New Jersey is one of only a few states that impose both an inheritance tax and a state estate tax. The inheritance tax applies when someone who lived in New Jersey, or owned property there, leaves property to someone who is not a close relative. The tax rate depends on how closely the inheritors and deceased person were related.
(1) How are inheritors classified?
The transfer inheritance tax is imposed, at graduated rates, on property having a total value of $00 or more that passes from a decedent to a beneficiary. New Jersey classifies inheritors into different groups, based on their family relationship to the deceased person.
a. Class A Beneficiaries
Class A beneficiaries are exempt from the inheritance tax. They include the decedent’s:
• Spouse, domestic partner, or civil union partner;
• Parent or grandparent;
• Child (biological, adopted, or mutually acknowledged);
• Stepchild (but not step-grandchild or great step-grandchild);
• Grandchild or other lineal descendant of a child.
b. Class B Beneficiaries
Class B was deleted when New Jersey law changed.
c. Class C Beneficiaries
Class C includes the decedent’s:
• Brother or sister;
• Spouse or civil union partner of the deceased person’s child;
• Surviving spouse or civil union partner of the deceased person’s child.
The first $25,000 of property inherited by someone in Class C is not taxed. On amounts exceeding $25,000, the tax rates are:
• Next $1,075,000: 11%
• Next $300,000: 13%
• Next $300,000: 14%
• Over $1,700,000: 16%
d. Class D Beneficiaries
Class D includes everyone else. There is no special exemption amount, and the applicable tax rates are:
• First $700,000: 15%
• Over $700,000: 16%.
e. Class E Beneficiaries
Class E includes the State of New Jersey or any of its political subdivisions for public or charitable purposes, an educational institution, church, hospital, orphanage, public library, and some other nonprofit agencies. These beneficiaries are exempt from inheritance tax.
(2) Other Inheritance Tax Exemptions
Other tax exemptions apply to all beneficiaries, in every legal classification. The New Jersey inheritance tax is not collected on:
• Transfers of less than $500;
• Life insurance proceeds paid to a named beneficiary;
• Charitable transfers for the use of an educational institution, church, hospital, public library etc.;
• Payments from the New Jersey Public Employees Retirement System, the New Jersey Teachers’ Pension and Annuity Fund, or the New Jersey Police and Fireman’s Retirement System;
• Federal Civil Service Retirement benefits payable to a beneficiary other than the deceased person’s estate;
• Annuities payable by the U.S. government under the Retired Serviceman’s Family Protection Plan or the Survivor Benefit Plan to a beneficiary other than the estate.
(3) Tax Planning Technique: Reducing the Size of the Estate Through Gifting During the Decedent’s Lifetime
In the simplest terms, the smaller the size of a client’s estate, the smaller the liability is for the Federal and New Jersey estate tax. Gifting can reduce the size of a client’s estate.
a. Reducing the Size of Estate Through Gifting
Under the gift tax laws, there are three primary ways to make non-taxable gifts: (1) the annual exclusion, IRC § 2503(b) (currently $14,000 per year per recipient); (2) the unlimited gift tax marital deduction, IRC § 2523; and (3) the gift tax exemption, IRC § 2505. In order to be valid gifts, however, the donor must relinquish all control over the gift. Treas. Reg. 25.25.11-1(b). For example, a father may not give stock to his son but retain dividends for his own use.
It is critical to recognize that the gift tax is payable by the donor, the person making the gift, and not the donee, the person receiving the gift. IRC § 2502(c), Treas. Reg. 25.2502-2. The donee need not pay income tax on the amount of the gift. IRC § 102. However, the donor is not permitted to claim a deduction for the amount of the gift.
In addition to his or her own annual exclusion, an individual may use his or her spouse’s annual exclusion with the spouse’s consent. If the donee’s gift is $14,000 or less, then the individual need not file a gift tax return. However, if one spouse makes a gift and uses the other spouse’s exemption, a gift tax return must be filed in order to memorialize the other spouse’s consent. See IRC § 6019 and Treas. Reg. 25.6019-2.
Gifts are by no means limited to cash. Indeed, they can be made with anything of value. The following are just a few examples of gifts: (1) real estate or partial interests in real estate, (2) stock, (3) bonds, (3) life insurance, (4) annuities, (5) income from a trust, (6) creation of a joint bank account, and (7) articles of personal value.
b. Unlimited Gift Tax Marital Deduction
The second important gift tax provision is the unlimited gift tax marital deduction. Under the Economic Recovery Tax Act of 1981, any gifts from one spouse to another are completely tax free. IRC § 2523. Neither spouse needs to file a tax return for a transfer by gift with respect to which a marital deduction is allowed under IRC § 2523 or IRC § 6019. The unlimited marital deduction is not available for gifts made to a spouse who is not a U.S. citizen.
c. Gift Tax Exemption
The third important gift tax provision is the gift tax exemption.
d. Death Bed Gifts – Beware!
Generally speaking, gifts are subject to the New Jersey inheritance tax if made “in contemplation of death.” The natural corollary to this rule is that gifts not made in contemplation of death are not subject to the New Jersey inheritance tax. Therefore, the operative phrase here is “in contemplation of death.”
The one caveat to this rule is if the recipient is among the class of beneficiaries exempt from the inheritance tax under the rules discussed above. In all other cases, such property is included in the decedent’s gross estate even if its’ value is less than the annual gift tax exclusion amount of $14,000.
If whether a gift is taxable depends on whether it is made in contemplation of death, then it is critical to know how that term is defined under New Jersey law. Under New Jersey law, a rebuttable presumption exists. And that presumption is that any gift made within three years of death is one made in contemplation of death. As such, it is taxable. If case law is any indication, that presumption is very difficult, if not impossible, to rebut.
An example will help illustrate the impact of the rebuttable presumption. John has a life insurance policy. On January 1, 2010, John transfers ownership of that policy to his friend, Fred. John dies on January 1, 2012. Are the proceeds of that life insurance policy included in John’s gross estate? Yes. Why? Because John transferred his life insurance policy to Fred within two years of his death and under the rebuttable presumption, gifts made within three years of death are in contemplation of death. Unless the presumption can successfully be rebutted, which is doubtful, the proceeds of the life insurance policy will be included in John’s gross estate. And if they are included in John’s gross estate, they will be taxed.
The rationale for why the proceeds of the life insurance policy are included in John’s gross estate is quite simplistic: had John not transferred ownership of the policy to Fred in the two years prior to his death, then the proceeds of the policy would have been included in his gross estate under IRC § 2042.
(4) Filing the Inheritance Tax Return
The personal representative of the estate (executor or administrator) must file an inheritance tax return. Only one return needs to be filed, even if several people owe inheritance tax.
New Jersey inheritance tax returns (Form IT-R, if the deceased person was a New Jersey resident), instructions, and current tax rates are available on the New Jersey Division of Taxation website. The tax return, along with copies of the will (if any) and the decedent’s last federal income tax return, must be filed with the New Jersey Division of Taxation.
The return must be filed, and any tax paid, within eight months of the date of death. Interest accrues on any unpaid tax. The state can grant an extension of up to four months to file the return, but the tax must still be paid by the original deadline.
(5) Inheritance Tax Waivers
Certain property can’t be transferred out of the estate until the inheritance tax is paid and the state issues a tax waiver. If no tax is due, a Class A beneficiary can file a “Request for Real Property Tax Waiver.” If the waiver is granted, an inheritance tax return need not be filed.