By: Wayne Buckwalter and Shawn R. Farrell
In 2013, only 19 states and the District of Columbia imposed inheritance or estates taxes on their residents. New Jersey is among one of the states that imposed such taxes. In fact, New Jersey has both an inheritance and an estate tax. As a result, you may have heard that some Garden State residents would rather live out their golden years elsewhere.
One only has to look at the numbers to see why. The current New Jersey estate tax exemption is $675,000, making it the lowest and most unfavorable in the nation. To put the New Jersey estate tax exemption in perspective, the current federal estate tax exemption is $5,340,000 and the current New York estate tax exemption is $2,062,500. But, unlike New Jersey, New York is taking steps to further reduce the discrepancy between New York and the federal exemption. To that end, New York will increase its exemption by slightly more than $1 million per year through 2017, meaning that New York’s exemption will match the federal exemption in 2019 and thereafter.
To illustrate the impact of New Jersey’s current estate tax law on various individual’s net worth, see the chart below:
|Estimated Estate Value||Tax|
What Does This Mean for the Average NJ Family?
Let’s look at a hypothetical retired couple living on a fixed income to determine what estate tax they would incur in New Jersey. Assume they have a home worth $700,000; $200,000 in savings; and an IRA worth $600,000. With no wills or simple wills, their children will pay $65,040 in New Jersey estate taxes, when the second spouse passes away. This hypothetical illustrates that New Jersey residents are facing taxes that are substantially higher – and in some cases not required – in 31 other states. Appropriate estate planning reduces taxes and safeguards against such disparities. For example, with an instrument such as a bypass trust, the children in this scenario will only pay $21,980.
Know the Tools to Reduce or Eliminate Estate Tax
• A Bypass Trust. As noted, a bypass trust is a useful tool for married couples seeking to lessen their estate tax liability. Through a trust or will, a spouse can direct assets up to the full exemption amount, $675,000, to be held in a bypass trust upon their death. Accordingly, at death, that amount is transferred into the trust, with the rest of the decedent’s estate being held by the surviving spouse outright. At the death of the surviving spouse, the children receive both the bypass trust assets (as successor beneficiaries to the trust) and the surviving spouse’s assets (as beneficiaries under the surviving spouse’s trust or will). Since assets in the bypass trust are not owned by the surviving spouse (held in trust for his or her benefit), they are not included in his or her estate when calculating the value of the estate for tax purposes. This can reduce the amount of estate tax liability significantly. In addition to having a properly drawn will or trust, it is vital to coordinate asset titling and beneficiary designations to take advantage of this important tool.
• Gifting. New Jersey does not have a gift tax and, therefore, lifetime gifts may be used to reduce the size of a taxable estate. While gifting has the potential to reduce New Jersey estate tax liability, it should be used carefully. For example, gifts made within three years of death are still subject to New Jersey estate tax with the exception of gifts to charities. In addition, the beneficiary of a lifetime gift may incur unforeseen and unfavorable capital gains tax consequences.
• Charitable Gifting. Charitable giving often takes the form of lifetime gifts or provisions for charities in trusts or wills. A donor may use a charitable trust to reduce the size of his or her estate while still retaining a stream of income. There are many types of charitable trusts which may benefit the donor and the donor’s children or other noncharitable beneficiaries of the donor.
• Irrevocable Life Insurance Trust. An irrevocable life insurance trust (ILIT) is an instrument used to hold life insurance policies while eliminating New Jersey estate taxes on the death benefit proceeds. The ILIT is named as the beneficiary of the life insurance policy. At death, the life insurance proceeds are held in trust for the benefit of the spouse or a partner during his or her remaining lifetime, the balance of the proceeds then passes to the children or other beneficiaries. As a result, the death benefit is not subject to New Jersey estate tax at the death of the surviving spouse or partner.
Ideas to Level the Playing Field
For many years there have been bills proposed in the New Jersey Assembly and Senate. To date, none have been enacted. Unless a bill to change the current tax regime is enacted, it is up to the taxpayers to put the pressure on legislators to take the necessary steps to level the playing field. Presently some of the pending bills include:
- Increasing the filing threshold as well as the exemption amount for the New Jersey estate tax to $1 million.
- Phasing out the estate tax over a five-year period.
- Increasing the filing threshold and exemption amount for the estate tax to $5 million over five years.
Unlike the tax reform policies being implemented in surrounding states and throughout the country, the current New Jersey estate tax system has remained unchanged since 2001. In 2012, the total state and local taxes collected in New Jersey were $51.10 billion. While there have been calls for relief and legislation has been proposed, the wheels of change move slowly. The best strategy to reduce your estate tax burden is to have a plan. The planning tools and techniques outlined above are not exhaustive. Determining and implementing the most appropriate plan and instruments should be done as soon as possible to protect your legacy.
Farrell is an owner and shareholder of Cohen Seglias Pallas Greenhall & Furman in Philadelphia. He is a member of the firm’s Construction Practice Group. Buckwalter is chairman of the firm’s Wealth Preservation Group.