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New Jersey Death Taxes Explained
On January 1, 2002, New Jersey implemented a new estate tax. The tax is applicable to all estates with assets, after allowed deductions, of $675,000.00 or more. This action was in response to reduction of the federal estate tax in tax revision legislation passed by the United States Congress as part of the Economic Growth and Tax Relief Reconciliation Act of 2001.
The new federal act increased the amount of money a person could leave to his/her heirs without paying a federal estate tax. The revised “unified credit,” the amount that can be left without paying a federal tax, was increased from $675,000.00 to $1,000,000.00 for the years 2002 and 2003 and to $1,500,000.00 for 2004 and 2005. The credit is scheduled to continue to increase until 2010 when the federal estate tax is due to be eliminated for that year and that year only. At present, the tax is scheduled to be reinstated in 2011 for all estates with taxable assets of $1,000,000.00 or more.
Prior to passage of the tax act of 2001, the State of New Jersey collected a tax on all federally taxable estates. The tax, generally referred to as a “sponge tax,” actually represented a portion of the tax due to the Internal Revenue Service. Upon completion of a New Jersey tax form, a portion of the tax due the IRS was paid instead to the State of New Jersey. The tax did not result in any additional payments by the estate. The state merely “soaked up” (as a sponge would do) the allowance permitted by the federal law.
With passage of the new law, the federal government began to phase out the states’ ability to claim the “sponge tax” and the states, as a result, lost the income realized by that tax. Thus, New Jersey responded with enactment of its own estate tax. The end result is that reduction of the federal estate tax was of only limited value to New Jersey tax payers.
The minimum New Jersey estate tax varies based on the value of the total net, taxable, estate. As the size of the estate increases the tax on the estate, expressed as a percentage, also increases. But, the tax is only imposed on net estates in excess of $675,000.00. Thus, from a tax perspective, one is concerned with those funds in excess of $675,000.00, and in that context, the tax, when compared to the excess over $675,000.00, impacts the smaller estate much harder than the larger estate.
For example, with a taxable estate of $1,000.000.00 the New Jersey estate tax is $33,200.00. The tax represents 3.32% of the total estate and 10.215% of the $325,000.00 excess. Compare that to a taxable estate of $750,000.00 for which a tax in the amount of $20,400.00 is due. The tax is 2.72% of the total estate but 27.2% of the $75,000.00 excess. With the $1,000,000.00 estate the tax payer retains $291,000.00, or 89.78%, of the excess ($325,000.00 - $33,200.00 = $291,000.00) while the tax payer with the $750,000.00 estate retains $54,600.00, or 72.8%, of the excess ($75,000.00 - $20,400.00 = $54,600.00).
This result, while it may seem at first incorrect, comes about because once the taxable estate exceeds $675,000.00 the tax is calculated from “dollar one.” Thus, smaller, taxable estates in reality pay a disproportionately higher tax.
And, if the estate is in excess of $1,500,000.00, a federal tax could also be due. The first $1,500,000.00 is the federal “unified credit” to which all tax payers are entitled. It is this credit which keeps estates of less than $1,500,000.00 from paying federal estate taxes. It is also important to bear in mind that estates passing between spouses do not incur any state or federal estate tax.
In addition to the previously described estate tax, New Jersey also collects an inheritance tax on all estates. An inheritance tax differs from an estate tax in that the inheritance tax is imposed on the gift passing to certain categories of beneficiaries. Inheritances by spouses, children, grandchildren and parents of the deceased do not result in the imposition of an inheritance tax. Similarly, gifts to charities and gifts of less than $500.00 do not result in inheritance tax liability. All other gifts, subject to certain allowances, result in imposition of the tax.
For example, gifts to a brother or sister require payment of an inheritance tax, subject to a $25,000.00 deduction. In other words, and for example, a gift of $50,000.00 to a brother results in a tax of 15% (the current tax rate applicable to siblings) on the second $25,000.00 or a liability of $3,750.00. In this example, the brother would inherit, either by will or intestacy (this means the deceased died without a will), $50,000.00, but would receive $46,250.00 after the tax was paid.
It is important to understand that an estate tax is the obligation of the estate while an inheritance tax is the obligation of the person who receives the gift. In both cases, however, the tax is actually paid by the executor of the estate. And, both taxes could be due in any given estate depending on how the deceased planned for his or her demise.
Proper planning can, in many cases, entirely eliminate the estate tax and, in all cases, planning can reduce the tax obligation. Merely passing all assets to one’s spouse will eliminate all estate and inheritance taxes. The potential problem with this approach is that passing all assets to the surviving spouse can result in creation of a taxable estate at the death of the second spouse.
Use of credit shelter trusts and proper allocation of assets can, in all cases where a married couple have up to $1,350,000.00 in assets, eliminate the New Jersey estate tax in its entirety. This approach uses to maximum advantage the first $675,000.00 of the estate which will generally pass tax free with proper planning. And, assuming the ultimate beneficiaries of the estate are children of the deceased (or even grandchildren), then no inheritance tax will be due either.
Other approaches to tax planning (and saving) may also be available depending on the particular facts of the case. Therefore, one should seek the advice of an estate planning specialist before drafting estate planning documents.