Don’t Forget About New Jersey Inheritance Tax when Doing New Jersey Estate Planning
The New Jersey state estate tax was repealed as of January 1, 2018. The absence of a state estate tax, coupled with the current generous federal lifetime gift and estate tax exemption ($12.06 million in 2022), has led to a decreased need for estate tax planning for many New Jersey residents.
However, beware of the New Jersey inheritance tax, which remains very much in effect and can have significant tax consequences for transfers by New Jersey residents, as well as non-New Jersey residents involving transfers of New Jersey real estate and tangible property, to certain “non-exempt” beneficiaries. The inheritance tax applies to transfers that occur either: (1) at death, or (2) in contemplation of death or which are intended to take effect at or after death.
Transfers to certain classes of beneficiaries are exempt from the New Jersey inheritance tax. These classes include (i) so-called “Class A beneficiaries”, consisting of spouses, civil union or domestic partners, parents, grandparents, children, stepchildren and grandchildren of the donor; and (ii) “Class E beneficiaries”, consisting of qualified charitable organizations and certain other institutions.
All other beneficiaries who are not included in Class A or Class E are not exempt and transfers to these individuals are subject to the New Jersey inheritance tax. Moreover, unlike the federal estate tax regime which provides a generous exemption amount, New Jersey inheritance tax is generally imposed on the first dollar of the gift, subject to limited exceptions.
Transfers to Class C beneficiaries, which include siblings, and sons-in-law and daughters-in-law of the donor, receive a $25,000 exemption from the New Jersey inheritance tax but are then taxed at a progressive tax system on amounts that exceed $25,000, starting at 11% for the next $1,075,000 and ultimately going to 16% on all transferred amounts that exceed $1,700,000.
Transfers to Class D beneficiaries, which consists of nephews, cousins, step-grandchildren, and anyone else without a familial relation to the donor, incur an inheritance tax at a tax rate of 15% on the first $700,000 of the transfer and 16% on all amounts that exceed $700,000. It should be noted that transfers with an aggregate value of less than $500 to any beneficiary are exempt from New Jersey inheritance tax.
Consequently, if a decedent dies with a $800,000 estate left mainly to the decedent’s kids, but which includes a gift of $100,000 to a nephew, the total New Jersey inheritance tax from this gift is $15,000 (15% on the $100,000). If New Jersey inheritance tax applies, this necessitates the preparation and filing of a New Jersey inheritance tax return, which must generally be filed and the inheritance tax paid within 8 months of death (or interest will accrue on inheritance tax owed), that would have been avoided if all bequests were to exempt recipients.
There are some ways to plan around New Jersey inheritance tax.
First, certain types of transfers are exempt. For example, a life insurance payable directly to a named individual beneficiary is exempt from New Jersey inheritance tax, including when the beneficiary is an otherwise non-exempt Class C or Class D beneficiary. So, for example, instead of transferring $100,000 to your favorite nephew on death (whether as a beneficiary named in your Will or naming him as a “payable on death” beneficiary of your bank account), which would result in a $15,000 New Jersey inheritance tax bill, you could name the nephew as the beneficiary of a $100,000 term life insurance policy. This strategy would avoid any New Jersey inheritance tax liability. In addition, while very narrow, the transfer of the rights to payments out of various New Jersey and federal government retirement funds are also exempt from New Jersey inheritance tax.
In addition to bequests under a will, New Jersey inheritance tax applies to gifts taking effect at death, gifts made in contemplation of death, or gifts which are intended to take effect at or after death. Because New Jersey does not impose an independent gift tax, there can be a significantly different transfer tax cost depending upon when a gift is made. Gifting while alive, whether directly to a non-exempt beneficiary or via the creation of certain types of trusts which benefit a non-exempt beneficiary, may not have New Jersey inheritance tax consequences. However, if the donor dies within 3 years of making such gifts, the transfer is presumed to have been made in contemplation of death and therefore would likely be subject to New Jersey inheritance tax. It is important to consider timing, the health of the donor, the potential tax implications and other factors before making any significant gifts.
An example of the importance of the language in the applicable controlling documents and its impact on New Jersey inheritance tax can be shown from the differing findings in two recent New Jersey decisions that involve individuals leaving a principal residence to a non-exempt beneficiary, while both remaining in the home during the remainder of their lives.
In the Van Riper decision, which was ultimately affirmed by the New Jersey Supreme Court (the highest court in New Jersey)[1], a husband and wife transferred their principal residence to an irrevocable joint trust which was structured to allow them to either live in the principal residence for life or if sold, the sales proceeds would be utilized for another residence where they could live for life. At the death of the second of the spouses to die, their niece received what remained in the trust. More than 3 years after the establishment of the trust, upon the death of the second spouse, who lived in the principal residence until her death, it was determined that New Jersey inheritance tax would be imposed upon the fair market value of the residence. The court reasoned that the “life interest” retained in the trust transformed the gift (i.e, the transfer of residence to the non-exempt niece beneficiary) into a gift intended to take effect at death, and hence well within the purview of the New Jersey inheritance tax regime.
In contrast, in the Shedlock decision,[2] an individual deeded a two family home to his two nieces where there were no provisions that gave him any rights to the home thereafter. Notwithstanding, this individual continued to live in the property, collect rent from a tenant which he deposited into a joint savings account with one of his nieces and even reported the rental income on his federal tax return. When he died more than 3 years after the date of deed transfer of the residence, still living in the residence, there was no New Jersey inheritance tax imposed. As was noted in the decision, he had no rights in the property after the transfer and everything was done at the discretion of his nieces, the owners of the property, such that there was no New Jersey inheritance tax owed as the gift was completed more than three years before his death.
In summary, you need to keep the New Jersey inheritance tax in mind when you are doing estate planning if you are either a New Jersey resident or a non-New Jersey resident with New Jersey real estate and tangible property.
[1] Estate of Mary Van Riper v. Director, Division of Taxation, 456 N.J. Super.314 (App. Div. 2018), affirmed on Feb. 5, 2020 by New Jersey Supreme Court. It should be noted that this decision involved some complex issues which are outside the scope of this article and its limited summary of the decision.
[2] Valerie Shedlock v. Director, Division of Taxation, 31 N.J. 175 (Tax 2019), affirmed on August 26, 2020 by New Jersey Superior Court, Appellate Division, in an unpublished opinion.
