Estate Planning: New Jersey Style

By: Richard Marmon 

If you are presently a resident of New Jersey, or are planning a move to the Garden State in the near future, you may want to consider an often overlooked potential tax assessment – the New Jersey Estate Tax.  Most people already know that real estate taxes are downright confiscatory in the Garden State, but many do not realize that New Jersey also boasts the highest estate tax in the United States and is one of only two states that impose both an estate tax and an inheritance tax. 

The calculation of the New Jersey estate tax requires navigating a convoluted sequence of Federal estate tax rules as they existed in 2001 and adjusting for any state inheritance tax paid. The reason for this is that the New Jersey Estate Tax was originally a “sponge” tax that siphoned off the state death tax credit allowed on the Federal estate tax return. That is, New Jersey imposed an Estate Tax equal to the amount that was allowed to reduce the Federal Estate Tax.  Ever since Congress began phasing out this state tax credit after 2001, it was finally phased out in 2005 and replaced by a deduction for estate taxes paid, New Jersey scrambled to find a convenient way to recoup the lost revenue. Their response was to enact legislation that imposes an estate tax equal to the state death tax credit that would have been allowed on the Federal return if the decedent had died in 2001.

Many individuals who may not be subject to a Federal estate tax, now that the exclusion amount is $5.45 million, may still be on the hook for the New Jersey estate tax. And the amount is not insignificant – the first $52,175 over the exclusion amount is taxed at a rate of 37%.  The tax is computed on assets that you own as of the date of death – even those that pass outside of your Will, known as “non-probate” assets, like a home owned jointly with a spouse. Estate assets include all New Jersey real estate; stocks and bonds; bank accounts; certificates of deposit; retirement funds; proceeds from insurance policies owned by the decedent; vehicles; household furnishings; jewelry; business interests; and numerous other beneficial interests provided for in the Internal Revenue Code.

Estate Planners employ many strategies and techniques for reducing or even eliminating the Federal and State death taxes.  However, it is not a “one size fits all” approach. For instance, gifting is usually an effective way to reduce one’s estate; but it may not be effective at fully eliminating the New Jersey estate tax and inheritance tax.  This is because some taxable gifts made during one’s life that exceeds the Federal gift tax annual exclusion amount (currently $14,000 per year per donee) are added back to the estate in determining New Jersey filing requirements.  Also, proceeds of any life insurance policies that are transferred to an irrevocable life insurance trust within three years of death are part of the gross estate. The gross estate determines whether a tax return is required to be filed, while the taxable estate, computed by subtracting allowable deductions from the gross estate, determines whether there will be an estate tax to pay.

Another planning technique to reduce one’s taxable estate is to take advantage of the unlimited marital deduction.  Like the Federal estate tax, any amount left to a spouse will be completely exempt from the New Jersey estate tax on the death of the first spouse.  This exemption also applies to the New Jersey inheritance tax for bequests made to spouses, children, grandchildren, and parents.

The unlimited marital deduction is generally effective for eliminating the Federal estate tax on most estates, especially in light of the new “portability” provisions. These rules allow a surviving spouse to utilize the deceased spouse’s unused exemption amount which is equivalent to leaving a taxable estate of $5.45 million free of tax. In other words, a surviving spouse can effectively leave an estate of $10.9 million, free of Federal estate tax, if a timely election is made on a properly filed estate tax return, for the estate of the predeceased spouse. No analogous provision is made in computing the New Jersey estate tax. This is why it is generally poor planning for couples with modest New Jersey estates to leave their assets to each other – all this does is postpone the imposition of the New Jersey estate tax, not eliminate it.

So what can be done? Typically, a credit shelter trust is established either while living or at death. This type of trust is designed to shelter the New Jersey exemption equivalent amount (currently $675,000) from the State estate tax, while leaving the remaining amount either outright to a spouse or in another trust called a QTIP trust. This second trust is designed to qualify for the unlimited marital deduction upon election by the trustee/executor. The purpose of the credit shelter technique is to take full advantage of each spouse’s State estate tax exemption amount while providing the surviving spouse access to the income and principal for their health, education, and support. Remember, there is no ability of a surviving spouse to use the deceased spouse’s unused exemption amount, as permitted in calculating the Federal estate tax, to shelter against the New Jersey estate tax without the use of that. In this way, a couple can ultimately leave $1.35 million free of New Jersey estate tax.

To effectively maximize each spouse’s New Jersey exemption amount, it is typically necessary to re-title certain marital assets so that each spouse has, at least, $675,000 of assets in their name. In this way, the credit shelter trust absorbs the exemption amount available to each spouse free of tax, with any remaining assets either (i) paid outright to the surviving spouse, or (ii) left in a second trust for the spouse.  In either case, these assets will qualify for the unlimited marital deduction. Upon the death of the surviving spouse, all the remaining assets in the trust, along with any appreciation in those assets, are distributable tax-free to the beneficiaries named in the trust.

The strategies mentioned in this article highlight some of the main planning techniques used to reduce the burden of the New Jersey estate tax. Individuals domiciled in New Jersey, or those planning a move to the Garden State in the near future, should consider meeting with one of our estate planning professionals to review their current estate plan to assure it is consistent with their wishes while maximizing any available tax savings.

For questions, comments or additional information, please contact Rick Marmon, member of our Estates & Trusts Group at rmarmon@regerlaw.com or via phone at 856.778.8950.