The Year 2010 In Review
Sharon L. Klein, New York Law Journal
January 31, 2011
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The year 2010 in New York was notable for significant developments, and the emergence of significant quandaries, in the trusts and estates arena. In addition to important state legislative, judicial and administrative changes, when the federal estate and generation-skipping transfer tax regimes lapsed on Jan. 1, 2010, there was a significant trickle-down effect at the state level.

Since New York's taxation regime is entwined with federal tax concepts, practitioners had to grapple with the impact of what happens when federal tax concepts disappear.

Some of those dilemmas were resolved in 2010 through state legislative and administrative action. Other quandaries for decedents who died in 2010 remain, despite the signing into law of the Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010 (act), by President Obama on Dec. 17, 2010.

While all of the issues discussed below may, of course, be affected by future legislation, interpretive releases and other developments, here is how things looked as of Dec. 31, 2010.

The Quandaries

A. Can property inherited from a decedent in 2010 give rise to both capital gains taxes and estate taxes?

Pursuant to the act, estates of decedents dying in 2010 are subject to a federal estate tax regime, with a $5 million exemption amount and a 35 percent estate tax rate. The act includes an option to elect out of estate tax treatment and be subject instead to a modified carry-over basis regime. However, while it is possible to opt out of the federal estate tax regime, New York imposes a separate state estate tax.

If an estate opts out of the federal estate tax regime, but is liable for the payment of New York estate taxes, it does not appear that the estate assets will be stepped up to date-of-death values for New York capital gains tax purposes.

New York Tax Law (Tax Law), Article 26, deals with New York's estate tax. Section 951 provides that, for the purposes of this article, any reference to the internal revenue code means the Internal Revenue Code (IRC) of 1986, with all amendments enacted on or before July 22, 1998. (Emphasis added.)

For income tax purposes, however, Article 22 applies. Section 612(a) provides that "…the New York adjusted gross income of a resident individual means his federal adjusted gross income as defined in the laws of the United States for the taxable year…" (Emphasis added).

If an election is made to opt out of the federal estate tax regime in 2010, modified carry-over basis will apply. Accordingly, because New York adopts federal law as of 1998 for estate tax purposes but adopts federal law for the current year for income tax purposes, both estate taxes and capital gains taxable appear to be payable.

Legislation was introduced on Sept. 1, 2010 to provide relief in the case of a sale of property acquired from a decedent who died when the federal modified carry-over basis regime was in effect. Essentially, the proposed legislation provides that, in the case of such a sale, the basis of the property shall be recalculated by applying the IRC step-up in basis rules in effect on Dec. 31, 2009.

At the time the legislation was introduced, the federal estate tax regime had lapsed. The relief in the proposed legislation would have applied generally for decedents who died in 2010. In light of the act, the proposed relief (if enacted) will apply only to those estates that opt out of the federal estate tax regime.

B. New York law enacted to construe formulaic dispositions may produce anomalous results in light of federal election.

Many dispositive instruments contain formulaic terminology tied to federal tax concepts. When the federal estate tax regime lapsed in 2010, many formulaic dispositions became distorted. For example, depending on the formulaic terminology used, dispositions intended to pass the maximum amount that could pass free of federal estate taxes ($3.5 million in 2009) may have significantly different interpretations.

If there is no federal estate tax, a disposition of the "federal estate tax exemption amount" could be interpreted to mean no disposition at all: if there is no tax, there can be no exemption amount.

On the other hand, a disposition of the "largest amount that can pass free of federal estate taxes" could be interpreted to mean a disposition of the whole estate: if there is no tax, the whole estate is the largest amount that can pass tax-free.

To prevent this type of distortion in estate plans, New York enacted legislation in 20102 to generally provide for the construction of formula clauses with reference to the law as it existed on Dec. 31, 2009.

Accordingly, in the absence of an applicable federal estate tax in 2010, a disposition of the "federal estate tax exemption amount" or the "largest amount that can pass free of federal estate taxes" would both be interpreted to mean a $3.5 million disposition.

