New Jersey Inheritance Tax: Planning Considerations in Light of Repeal and Possible Federal Changes

By:
Martin M. Shenkman, Esq., Glenn A. Henkel, Esq., Richard Greenberg, Esq., Alan A. Davidson, Esq. and Andrew Wolfe, Esq.
Published Date:
Apr 1, 2017

Only about 18 states have an estate tax. New Jersey recently repealed its estate tax effective Jan. 1, 2018, but it remains one of a handful of states that will still have an inheritance tax: a tax on beneficiaries receiving a bequest. The inheritance tax will come as a shock to many affected by it, particularly given the recent repeal of the state’s estate tax. The fate of the New Jersey inheritance tax remains uncertain in two distinct ways. First, if the Trump administration repeals the federal estate tax, it might be more difficult for any state to retain any type of death tax. On the flip side, many commentators are concerned that budget pressures will force New Jersey to reinstate the estate tax. Practitioners must deal with New Jersey inheritance tax issues amidst all this uncertainty. 

The New Jersey inheritance tax is assessed on a schedule based on the relationship of the beneficiary. One of the areas of uncertainty is how New Jersey will treat trusts that have a mixture of different classes of beneficiaries—particularly when it comes to drafting changes in face of possible federal estate tax repeal. Most practitioners recognize that bequests in trusts are superior to outright bequests, and a growing number of practitioners are beginning to provide in wills (and revocable trusts) that no state estate tax will apply and all assets will pass to a credit shelter or “family” trust if the federal estate tax is repealed. These are often pot or sprinkle trusts with a broad class of beneficiaries.

From a planning perspective, using a broad class of beneficiaries is a positive step because it permits shifting income via distributions to beneficiaries in a lower income tax brackets; enables the trustee to shift distributions away from a beneficiary who is being sued or divorcing; and permits channeling funds to those in need. Given the focus many practitioners have on maximizing the basis step up available to client assets, it is not uncommon to include other relatives as beneficiaries—for example, an elderly parent or aunt. If they have small estates, these individuals might be given a limited power of appointment over credit shelter trust assets. That permits them to direct where the assets may be distributed on their death, but excludes their estate or creditors from the class of permissible appointees. Someone else may be given the authority to convert that limited power of appointment into a general power of appointment by adding, for example, the creditors of the power holder’s estate to the class of permissible beneficiaries. That modification of the limited power of appointment to a general power of appointment can be used proactively to cause inclusion in that power holder’s estate federal tax base and thereby secure a basis step up in assets subject to the power. But what does this increasingly common planning approach mean in terms of New Jersey inheritance tax?

What approach might the New Jersey Division of Taxation take in terms of trying to tax testamentary trusts for inheritance tax purposes when the estate tax is not applicable—or if it is repealed? If funds pass into a family or credit shelter type trust with a surviving spouse and descendants as beneficiaries (all Class A beneficiaries under the New Jersey inheritance tax system), might they argue the trust is characterized as something different than a Class A beneficiary and thus in part subject to inheritance tax? Under current law, if the estate files an NJ Form IT-Estate- Estate Tax Return, the Division of Taxation does not expect the estate to also file an Inheritance Tax Return (NJ-ITR). Some practitioners, however, have recommended filing the NJ-ITR in all events to begin the statute of limitations. Perhaps for a credit shelter trust with all Class A beneficiaries, the New Jersey Division of Taxation would be hard-pressed to argue that the trust itself is anything other than a Class A beneficiary not subject to inheritance tax. Under the New Jersey inheritance tax, a beneficiary can be a “Class A” beneficiary [spouse, child, grandchild, stepchild (not step grandchild)], a “Class C” beneficiary (sibling or child in law) taxed generally at 11%, or a “Class D” beneficiary (anyone else including a niece or nephew) taxed at 15%.

But some credit shelter trusts include other beneficiaries. Once any of the current credit shelter trust beneficiaries or remaindermen are not Class A beneficiaries, then the estate might have to address what is referred to as a “compromise tax.” The compromise tax might be minimal, if anything, depending upon the terms of the trust. For example, a trust which is primarily for the benefit of Class A beneficiaries—but still has C or D beneficiaries whose effective status is as a remote contingent beneficiary—currently produces a minimal compromise tax, or none at all.

The less remote, however, the more severe the tax issue. For example, in a credit shelter trust designed to maximize its funding to avoid New Jersey estate tax—$2 million in 2016—the identical issues exist; there is no estate tax but there is a possibility of an inheritance tax.

Anytime there are potential Class C or D beneficiaries in the credit shelter (or other) trust, there is the possible imposition of the compromise tax. Submission of a strong supplemental affidavit with the NJ-ITR might be important to demonstrate that it is highly unlikely that any of these non-Class A beneficiaries will actually inherit. The only alternative to paying the compromise tax is to post a bond. That might be worse than the compromise tax offered by the state.

As it becomes more common for clients to add other family members to the credit shelter or family trust, giving them limited powers of appointment and leaving open the possible conversion to a general power for estate inclusion in that family member’s estate for basis step up, the risk of incurring a compromise tax grows. With the specter of federal estate tax repeal, the provision for a sprinkle family trust in the event of repeal becomes more common. For New Jersey residents, that increasingly common planning approach might inadvertently trigger a surprise comprise inheritance tax.

