From new legislation, to important proposals, to instructive case law, 2018 saw some significant developments, lessons and reminders.

10. Prenuptial Agreements Must Be Acknowledged. 

Under Domestic Relations Law §236(B)(3), agreements made by parties before or during marriage must be acknowledged with the same formality required to record a deed. In In re Koegel, 70 N.Y.S.3d 540 (2018), the Second Department addressed the question of whether a defective acknowledgement to a prenuptial agreement could be cured. In an agreement signed before marriage, a decedent and his wife each waived rights to the other's estate and their signatures were acknowledged by their respective attorneys as notaries. However, the acknowledgements did not specifically attest to whether the parties were known to the notaries. Although the wife received substantial benefits under the will, she filed a right of election. She alleged that the prenuptial was defective pursuant to the Court of Appeals decision in Galetta v. Galetta, 969 N.Y.S.2d 826 (2013), which invalidated a prenuptial agreement because the acknowledgments omitted language expressly stating that the notaries knew the signers or had ascertained, through proof, that the signers were the persons described. The Galetta court left open the issue of whether a defective acknowledgment could be cured by extrinsic evidence provided by the notary public who took a party's signature. The Koegel court determined that affidavits submitted by the attorney notaries (30 years after the agreement was signed) cured the defect. Those affidavits confirmed that they each observed the document being signed and personally knew the signer, so it was unnecessary to ask for identification.

This case highlights the importance of checking boiler plate signatory provisions to ensure that prenuptial agreements, and all other agreements requiring acknowledgement, are duly signed with the requisite formality.

9. New York Decouples From Certain Federal Income Tax Changes

In TSB-M-18(6)I, issued Dec. 28, 2018, the Department of Taxation and Finance (the Department) affirms that the state and federal tax treatment of certain items of income and deductions will differ for tax years 2018 and thereafter.

Alimony Continues to Be Deductible. Until 2019, alimony payments were characterized as taxable income to the recipient and deductible by the payer (Internal Revenue Code [IRC] §§71(a) and 215(a)). With the spouse paying alimony likely to be in a higher income tax bracket than the recipient spouse, the recipient potentially could pay taxes on the alimony at a lower rate. This bracket play often resulted in overall tax savings between the parties. Pursuant to federal changes effected by the 2017 Federal Tax Cuts and Jobs Act (the Federal Tax Act), alimony payments made pursuant to a divorce or separation agreement signed after Dec. 31, 2018 will no longer be treated as taxable income to the recipient or be deductible by the payer. Since New York has decoupled from the federal treatment of alimony payments, alimony can be subtracted from federal adjusted gross income in computing New York taxable income (N.Y. Tax Law §612(w)).

Deductions Can Be Itemized, Even If Not Itemized for Federal Purposes. Taxpayers may claim some deductions on their New York returns that are no longer available for federal purposes (N.Y. Tax Law §615(a)), including:

State and local real estate taxes, including amounts over the $10,000 federal limit; and

Certain miscellaneous deductions that are no longer allowed federally, such as tax preparation fees and investment expenses.

529 Plan Withdrawals for K-12 Grade Tuition Are Nonqualified. A 529 plan is an investment account created for the purpose of paying educational expenses of a designated beneficiary. Funds invested in a 529 plan will accumulate and grow federal income tax free, and if the funds are used for qualified educational expenses (such as tuition, room & board, fees, books, supplies and equipment for college [IRC §529(e)(3)]), funds are exempt from federal income tax. New York accords similar favorable tax treatment to 529 plans and allows taxpayers to take an income tax deduction up to $5,000 ($10,000 for a married couple filing jointly) for contributions to New York's 529 plan.

As a result of changes effected by the Federal Tax Act, as of Jan. 1, 2018, 529 plans (up to $10,000 annually) can now be used to pay for tuition for elementary and secondary schools for federal tax purposes. According to the TSB, however, New York limits qualified withdrawals to post-secondary educational institutions. Withdrawals for tuition payments to elementary or secondary schools will be considered nonqualified.