Note, however, that the statute applies to decedents dying after Dec. 31, 2009, and before Jan. 1, 2011 or such earlier date that the federal estate tax "becomes applicable." Presumably, if an estate is subject to estate tax under the act, the statutory rules of construction will not apply, and formulaic provisions will be keyed to the $5 million exemption amount. But what if an estate elects to opt out of the estate tax regime?

If the estate tax has to "become applicable" to the case at hand in order for the statutory construction rules not to apply, there may be an anomalous result: In the estate tax default scenario, a $5 million exemption would presumably apply in the interpretation of formula clauses.

However, if carry-over basis treatment is chosen and the statutory construction rules are applicable, formulaic clauses may be interpreted with a $3.5 million exemption amount.

Note also that if the result is unclear, or if the statutory rules of construction do not produce the desired result, an executor, trustee or other interested person may bring a construction proceeding to determine the decedent's intent. However, such a proceeding must be commenced within 12 months of death…so time may be running out. Accordingly, practitioners may wish to consider commencing a proceeding to keep their options open.

These issues are ripe for legislative change, both to avoid the anomalous result of having a different formulaic construction apply if an executor opts out of the federal estate tax regime, and to extend the time frame for commencing a construction proceeding.

C. Does New York's disclaimer law require amendment to dovetail with federal law changes?

Pursuant to §301(d)(1)(C) of the act, the time for making a qualified disclaimer under IRC §2518 is extended to nine months after the act's date of enactment. EPTL §2-1.11(c)(2), however, requires a disclaimer to be filed within nine months of the effective date of the disposition.

While disclaimers for interests created prior to 1977 must be effective under local law, that is not a requirement for disclaimers effected after 1976. Under IRC §2518(c)(3), certain transfers are treated as disclaimers: a written transfer that meets requirements similar to those in §2518(b)(2) [timing and delivery] and 2518(b)(3) [no acceptance] and that is to a person who would have received the property had the transferor made a qualified disclaimer, will be treated as a qualified disclaimer.

Although an amendment to New York law may not be required in light of this provision,4 many practitioners believe that a conforming amendment would be helpful to foreclose the possibility that creditors might reach assets not effectively disclaimed under local law. A disclaimer that is voided by the disclaimant's creditors cannot be a qualified disclaimer.5

In the absence of a statutory amendment, one practical solution might be to perfect the New York disclaimer by petitioning the court for an extension of time.6

Proposed Trust Tax Change

The governor's budget bill, introduced on Jan. 19, 2010, included a proposal to amend the taxation of resident trusts. The stated purpose was to reduce tax avoidance through the use of nonresident trustees.

Pursuant to Tax Law §601(c) an income tax is imposed on the income of a "resident trust." A resident trust includes a trust created by a New York decedent, an irrevocable trust created by a New York domiciliary or a trust that became irrevocable while the creator was a New York domiciliary.

However, under §605(b)(3)(D) of the Tax Law, a resident trust will not be subject to tax if three conditions are satisfied:

1. all trustees are domiciled outside of New York;

2. the entire corpus of the trust, including real and tangible property, is located outside of New York; and

3. all income and gains of the trust are derived from sources outside of New York.

Intangible property is considered located in New York if one or more trustees are domiciled in New York.

Accordingly, a New York resident trust with no trustees in New York, no assets in New York and no New York source income would not be subject to New York income tax.

Often, New York tax liability at the trust level could be eliminated merely by appointing a non-New York trustee. The proposal would have eliminated the three conditions for tax exemption, making residency of the trustee irrelevant. The proposal was ultimately stricken from the budget bill.

However, on July 23, 2010, the New York Department of Taxation and Finance (Department) issued TSB-M-10(5)I that provides that, although resident trusts that meet the conditions of §605(b)(3)(D) are not currently subject to New York tax, a New York state fiduciary income tax return must be filed if the trust meets the filing requirements for resident trusts.