When the New Jersey estate tax is repealed, more NJ-ITRs will have to be filed. Will the New Jersey Division of Taxation become more aggressive in auditing these returns in the absence of estate tax returns? If the federal estate tax is also repealed, it is uncertain how a new federal transfer tax system will be structured. If, under the new system, it proves advantageous to fund family-type trusts rather than marital type trusts exclusively for a spouse, the impact on New Jersey inheritance tax might be important to consider. Should this be a marital trust that qualifies for the so-called QTIP election under Revenue Procedure 2016-49?  This really cannot be known until the future tax legislation is enacted, but here are a few thoughts.

If the estate and generation-skipping transfer tax are repealed and a capital gains tax on death enacted with a $10 million exclusion and basis step-up on death is retained, then for most clients the best approach might be a marital type trust if that will result in inclusion in the surviving spouse’s estate. There will be no inheritance tax issues for assets passing to a surviving spouse. Because, however, only about 20% of families are “traditional” intact type families (mother, father, and the children of that marriage), there might be an incentive to use a family type trust. There might be no reason for the “credit shelter” moniker in the future if there is no estate tax. But if that is done, measures will have to be taken to facilitate estate inclusion for basis step up purposes. Given the diversity of so many families, these family trusts might find themselves negotiating a compromise tax under the New Jersey Inheritance Tax with the Division of Taxation.

For larger estates with potentially substantial appreciation, the handling of a family type trust versus a marital type trust might depend on how the assets in those trusts are treated for purposes of the capital gains (mark to market) on death rule if those are in fact enacted. If assets in a family type trust avoid the capital gains on death tax, then there might be an incentive for wealthy families to fund those trusts with as much wealth as permitted on the first spouse’s death. For many taxpayers, that might raise the negotiation of a compromise inheritance tax with the New Jersey Division of Taxation.

It seems that the state of the estate tax plan has become one of constantly pondering the unknowns of what the law might be—and what we might do for our clients to protect them from changes that will only change yet again. Complexity and change seem to have become permanent fixtures of estate planning.


martin_ShenkmanMartin M. Shenkman, CPA, MBA, PFS, AEP (distinguished), JD, is an attorney in private practice in Fort Lee, New Jersey and New York City. He is an editorial board member of Trusts & Estates Magazine and the Matrimonial Strategist. He is also the recipient of many industry and charitable awards including: Worth Magazine’s Top 100 Attorneys, CPA Magazine Top 50 IRS Tax Practitioners, the AICPA Sidney Kess Award for Excellence in Continuing Education for CPAs and Financial Planning Magazine 2012 Pro-Bono Financial Planner of the Year for efforts on behalf of those living with chronic illness and disability. He is also active in many charitable and community organizations and boards including a Board Member of the American Brain Foundation. He is the founder of Chronic Illness Planning.org and lectures around the country for more than two months a year on planning for those living with chronic illness or disabilities. For additional information, please visit www.shenkmanlaw.com.

 

glenn_HenklelGlenn A. Henkel, JD, LLM (taxation), CPA, AEP, is a shareholder in the Haddonfield New Jersey tax and estate planning firm, Kulzer and DiPadova. Mr. Henkel is a Fellow of the American College of Trust and Estate Counsel and is on the Board of Directors of the Philadelphia Estate Planning Council.  In 2015 Glenn received the Dorothy G. Black award for distinguished service from the Real Property, Trust and Estate Law Section of the New Jersey State Bar Association.   

 

GreenbergRichard H. Greenberg, JD, LLM (taxation) is senior partner of Greenberg & Schulman, Attorneys at Law in Woodbridge, New Jersey, where he focuses on estate planning and estate administration, tax matters and business and corporate matters. A Fellow of the American College of Trust and Estate Counsel (ACTEC), Mr. Greenberg is the Former Chair of the Taxation Law Section of the New Jersey State Bar Association, the Former Chair of the Board of Consultors of the Real Property, Trust and Estate Law Section, Co-Chair of the Estate and Gift Tax Committee of the Taxation Law Section, a member and former Chair of the Corporate Tax Committee and a member of its Inheritance Tax and Partnership Tax Committees.  He is also a member of the New York State Bar Association and its Tax, Trusts and Probate Committees.

 

Alan A. Davidson, Esq., LLM (taxation), is a member of the firm of Davidson, Sochor, Ragsdale & Cohen, LLC and has practiced in Bergen County for over 35 years. Mr. Davidson is a member of the Bergen County and Northern New Jersey Estate Planning Councils and a member and past president of the Greater New Jersey Estate Planning Council.  He has written in several publications including “Using QTIP Trusts in Planning Elective Share Bequests,” which was published in the New Jersey Law Journal; and he has co-authored in an ICLE publication entitled “Sophisticated Estate Planning: Using the Tax Laws to Your Client’s Advantage.”

 

Andrew T. Wolfe, Esq., is a member of the firm Hartman & Winnicki, P.C.  Prior to joining the firm, he was director of estate planning at J.H. Cohn LLP (now CohnReznick). He has published numerous articles on tax and estate planning issues, and frequently lectures on tax, trust and estate planning and administration topics to various professional and civic organizations. Andy has also served as an expert witness for trust and estate litigation matters. He was admitted to the New Jersey Bar and United States Tax Court in 1984 and is a member of the Estate Planning Council of Northern New Jersey, the Taxation and Real Property Trust and Probate Sections of the New Jersey State Bar Association, and the American Association of Attorney-Certified Public Accountants.

 
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