The Changing Landscape of New Jersey's Estate Tax
March 29, 2017
On October 14, 2016, New Jersey went from having one of the most oppressive death tax regimes in the U.S. to having one of the most generous. But will it last? As part of the negotiations to save New Jersey’s transportation trust fund, Governor Christie provided expansive relief to estates, as well as other concessions, in exchange for a hefty 23 cent per gallon increase in the gasoline tax. Giving credence to Einstein’s observation that taxation is “the hardest thing in the world to understand,” New Jersey’s legislature did not disappoint. Young retail clerks will have a hard time figuring out the new 6.625% sales tax, down from 7%; but they’ll have two years to master its phase-in. On the other side of the equation, estate planning attorneys will be busy reviewing prior estate plans with clients in light of the new laws, or crafting new documents to accommodate the increase in the estate tax exclusion amount (the amount of a decedent’s estate not subject to New Jersey estate tax) from $675,000 to $2,000,000 for decedents dying after December 31, 2016.
Under the new law, the New Jersey estate tax is to be repealed effective January 1, 2018. However, New Jersey has retained the New Jersey inheritance tax. Consequently, estates leaving property to anyone other than exempt individuals including spouses, children, and their descendants, may still face significant inheritance taxes regardless of the repeal of the estate tax. The inheritance tax ranges from 11% to 16% depending upon the degree of relationship between the beneficiary and the deceased. Bequests to siblings or spouses of children, which exceed $25,000, fall within this range, and inherited property exceeding $500 by all other non-exempt beneficiaries, are taxed at rates between 15 percent and 16 percent. Additionally, it should be noted that nonresidents of New Jersey, if they are not exempt individuals, may be subject to New Jersey inheritance tax; although, they are not subject to the New Jersey estate tax.
Certain transfers are exempt from the inheritance tax, such as some retirement plan assets and proceeds from life insurance payable to a named trust or beneficiary. However, gifts and certain other transfers made within three years of death are subject to tax.
Added to the complexity of these recent changes affecting the taxation of New Jersey estates is the possible changes to the Federal estate tax laws. President Trump has suggested repealing the Federal estate tax altogether and instituting a capital gains tax on estates. This would represent a significant departure from the current estate tax. Currently, there is an unlimited marital deduction at both the federal and state level. This means that a decedent may leave their entire estate to a surviving spouse free of Federal or state estate taxes. If a capital gains tax takes the place of the Federal estate tax, it is uncertain whether a deferral of the tax will be permitted by utilizing the marital deduction. Also, there is uncertainty as to whether the gift tax will remain in force in the event of a Federal estate tax repeal. If the Federal estate tax is repealed, it may have dramatic effects on estate plans that are currently in force, especially if New Jersey reinstates its estate tax. For instance, the provision permitting an election to qualify a trust as eligible for the marital deduction (a so-called QTIP election), will be unavailable and may disrupt certain trusts from qualifying for the New Jersey estate tax marital deduction.
Regardless of whether there is a future change in the Federal estate tax laws, estate planning for New Jersey residents remains very complex because of the former "decoupling" of the state estate tax from the Federal estate tax. Often, many estate planning strategies implement formula bequests using one or more trusts that are linked to either the federal or state estate tax exemption amounts or a combination of the two. For instance, in a typical situation a credit shelter trust or family trust, would be established to absorb the largest amount of assets without increasing federal or state estate taxes upon death – last year, this amount would have been capped at $675,000. A second trust, known as the marital trust, would provide for a mandatory distribution of income to the surviving spouse for life, and would receive whatever assets did not flow into the first trust. Due to the increasing and planned elimination of the New Jersey estate tax, these formulas, if left unaltered, may result in amounts being transferred into one or more trusts that conflict with the testator’s intent. In some cases, a formula clause may act to disinherit a child or even a surviving spouse. Indeed, many commentators predict that future litigation over interpretation of wills and revocable trusts, triggered by these formula clauses, will result from unintended dispositions as the tax laws change around those pre-existing provisions.
In the event that all estate taxes disappear, some may conclude that sophisticated estate planning is not required. However, there will always remain significant practical reasons for estate planning, including providing for minor or disabled beneficiaries, addressing special situations resulting from second marriages, and asset protection planning, all of which would still warrant the use of trusts and other planning devices. Some simple fixes to current estate plans given the uncertainty of death taxes may involve redrafting wills to provide for outright distributions to a surviving spouse with a disclaimer provision granting the surviving spouse the right to redirect any portion of the assets to a credit shelter trust. This plan would most likely be used in situations where spouses have only been married once with children solely from that marriage. In the alternative, decedents may transfer all of their assets into a trust to provide income to the surviving spouse and then giving the executor or other third-party the discretion to make an election to qualify all or part of the trust for the marital deduction.
With the new tax breaks on retirement income exempting almost 85% of New Jersey retirees from income tax, New Jersey is beginning to look more and more like the Florida tax haven to which many residents flee. However, it’s not likely that New Jersey will retain a zero percent tax on all estates following the Christie administration. Even assuming another Republican governor will succeed him, the State will soon be looking for ways to fill the $522 million dollar budget deficit resulting from the estate tax repeal. Whatever the outcome of the political landscape, New Jersey residents will still need to look for creative ways to minimize Federal estate tax, Federal and state income tax, and New Jersey inheritance tax. Accordingly, many estate plans will likely need to be reviewed and revised to avoid unintended results.