8. Department Reaffirms Closing of Nonresident Income Tax Loopholes

Co-operative Shares Included in Definition of Real Property When Determining New York Source Income. The definition of a nonresident's New York source income was expanded in the 2017-2018 Executive Budget. As explained in TSB-M-18(1)I, issued April 6, 2018, if more than 50 percent of an entity's value consists of co-operative apartment shares, gains from the sale of an ownership interest in that entity will be taxable to a nonresident as source income (N.Y. Tax Law §631(b)(1)(A)(1)). Previously, although gains from the sale of a cooperative apartment interest in New York generated New York source income (N.Y. Tax Law §631(b)), the nonresident could exclude the gain from source income if the apartment was held in an entity. The TSB provides that these rules apply to part-year residents, entities in tiered structures and resident trusts that previously were not subject to New York tax because they satisfied the resident trust exception under N.Y. Tax Law §605(b)(3)(D) (no New York Trustee, no New York situs assets, and no New York source income).

Sales of Certain Partnership Interests Will Generate New York Source Income to Nonresidents. Previously, a nonresident could sell a partnership interest and classify the transaction as the sale of a nontaxable intangible partnership interest. In TSB-M-18(2)I, issued April 6, 2018, the Department explains that a 2017-18 Executive Budget amendment treats the sale by a nonresident of a partnership interest as New York source income when trade or business assets held by the partnership were in New York and the sale is treated as an asset sale under IRC §1060 (N.Y. Tax Law §632(a)(1)).

7. Limitations on Using Exculpatory Provisions Extended to Trustees of Inter Vivos Trusts

Under Estates, Powers and Trust Law (EPTL) §11-1.7, it is against public policy to exonerate an executor or testamentary trustee from failure to exercise reasonable care, diligence and prudence. An amendment, signed into law by Gov. Cuomo on Aug. 24, 2018, extends the prohibition on exonerating testamentary fiduciaries to trustees of inter vivos trusts.

6. Battle over Cap on State and Local Tax (SALT) Deductions Continues

The Federal Tax Act limits an individual's SALT deduction to $10,000 for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026. In response, the 2018-19 Executive Budget introduced state proposals to provide relief, including two state-operated charitable funds, one for health, the other for education, effectively allowing taxpayers to make deductible charitable contributions instead of state tax payments (N. Y. Tax Law §606(iii)). However, on Aug. 27, 2018, the IRS and Treasury Department issued proposed regulations 83 FR 43563, which provide that taxpayers must reduce their charitable deductions by the amount of any state or local tax credit they receive or expect to receive, if that credit exceeds 15 percent of the contribution. According to Gov. Cuomo, in a notice issued on Aug. 24, 2018:

We are confident that our recently enacted opportunities for charitable contribution … are consistent with federal law and follow well-established precedent, and I have made it very clear that we will use every tool at our disposal, including litigation, to fight back to ensure New Yorkers aren't being used as a piggy bank to pay for tax cuts for big corporations.

On July 17, 2018, four states—New York, Connecticut, New Jersey and Maryland—filed a law suit against the federal government in the U.S. District Court for the Southern District of New York, alleging that the SALT deduction cap is unconstitutional. On Nov. 2, 2018, the federal government moved to dismiss the suit on jurisdictional grounds, and for failure to state constitutional violations (18 Civ. 6427 (JPO)).

5. Intent to Minimize Taxes Can be Sufficient to Reform Clear and Unambiguous Instruments

In Matter of Sukenik, 75 N.Y.S.3d 422 (2018), the Appellate Division allowed a petition to reform an inter vivos trust and IRA beneficiary designation form, even though the documents were clear and unambiguous on their face. The purpose of the reformation was to remedy “inefficient estate and income tax planning,” resulting in an income tax liability of $1.6 million.

