Recent Changes to the New Jersey Estate Tax

On October 14, 2016, Governor Christie signed important new tax legislation into law affecting New Jersey residents.  At the heart of the new law is an increased gas tax, but various tax breaks were included as a compromise for New Jersey residents and their heirs.  Under the new law, the New Jersey estate tax exemption is increased to $2,000,000 in 2017^[1] and the estate tax is eliminated for deaths occurring on and after January 1, 2018.

The changes to the New Jersey estate tax require a review of existing estate planning documents.  Many current planning documents provide for the funding of one or more trusts upon the first spouse’s death, a historically common plan aimed at preserving the deceased spouse’s estate tax exemption, while simultaneously deferring estate tax until the survivor’s death.  It is important for New Jersey residents to review their existing planning documents considering the recent changes to the New Jersey estate tax, particularly to ensure that their documents remain consistent with their current intentions and that the use of prior funding formulas does not cause unintended results.

The remainder of this article provides a brief summary of the current estate and inheritance taxes imposed in New Jersey, the changes made to such taxes by the new legislation and addresses planning considerations.

Two Separate Death Taxes Imposed

New Jersey currently imposes two separate and distinct taxes on estates of resident decedents: (1) an inheritance tax; and (2) an estate tax.  The inheritance tax is focused on the relationship between the decedent and the transferee receiving assets from the decedent’s estate, while the estate tax is concerned with the net value of the decedent’s estate.  There is a credit against estate tax for inheritance tax paid; therefore, only the greater of these two taxes is actually paid.

New Jersey Inheritance Tax

The New Jersey inheritance tax is imposed on transfers of property at death exceeding $500 in value (and certain transfers having occurred within three years of death) to individuals other than a parent, spouse, child, grandchild or any other lineal descendant of the decedent.  Because the inheritance tax is based upon the relationship of the beneficiary to the decedent, the applicable tax rate imposed on the transfer and the exemption amount vary depending upon whether the transferee is classified as a Class A, C, D or E beneficiary.  The chart below illustrates the distinctions among the various classes.

The inheritance tax is imposed not only on transfers by will and intestacy, but also transfers within three years of death, transfers intending to take effect at or after the decedent’s death and transfers of property at death by joint ownership (although a transfer of New Jersey real estate held between spouses as “tenants by the entirety” is not taxable).

The inheritance tax is generally imposed on all the above-listed transfers of a resident decedent at or in contemplation of death; however, real estate and tangible personal property of a New Jersey resident decedent located outside of New Jersey are not subject to inheritance tax.  Proceeds of life insurance payable to a named beneficiary other than the decedent’s estate and certain retirement accounts are also exempt from inheritance tax.  Any inheritance tax required to be paid is due within eight months of the death.

The typical scenario is to leave property to, or in trust for, a surviving spouse, and then subsequently to children and/or grandchildren, in which case no inheritance tax is due.

New Jersey Estate Tax

Unlike the inheritance tax, the New Jersey estate tax only applies to estates of decedents who were domiciled in New Jersey at the time of death.  Also unlike the inheritance tax, which is based upon the relationship of the beneficiary to the decedent, the New Jersey estate tax is imposed only on estates that exceed $675,000^[2] in value.

For deaths occurring in 2016 where the gross value of the estate less deductions (including marital and charitable deductions) exceeds $675,000, tax is imposed on the estate at rates ranging from 4.8% to 16% depending upon the net value of the estate.  Any estate tax required to be paid is due within nine months of the decedent’s death.

Phase-Out of the New Jersey Estate Tax;

Inheritance Tax Remains in Place

 The new tax law increases the estate tax exemption for New Jersey residents dying in 2017 from $675,000 to $2,000,000, and eliminates the New Jersey estate tax altogether for deaths occurring on and after January 1, 2018.  No changes have been made to the inheritance tax, however, which will continue to be imposed where a taxable transfer occurs.