A trust that is required to file a New York state income tax return must file using Form IT-205, Fiduciary Income Tax Return. Resident trusts that are not subject to tax under the conditions of §605(b)(3)(D), but are required to file Form IT-205, will be required to attach newly released Form IT-205-C, New York State Resident Trust Nontaxable Certification.

There is a box to check on the face of Form IT-205 to indicate Trust meets conditions of section 605(b)(3)(D). Form IT 205-C requires an "X" to be checked for all that apply of three factors that mirror the three conditions contained in §605(b)(3)(D).

When the proposal to amend the taxation of resident trusts was introduced, it was projected to increase revenues by $25 million annually. Many practitioners believe that the original $25 million revenue projection was a substantial underestimate. Perhaps the filing requirements have been introduced to more accurately gauge the potential revenue increase and lay the groundwork for a possible reintroduction of the proposal.

Additionally, the filing requirements will probably serve as a policing mechanism to enable New York to adjudicate on a position that no New York tax is due.

New Institutional Funds Act

On Sept. 17, 2010, New York adopted the Prudent Management of Institutional Funds Act (PMIFA), creating a new standard of conduct for managing and investing institutional funds. PMIFA applies to institutions including private foundations, not-for-profit corporations and public charities.

PMIFA requires institutions to consider a specific set of factors for investing in a prudent matter (including tax consequences of investment decisions or strategies, total return and needs for distributions and capital preservation). Institutions are required to adopt a written investment policy, and must review a determination not to diversify at least annually.

Only investment costs that are appropriate and reasonable may be incurred. Delegation of the investment function to outside managers is permitted, provided the institution acts prudently in selecting the agent, establishing the scope of the delegation and monitoring the agent. Very significantly, an institution that fulfils those delegation requirements is not liable for the actions of the agent.

Institutions are no longer subject to "historic dollar value" spending limitations, but can spend the amount the institution considers prudent after required consideration of listed factors (including the purpose of the fund, total return and other resources of the institution). The institution is required to keep a contemporaneous record describing consideration given to each of the factors.

State-Only QTIP Election

New York law has no provision for a separate state QTIP election that is independent from the federal QTIP election.

When the federal estate tax regime lapsed in 2010 (before the act passed), it was not necessary or perhaps even possible to make a federal QTIP election. Accordingly, it was unclear whether a QTIP disposition in 2010 (in excess of the $1 million New York estate tax exemption) would be fully taxable for New York estate tax purposes.

On March 16, 2010, the Department issued TSB-M-10(1)M, clarifying that an executor will be permitted to make an election to treat certain property as QTIP property for purposes of the New York estate tax marital deduction, when no federal return is required to be filed.

Presumably, in light of the act's passage, if an estate opts out of the federal estate tax regime in 2010 and no federal estate tax return is required to be filed, a separate New York QTIP election can be made.7

New York Unified Credit Set

Tax Law §951(a) provides that the New York unified credit against estate tax is the federal unified credit in effect on the decedent's date of death, not to exceed the tax due on a federal taxable estate of $1 million.

When the federal estate tax regime lapsed in 2010 (before the act passed), the federal unified credit for a New York decedent dying in 2010 was zero. Accordingly, one interpretation of the Tax Law was that the New York available credit was also zero.

If so, since New York has decoupled from the federal estate tax system, the entire New York taxable estate would be subject to estate tax (apart from a potential $100,000 exemption). In light of the act, the same result would presumably follow if an estate opts out of the estate tax regime.

Section 951(a) was amended in August to eliminate the reference to the federal unified credit in effect on the decedent's date of death. The unified credit against the New York estate tax is fixed at $1 million. The law applies to estates of decedents dying on or after Jan. 1, 2010.

Malpractice Claim Approved

In Estate of Saul Schneider v. Finmann,8 the New York Court of Appeals held that sufficient privity existed between the personal representative of an estate and the estate planning attorney for the personal representative to maintain a malpractice claim against the attorney on the estate's behalf.

The estate essentially "stands in the shoes of a decedent," giving the estate capacity to maintain the malpractice action.