The decedent designated his wife as the beneficiary of his IRA, which triggered the substantial income tax liability. He named a foundation as a beneficiary of an inter vivos trust. By swapping the IRA assets received by the wife with trust assets, and naming the foundation as the IRA beneficiary, the income tax liability could have been avoided. The Surrogate denied the petition. She pointed out that tax-related reformations are normally sought to correct drafting errors or cure an instrument's failure to comply with subsequent changes in the law, there being no authority to support the reformation of a clear and unambiguous instrument in order to remedy the adverse tax consequences of poor tax planning. The Appellate Court reversed, despite the Surrogate's warning that:

To reform instruments … based only upon the presumption that one who executes testamentary instruments intends to minimize taxes would expand the reformation doctrine beyond recognition and would open the flood gates to reformation proceedings aimed at curing any and all kinds of inefficient tax planning.

The Appellate Division found that the decedent's intent to minimize taxes and provide for his wife of 39 years was apparent in the donative instruments, which demonstrated his intent to take full advantage of all deductions and exemptions provided by law.

4. Informal Accountings Can Be as Effective as Judicial Settlements

In In re Spacek, 64 N.Y.S.3d 65 (decided at end of 2017), the decedent provided for her residuary estate to be split equally among six beneficiaries. The executor sent an agreement, in lieu of a formal accounting and judicial settlement, to the estate beneficiaries. The agreement, amongst other things, released her from any claims relating to her acts as executor. The estate's tax return and other financial documents were annexed to the agreement. After the executor petitioned to judicially settle her account, one of the beneficiaries who signed the release sought to revoke it, alleging she was not made aware that the executor was to receive a larger share of the estate assets because the executor was a joint holder of various bank accounts with the decedent. The Surrogate's Court denied the motion to set aside the release. The Appellate Division affirmed, holding that, while formal estate accountings are generally done in the context of a judicial proceeding, a fiduciary may also account informally:

Such an informal accounting is as effectual for all purposes as a settlement pursuant to a judicial decree … [I]f a fiduciary gives full disclosure in his [or her] accounting to which the beneficiaries are parties…they should have to object at that time or be barred from doing so after the settlement of the account.

This case illustrates the importance of a fiduciary's obtaining releases from beneficiaries, even pursuant to an informal accounting, to sever otherwise lingering liability. Particularly in a state like New York, where there is no requirement for recurring trust accountings, for example, trustees might consider periodic accountings, particularly if an investment strategy or proposed distribution could be contentious.

3. Three-Year Gift Add-Back Expires

While New York does not impose a current gift tax, as a result of 2014-15 Executive Budget changes, the New York gross estate of a deceased resident was increased by the amount of any taxable gift made within three years of death. The gift add-back does not apply to estates of individuals dying on or after Jan. 1, 2019 (N.Y. Tax Law §954(a)(3)). Accordingly, even if a gift was made before Jan. 1, 2019, it will not be brought back into the estate if the donor dies after Jan. 1, 2019.

(Note, the proposed 2019-2020 Executive Budget, released Jan. 15, 2019, includes a proposal to extend the three-year add-back to Jan. 1, 2026 and would apply to estates of individuals dying on or after Jan. 1, 2019.)

