Blanche Lark Christerson
Managing Director, Senior Wealth Planning Strategist
Tax Topics
03/30/17
2017-03
Health care reform…
The House Republican effort to repeal and replace “Obamacare” (or the Affordable Care Act) collapsed on
th
March 24 . The question is what comes next.
The answer seems to be tax reform. Yet that just got more difficult for budgetary reasons.
To elaborate, a likely reason for putting “repeal and replace” first is that in addition to eliminating Obamacare’s
health care provisions (a long-standing Republican promise), the “American Health Care Act” (AHCA) also
would have eliminated the various Obamacare taxes, including the 3.8% tax on net investment income and the
additional 0.90% Medicare tax on higher earners. What does this have to do with tax reform per se? It’s all
about the budget “baseline” that is used to “score” the revenue impact of tax proposals.
In other words, the Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) issued a
joint cost estimate of the initial version of AHCA. That estimate, while acknowledging inherent uncertainties,
predicted that, over a ten-year period, AHCA would have reduced the federal deficit by a net $337 billion, the
result of $1.2 trillion in decreased direct federal spending (including $880 billion in reduced Medicaid outlays)
offset by $883 billion in foregone revenues (repealing the Obamacare taxes). Although the CBO and JCT did
not have sufficient time to issue additional revenue estimates for later versions of the bill (one of which would
have kept the additional 0.90% Medicare tax in place until 2022), the point is that the AHCA’s proposed
spending reductions more than paid for repealing Obamacare’s tax provisions, and even resulted in some
projected deficit reduction.
Thus, had AHCA become law, those spending reductions and repealed taxes/revenue losses would already
have been “baked in” to the current law budget baseline that the CBO and JCT would use to score the
forthcoming tax reform proposals. Yet since AHCA didn’t become law, repealing the Obamacare taxes as part
of tax reform will incur additional cost, and complicate the stated Republican goal of “revenue-neutral” tax
reform, whereby the revised tax law brings in the same amount of revenue as the old tax law. The Obamacare
taxes therefore seem likely to remain, at least as long as Obamacare is still around (note that the House may
try to resurrect a repeal and replace bill, but the timing is far from certain, and there is no guarantee that Senate
Republicans would agree with whatever approach the House puts forth).
Where does that leave us? Waiting to see what happens. Speaker of the House Paul Ryan may have just as
hard a time with tax reform and the fractured Republican caucus as he did with “repeal and replace”; the
constant “push me/pull you” that goes with tax reform produces inevitable winners and losers, and is difficult.
To quote Bette Davis’s famous line from the classic movie, All About Eve, “Fasten your seat belts. It’s going to
be a bumpy night.”
New York’s exclusion amount
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On April 1 , New York’s estate tax exclusion amount climbs from $4,187,500 to $5,250,000, where it will
remain through December 31, 2018; as of January 1, 2019, that exclusion will be indexed for inflation, so that it
matches the inflation-indexed federal exclusion amount (currently, $5.49 million). Yet if the tax reform alluded
to above brings the repeal of the federal estate tax, is New York’s estate tax so inextricably linked to that
federal law that it will disappear or become meaningless by referring to tax law provisions that no longer exist?
The answer is that regardless of what happens to the federal estate tax, New York has a stand-alone estate
tax, and its cross references to federal tax law are generally to the 1986 Internal Revenue Code, as in effect on
or before January 1, 2014. So barring changes from the legislators in Albany, New York’s estate tax is here to
stay.
The tax’s longevity aside, the pending $5.25 million New York exclusion is good news for taxpayers, and a
dramatic increase from the $1 million exclusion that existed prior to New York’s revision of its estate tax law in
early 2014. Yet there are several important things to keep in mind – first, the exclusion disappears if a
decedent’s New York taxable estate is “too big,” and second, unused exclusion is not portable to a decedent’s
surviving spouse.
The disappearing exclusion. The New York exclusion disappears entirely if the decedent’s New York taxable
estate exceeds the exclusion amount by 5% or more (the exclusion is phased out if the taxable estate exceeds
the exclusion by less than 5%).
In other words, suppose that divorced Dad, a New Yorker, has made no taxable gifts during his life, and dies on
April 1, 2017. He leaves his entire estate to his children. After debts and expenses, what’s left (Dad’s “taxable
estate”) is exactly $5.25 million – or the amount of New York’s exclusion. Dad’s estate owes no New York
estate tax (it doesn’t owe any federal estate tax either because it’s under the $5.49 million federal exclusion).
Yet if Dad’s taxable estate were just 5% bigger, at $5,512,500, it would entirely lose the $5.25 million New York
exclusion, and owe $452,300 in New York estate tax. That is, the difference between the two amounts –
$262,500 – is effectively subject to about a 172% tax. (In truth, we exaggerate: because the tax applies to the
entire estate, the percentage is really only 8.2%...not that this makes the number any easier to swallow!) The
good news, however, is that Dad’s estate owes no federal estate tax, as the deduction for state estate tax
brings his taxable estate under the $5.49 million exclusion.
Although this disappearing exclusion is consistent with “old” New York law, the numbers are no less stark.
No portability. Like most states with an estate tax, New York does not permit a deceased spouse’s unused
exclusion to carry over to the surviving spouse (what’s known as “portability”); thus, married New Yorkers are
Tax Topics 03/30/17
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faced with a “use it or lose it” proposition. Given how expensive the loss of the exclusion can be (see above), it
is all the more important for married couples to take advantage of the exclusion when the first spouse dies.
To illustrate, suppose that Mom and Dad, both New Yorkers, have made no taxable lifetime gifts. Dad dies on
April 1, 2017, and leaves his entire $5 million estate to Mom, who also has $5 million worth of property. Mom,
Dad’s executor, files a federal estate tax return so that Dad’s unused exclusion ($5.49 million) carries over to
her. Mom dies on April 1, 2018, and leaves her $10 million estate to her children (for simplicity’s sake, we’re
assuming her estate has no debts or expenses). Although Mom’s estate is fully protected from federal estate
tax, thanks to her exclusion and Dad’s unused exclusion, it owes $1,067,600 in New York estate tax. The
children net just over $8.9 million in property.
Neither Dad nor Mom benefits from the New York exclusion.
Suppose, instead, that Dad leaves his $5 million estate in a trust for Mom and their children. The trust is a
taxable disposition, but is protected from New York and federal estate tax by Dad’s New York and federal
exclusion amounts, which effectively “absorb” tax. The trust therefore passes tax-free in Dad’s estate, and will
pass tax-free to children at Mom’s death. When Mom dies on April 1, 2018, and leaves her own $5 million
estate to her children, no federal OR New York estate tax is owed. The children net $10 million in property.
Both Mom and Dad benefit from the exclusion. Note that if Mom’s estate was “too big” (say, $6 million) and she
lost the exclusion, at least Dad’s estate would have benefited from it.
The point is that New York’s increasing estate tax exclusion is good news, but New York’s estate tax can still
bite – and requires planning so that married couples don’t incur unnecessary New York estate tax when both
spouses are gone.
April 7520 rate
The April 2017 7520 rate is 2.6%, a 0.20% (20 basis points) increase from the March rate of 2.4%. The April
mid-term applicable federal rates (AFRs) are also up slightly: 2.12% (annual), 2.11% (semiannual), and 2.10%
(quarterly and monthly). The March mid-term AFRs were: 2.05% (annual), 2.04% (semiannual), and 2.03%
(quarterly and monthly).
Blanche Lark Christerson is a managing director at Deutsche Bank Wealth Management in New York City, and
can be reached at [email protected].
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