The New Jersey estate tax was repealed effective January 1, 2018. Coupled with the significant increase in the federal estate and gift tax exemption ($11.4 million in 2019), the repeal has reduced the need for transfer tax planning by many New Jersey residents. However, because the New Jersey inheritance tax remains in place, clients must still consider the effect of the inheritance tax upon their estate plans.
New Jersey is one of six states that have an inheritance tax, the others being Iowa, Kentucky, Maryland, Nebraska and Pennsylvania. New Jersey’s rates begin at 11% and rise to 16%. N.J.S.A. 54:34-2. The inheritance tax applies to gifts at death, or within 3 years of death, to beneficiaries who are separated into different classes based upon the relationship of the decedent to the beneficiary. N.J.S.A. 54:34-1 and 54:34-2. Class A beneficiaries (spouses, civil union partners, direct descendants, direct ancestors, and stepchildren) are exempt from the tax. Class B was eliminated as a category in 1963. Class C beneficiaries (siblings, sons- and daughters-in-law, and civil union partners of children) receive a $25,000 exemption and are taxed at rates ranging from 11% to 16%. Class D beneficiaries (everyone else) are taxed at 15% on bequests up to $700,000, with a rate of 16% for amounts above $700,000. Qualified charities are Class E beneficiaries and gifts to them are exempt from application of the tax.
There is no exemption from the New Jersey inheritance tax based upon the size of one’s estate. Even transfers from a very modest estate will incur the tax if the recipients are in a taxable category. The inheritance tax is assessed against the recipients unless the will directs otherwise. Executors are charged with deducting the tax from the bequests before distributing to the beneficiaries. N.J.S.A. 54:35-6.
When the New Jersey estate tax was in effect, if an estate was subject to inheritance tax and estate tax, the effect was that the higher of the two taxes was due because the estate received a credit for taxes paid. Estates usually were in the position of paying New Jersey estate tax rather than inheritance tax. Thus for estates in excess of the New Jersey estate tax exemption amount ($2 million in 2017), if a will primarily benefited a decedent’s children but included small gifts to non-Class A beneficiaries such as cousins, nieces and nephews, the inheritance tax often was less than the estate tax and therefore did not increase the total transfer taxes owed by the estate.
Now that there is no New Jersey estate tax, small bequests that are subject to New Jersey inheritance tax can incur a tax, which result is often unexpected. If a decedent dies with a $3 million estate bequeathed outright mostly to his children, and the will includes bequests of $20,000 to each of 5 nieces and nephews, the inheritance tax will be $15,000. This necessitates the preparation and filing of a New Jersey inheritance tax return that would have been avoided if all bequests were to Class A recipients. The need to prepare the tax return can add to the expense of the estate administration as well as lengthen its duration.
Step-families can present special challenges. While stepchildren are Class A beneficiaries and therefore transfers to them avoid the tax, step-grandchildren are Class D beneficiaries. A bequest in a will to a step-grandchild will incur inheritance tax.
Appropriate planning may allow gifts to desired recipients in a way that avoids inheritance tax. There are several types of assets that are not subject to the tax, such as federal civil service retirement benefits and life insurance payable to a named beneficiary. N.J.S.A. 54:34-4. Because the inheritance tax is not applicable to insurance proceeds payable to an individual beneficiary, it is possible to use life insurance to transfer assets to non-Class A beneficiaries such as nieces, nephews, cousins and friends without incurring an inheritance tax. Another possibility is to establish an irrevocable trust during life and make transfers to the beneficiaries from the trust rather than from the estate. N.J.S.A. 54:34-4.c.
If you have questions about the applicability of the New Jersey inheritance tax to your estate plan, attorneys at Lindabury, McCormick, Estabrook & Cooper are always happy to speak to you about your estate planning concerns.