap.

• Author: Arlen, Robert M.

It is no secret that more people retire to Florida than any other state. Indeed, Florida's population increased by approximately 340,000 people between July l, 2001, and July 1, 2002. (1) Many individuals who move to Florida from another state become Florida residents, but keep a home in their former state as a secondary residence. These individuals are often referred to as "snowbirds." Our "snowbirds" (or their estates) may be in for a very unpleasant surprise if they own real estate or tangible personal property in their "former" states.

Most practitioners and estate planning clients are aware of the changes made to the estate tax exemption and estate tax rates in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (2) as well as the creation of a carry over basis regime in 2010 and sunset of these provisions in 2011.

Another significant, but rarely spoken about, change made by EGTRRA to the estate tax provisions of the Internal Revenue Code of 1986, as amended, was the phase-out and eventual repeal of the state death tax credit (SDTC) provided under Code [section] 2011. Prior to EGTRRA, a credit was allowed against the Federal estate tax for any estate, inheritance, legacy, or succession taxes ("death taxes") actually paid to any state or the District of Columbia with respect to any property included in a decedent's gross estate. (3) The maximum allowable credit for state While the article focuses on New York state, a majority of northern states either have or are contemplating a death tax independent of the federal estate tax. death taxes was determined under a graduated rate table; the top rate was 16 percent. (4) Pursuant to EGTRRA, the SDTC was reduced by the following percentages: 25 percent in 2002, 50 percent in 2003, and 75 percent in 2004. (5) In 2005, the SDTC is repealed and a new deduction for death taxes actually paid will apply. (6)

While the replacement of the SDTC with a deduction received relatively little attention, as compared to the increase in the exemption and decrease in the maximum estate tax rate, for Florida residents who own real or tangible personal property in another state, such as New York, this change in the law could result in additional estate tax being owed to the state in which such property is situated. This article discusses the imposition of such estate tax. While the article focuses on New York state, a majority of northern states either have or are contemplating a death tax independent of the federal estate tax. The accompanying chart summarizes the laws regarding death taxes (estate and inheritance taxes), including pending legislation, in a sampling of states where Florida snowbirds commonly seem to have second homes. (7)

Northern Death Taxes--A Primer

There are two types of death taxes: estate taxes and inheritance taxes. Estate taxes are based upon the gross estate of the decedent less allowable deductions. With the exception of marital and charitable bequests, estate taxes are not dependant upon the identity of the recipient. Most states that have an estate tax "pick up" the SDTC amount which is allowed as an offset to the Federal estate tax." Presently, 26 states are coupled with the Federal SDTC which is being phased out. Other states determine their tax using the SDTC in effect before EGTRRA and, thus, are not affected by the phase-out of the Federal SDTC.

All states pick up the Federal SDTC, whether they are coupled or decoupled from the phase-out of the SDTC. In the 13 states imposing a separate inheritance tax (see chart for some of these states), the greater of the two taxes is paid. (9) Although an inheritance tax is levied upon a decedent's property, its computation is determined by who receives the property. Heirs are classified as to their relationship to the decedent (e.g., spouses, ancestors, and lineal descendants, brothers and sisters and their lineal descendants, more remote heirs, and others) and separate exemptions and rates of tax are applied to each class of recipients. With some inheritance taxes, each class is aggregated in determining the exemption and rate. In other regimes, the exemption and rate may be determined on an individual basis.

An inheritance tax is a tax on the decedent's transmission of property, not upon the receipt of property by the beneficiary. Even though the amount of an inheritance tax may be computed with regard to the identity of the recipient, the primary liability for the inheritance tax belongs to the estate of the decedent. If the assets comprising the estate are insufficient, then the recipient may have transferee liability. For example, if a Florida resident owning real and personal property entirely within Florida leaves a portion of his or her estate to a relative who resides in a state maintaining an inheritance tax, the recipient relative is not obligated to file and pay a tax upon the receipt of his inheritance in his home state.

Nonresident Estate Tax

A northern state typically imposes a nonresident estate tax on real and tangible personal property situated within the state. The identity of such property having a tax situs in the northern state is usually a straightforward matter, but may have twists in specific circumstances. For example, many people consider a cooperative apartment to be real estate because, as a practical matter, it is indistinguishable from a condominium. Yet a condominium under state law is an interest in real property, whereas a cooperative apartment is typically a stock ownership in a cooperative association coupled with a proprietary lease for occupancy of the apartment. Accordingly, shares in a cooperative apartment are not real property for purposes of the New York estate tax. (10)

Another common situation is when an individual owns real property in the northern state, apparently in cotenancy with others because that is the way title is held under the deed. However, the client and the cotenants operate the property under a written partnership agreement. Does the client own a nonresident interest in the real property by virtue of the deed or does the client possess an intangible asset (i.e., an interest in the partnership)? In states that have adopted the Uniform Partnership Act, the answer should be "intangible asset, not ownership of realty" New York, which has adopted the Uniform Partnership Act, deems the interest to be an intangible asset, rather than an interest in real property." Although the tax result may be favorable, a local title examiner seeing an apparent tenancy in common by deed may request an estate tax release from the northern state for the estate of a deceased coowner. This will likely raise the characterization issue with the northern state's revenue authority. If real property is operated by a partnership, the real property should be titled in the name of the partnership.

Another issue arises when northern real estate is subject to an agreement for deed whereby title is retained until the purchase price is paid. In this case, the issue is whether the decedent had an interest in the real estate or had there been equitable conversion of real estate ownership to the purchaser so that the decedent only had an intangible right to contract payments? Northern states may differ on this issue. If northern real estate is sold, but a mortgage is retained to secure a note, is this a taxable interest in real estate or an intangible right to receive payments? A mortgage on real property in New York is an intangible asset even though New York real property may secure the payment of the note. (12) The result may be different in other states.

Estate Taxes in Decoupled State

The most effective way to explain the potential estate tax liability for a Florida resident who owns real property in a decoupled state is by way of example. Assume a Florida resident dies with a taxable estate of $3 million, which, for purposes of simplicity, is also assumed to be the gross estate. The estate consists of northern realty worth $500,000, Florida realty and tangible personal property worth $300,000, and portfolio assets worth $2.2 million. It is also assumed that the northern state computes its estate tax using the SDTC under the law in effect prior to EGTRRA, but allows a $1 million estate tax exemption amount. (13) His further assumed that the northern state computes its resident tax based upon a ratio, the numerator of which is the...