2. Estate Tax Refund Claims for State Only Qualified Terminable Interest Property (QTIP) Trusts Could Soar

In Estate of Evelyn Seiden, 2018 N.Y. Slip Op 32541(U), the New York Surrogate's court found that a QTIP trust, created for state purposes after a husband died in 2010, was not includible in the estate of the surviving wife for New York estate tax purposes. Specifically, since the federal estate tax had lapsed in 2010 when the husband died, no federal estate tax return was filed. The husband's executor made a QTIP election on a pro-forma federal return filed with the New York return, taking a marital deduction for New York estate tax purposes. The Department issued a closing letter in 2012. After the wife died, her executor excluded the value of the trust property on her federal estate tax return on the basis that no federal marital deduction had been claimed or “allowed” in her husband's estate, as is required to trigger inclusion in the second estate under IRC §2044. The Internal Revenue Service issued a closing letter accepting the return as filed. The estate also excluded the trust property on the wife's New York estate tax return, taking the position that New York law defines its gross estate by reference to the federal gross estate, which clearly excluded the property. The Department disagreed and assessed additional tax and interest of almost $530,000. However, the New York court rejected the Department's various arguments that IRC §2044 applied, finding that the husband's executor simply did not make that election. Consequently, the property was not included in the wife's federal gross estate, nor in the New York gross estate.

Accordingly, the QTIP property escaped New York and federal estate taxation in both estates! Further, the rationale of the case does not seem to be limited to estates of surviving spouses where the first spouse died in 2010. If an estate was under the federal filing threshold and filed only a New York estate tax return with a pro forma federal return that contained a QTIP election, the same logic should apply to exclude QTIP trust assets from a survivor's estate.

(Note, the proposed 2019-2020 Executive Budget, released Jan. 15, 2019, includes a proposal to prevent the result in the Seiden case by requiring an executor to make a QTIP election on the New York return in order to claim a marital deduction, whether or not a federal return was required to be filed. As explained in the Memorandum in Support, the bill expressly requires QTIP property to be included in the surviving spouse's estate if a New York marital deduction for the property was previously allowed. The new law would apply to estates of individuals dying on or after April 1, 2019.)

1. Estate Planning Needs Revisiting in Light of New Tax Laws

The Federal Tax Act doubled the federal estate and gift exemption, which rose to $11.4 million per person ($22.8 million per married couple) on Jan. 1, 2019, and is slated to sunset after 2025 to $5.6 million (plus inflation adjustments after 2018).

The New York estate tax exemption amount is $5.74 million in 2019, but it is not portable between spouses. If spouses each die in 2019, each has a $5.74 million estate and each uses his/her exemption with appropriate planning, no New York estate tax will be due. If, however, the first to die leaves everything to the survivor, who dies in 2019 with an $11.48 million estate, the exemption of the first spouse to die will have been lost, potentially generating unnecessary taxes of over $800,000 in the second estate.

Further, the substantial gap between state and federal exemption amounts could have potentially significant dispositive and tax consequences. Dispositive provisions can be distorted if linked to federal exemption amounts that have increased beyond what was originally envisioned. From a tax standpoint, care must be taken with formula bequests designed to take advantage of the full federal exemption amount, particularly because an estate that exceeds 105 percent of the New York exemption faces a cliff, causing the estate to be taxable from dollar one. In 2019, if a credit shelter disposition is pegged to the largest amount that can pass free of federal taxes, that might generate a state estate tax of close to $1 million. This tax bite might be further compounded with an interrelated tax computation if the tax is payable from a marital or charitable residuary.

Since New York does not impose a current gift tax and the three-year gift add back has expired, utilizing the increased federal exemption through lifetime gifting might be very attractive: Individuals could leverage the full federal exemption while reducing their New York estate tax since the gifted assets will be excluded from the New York estate. Given that the enhanced gift tax exemption is slated to disappear after 2025, this also presents a limited window of opportunity. It is particularly attractive in light of the fact that the IRS published proposed regulations on Nov. 23, 2018 (83 FR 59343) that eliminate the concern that an individual's increased gift exemption may be “clawed back” if exemption levels are lower on the date of death.

The bottom line is that practitioners should consider reaching out to their clients to discuss whether they should sign new wills and revocable trusts or make changes to otherwise irrevocable documents through a decanting or other revision process to take advantage of new planning opportunities and ensure their existing plans still accord with their intent.

Sharon L. Klein is President of Family Wealth, Eastern US Region, at Wilmington Trust, N.A. This article includes developments through Dec. 31, 2018