Trustees' Counsel Fees

In Matter of Hyde,9 certain beneficiaries unsuccessfully sued corporate fiduciaries for failure to diversify trust assets.

Very significantly, on the issue of attorney's fees, the New York Court of Appeals overturned previously controlling law that trustees' counsel fees were to be paid equally from all trusts, regardless of the fact that certain trust beneficiaries did not participate in a litigation.

The Court held that, under Surrogate's Court Procedure Act §2110(2), the trial court has discretion to allocate responsibility for payment of a fiduciary's attorney's fees for which the estate is obligated to pay, either from the estate as a whole or from shares of individual estate beneficiaries.

A multi-factored assessment of the sources from which the fees are to be paid is to be undertaken by the trial court. Factors to be considered, none of which should be determinative, may include: whether the objecting beneficiary acted solely in self-interest or in the common interest of the estate, the possible benefits to individual beneficiaries from the outcome, whether there was justifiable doubt regarding the fiduciary's conduct and the effect of fee reallocation on future interests.

Same Sex Couples

In Martinez v. County of Monroe,10 the Fourth Department held that same sex marriages legally performed in other jurisdictions are entitled to recognition in New York in the absence of express legislation to the contrary.

In the wake of Martinez, on May 14, 2008, then-Governor David Paterson sent a directive to all state agencies to afford comity to same-sex marriages legally performed in other jurisdictions.

On May 12, 2010, the Department issued TSB-A-10(2)I, to address the question of whether marriage to a same-sex partner will be recognized for New York state personal income tax purposes as a result of Governor Paterson's 2008 directive.

The Tax Law provides, in essence, that New York follows the federal determination of filing status. Pursuant to the federal Defense of Marriage Act, the IRS does not recognize same-sex marriages for federal income tax purposes. Accordingly, the advisory opinion concludes that a marriage to a same-sex partner will not be recognized for purposes of New York state personal income tax.

Pet Trust Laws Amended

Under New York law,11 trusts for the care of a designated pet are valid, and their intended use for the care of the animal may be enforced by a named or court-appointed individual.

Amendments enacted on May 5, 2010 eliminate the former 21 year limit, and provide that the trust will terminate when the living animal beneficiaries die.

Power of Attorney Law

On Aug. 13, 2010, corrective amendments were enacted to the Power of Attorney Law, sweeping changes to which went into effect on Sept. 1, 2009.

Among the more significant revisions, powers of attorney created on or after Sept. 1, 2009 will no longer automatically revoke prior powers of attorney unless the principal specifically provides otherwise.

It was clarified that powers of attorney can be used to make annual aggregate gifts (not per recipient) of up to $500, but any additional gift giving authority must be made pursuant to a "statutory gifts rider," executed separately.

Sharon L. Klein is a managing director and head of wealth advisory at Lazard Wealth Management.

Endnotes:

1. S.8478.

2. Estates, Powers and Trusts Law (EPTL) §2-1.13.

3. IRC Reg. §25.2511-1(c).

4. An ineffective disclaimer under New York law would presumably constitute a gift but, since New York does not impose a gift tax, there would not seem to be a tax consequence.

5. IRC Reg 25.2518-1(c)(2). However, the fact that a disclaimer is voidable by the disclaimant's creditors has no effect on the determination of whether such a disclaimer constitutes a qualified disclaimer (Id).

6. EPTL §2-1.11(b)(2), but query whether the possible extension relates only to procedural defects or also to signing the disclaimer.

7. New York does not currently permit a separate QTIP election for the difference between the state and federal exemption amounts when there is a federal filing requirement.

8. 2010 NY Slip Op 05281 (2010).

9. 845 N.Y.S.2d 833 (3rd Dept. 2007), appeal denied by, 881 N.E.2d 1197 (Ct. App. 2008), subsequent appeal, 876 N.Y.S.2d 196 (3rd Dept. 2009).

10. 850 N.Y.S.2d 740 (4th Dept. 2008)

11. EPTL §7-1.8