Planning Considerations

New Jersey residents should have their estate planning documents reviewed considering the changes to the New Jersey estate tax.  Many documents contain a “formula” clause directing that a trust be funded at the first spouse’s death equal to the decedent’s state or remaining federal estate tax exemption.  In light of changes in the tax laws, this type of planning should be re-evaluated so that a determination can be made on a case-by-case basis whether such plan continues to serve a legitimate purpose or whether it could lead to unintended consequences if left in place.

Many New Jersey residents may find that the phase out of the New Jersey estate tax may help simplify their estate plan.  Under federal law, the estates of U.S. citizens and U.S. resident decedents are not subject to estate tax unless the taxable estate plus adjusted taxable gifts made during lifetime exceeds $5,450,000 (increased to $5,490,000 in 2017 as an inflation adjustment).  The concept of portability^[3] allows for the unused estate tax exemption of the deceased spouse to be transferred to his or her surviving spouse if certain requirements are met and a timely election is made on a complete and properly prepared federal estate tax return.  Thus, in most situations, spouses can together pass almost $11,000,000 to their heirs without incurring federal estate tax.

Although the new tax law repeals the New Jersey estate tax for deaths occurring on and after January 1, 2018, a new governor will be elected next year who will take office in January 2018.  Depending upon the political and budgeting views of the newly elected official, it is possible that efforts may be made to reinstate the estate tax, likely with an increased exemption amount (possibly at $2,000,000, unified with the federal exemption or some other figure in between).

Thus, even in situations where the direct funding of a trust upon the first spouse’s death may no longer be necessary, the inclusion of a disclaimer trust within planning documents is important and should be considered in most cases.  Disclaimer planning allows the surviving spouse an opportunity to evaluate the existing tax laws upon the death of his or her spouse as well as his or her own tax and  non-tax objectives so that a decision can be made regarding whether assets should be disclaimed into the Disclaimer Trust created under the decedent’s will or revocable trust, which can provide for the primary benefit of the surviving spouse.

For those with much larger estates, appropriate federal tax planning should still be considered.  In 2018, this type of planning may also be simplified as traditional credit shelter trusts (also known as family or by-pass trusts) may be fully funded at the first spouse’s death (so that the appreciation is not subject to estate tax upon the subsequent death of the surviving spouse) without incurring substantial New Jersey estate tax when doing so.[4]

It is important to keep in mind, however, that while taxes play a significant role in estate planning, other factors such as second marriages, young or disabled beneficiaries, and creditor concerns continue to justify the use of trusts in an estate plan.  Additionally, the transfer of certain assets upon death require New Jersey tax waivers, the obtaining of which can delay access to cash and transferring assets to beneficiaries.  Tax waivers are one factor to consider when determining whether the implementation and funding of a revocable trust during a lifetime is beneficial as the tax waiver requirement does not apply to assets transferred to a revocable trust during lifetime.

Lastly, the new law does not make any changes to the New Jersey inheritance tax.  New Jersey residents (and non-residents owning New Jersey real estate) who intend to benefit individuals other than Class A beneficiaries should consider the impact of the inheritance tax, address tax clauses in planning documents and consider available planning options.

Disclaimer:  This summary of legal issues is published for informational purposes only.  It does not dispense legal advice or create an attorney-client relationship with those who read it.  Readers should obtain professional legal advice before taking any legal action.

[1] The New Jersey estate tax is currently based upon the federal estate tax laws existing in 2001, which provide a $675,000 exemption.

[2] However, the new tax law increases the exemption for deaths occurring in 2017 and eliminates the New Jersey estate tax for deaths occurring on and after January 1, 2018.

[3] Portability generally permits a surviving spouse to use the most recent deceased spouse’s unused exemption, effectively avoiding any waste of a first-to-die spouse’s remaining exemption.

[4] The 2016 and 2017 New Jersey estate tax exemptions remain less than the $5,450,000 federal exemption ($5,490,000 in 2017); therefore, the full funding of a credit shelter trust equal to the decedent’s unused federal estate tax exemption may trigger substantial New Jersey estate tax upon the death of the first spouse.