Revisions to New Jersey Estate Tax May Require Review of Existing Estate Plans
New Jersey has two separate and very different death taxes: the transfer inheritance tax, which is a tax on the amount each beneficiary receives from the estate, and the estate tax, which is based on a credit against the federal estate tax.
Prior to 2002, the New Jersey estate tax was exactly equal to the federal state death tax credit (i.e., a dollar-for-dollar reduction in federal estate tax payable equal to an amount of state death tax payable), reduced by the amount of New Jersey transfer inheritance tax paid. The result was that this tax never caused an addition to the death taxes payable by a taxable estate; it merely re-directed some amount of federal estate tax otherwise payable to the IRS into New Jersey's tax coffers. For example, if $100 of federal estate tax was due, but a federal state death tax credit of $10 was available, New Jersey would exact a $10 estate tax to take advantage of the credit. The estate would then pay $90 to the IRS ($100 reduced by the $10 credit) and $10 to New Jersey - the same $100 total that would have been payable if no credit had been available.
Since the New Jersey estate tax was not due unless an estate was subject to federal estate tax, the one-page New Jersey estate tax return was very simple to prepare.
In addition, prior to 2002, the New Jersey estate tax (unlike the New Jersey transfer inheritance tax) produced no lien against estate property; therefore, no waivers from the Division of Taxation were needed with respect to that tax prior to transfer or distribution of estate assets.
For estates of decedents dying after December 31, 2001, the New Jersey estate tax regime has changed. That change is due to the phase-out of the federal state death tax credit, which ranged from 1% to 16% of the federal adjusted taxable estate. In 2002, the credit is now only equal to 75% of its pre-2002 amount; in 2003, it becomes 50% of that amount; in 2004, 25%; and it disappears completely from the federal system in 2005, to be replaced with a deduction (rather than a dollar-for-dollar credit) for state death taxes paid.
The result - for New Jersey and many other states that have death taxes mirroring the federal state death tax credit - was a projected reduction in tax revenue as the state death tax credit dwindles to nothing. The response - for New Jersey and many other states - has been to "decouple" the state estate tax from the federal state death tax credit as it changes in 2002 and later years. Therefore, for decedents dying after December 31, 2001, the New Jersey estate tax is computed using the federal rates and credits in effect on December 31, 2001 - i.e., as though the tax rates, applicable credit amount, state death tax credit and other aspects of the federal tax calculation were frozen at 2001 levels.
For example, the estate of a decedent who dies in 2002 with a $2,000,000 taxable estate, $1,000,000 of which passes into a credit shelter trust (taking full advantage of the applicable credit amount), and $1,000,000 of which passes to the surviving spouse outright, pays no federal estate tax and, prior to the changes in New Jersey law, would have paid no New Jersey estate tax. However, under the revised law, that estate now must pay a New Jersey estate tax of $33,200 - an amount equal to the federal state death tax credit using 2001 federal tax rates (i.e., applicable credit equivalent of $675,000 and 100% of the state death tax credit rates).1
In addition to the estate tax payable, there is now also a tax waiver requirement imposed with respect to the New Jersey estate tax. Therefore, even though an estate passes entirely to Class A beneficiaries (i.e., surviving spouse, parents, children, grandchildren - all of whose bequests are exempt from the New Jersey transfer inheritance tax) - who in prior years might have been able to use self-executed affidavits to free estate assets for transfer - there will still be a separate New Jersey estate tax waiver required from the Division of Taxation.
As under prior law, the revised New Jersey estate tax requires the filing of a copy of any federal estate tax return filed - including any subsequent changes made to the federal return (e.g., for after-discovered assets or upon audit). For estates required to file federal returns, New Jersey will require a separate computation of federal tax at 2001 rates. For estates not required to file federal returns, New Jersey offers a "simplified tax system" that will produce a liability "similar to" the liability determined by a detailed computation but which will take into account the lack of information for compliance due to factors such as the absence of valuation for federal estate tax purposes and the absence of a reliable measure of the impact of gifts made during life. In estates that must file the New Jersey transfer inheritance tax return, appraisals will still be done and much of the information necessary for the New Jersey estate tax will be accumulated anyway. But for estates that would not have to file that return or a federal estate tax return, the new New Jersey estate tax itself may now require considerable effort and administrative expense to comply with these new rules, even under the "simplified" system.
For planning purposes, under the current federal estate tax regime, it may still make sense to maximize the use of the federal credits and pay the New Jersey estate tax from the credit shelter amount in any year in which a federal estate tax is applicable. For example, assuming family assets of $2,000,000 (held equally by husband and wife) and no change in the current federal and state death tax laws, the largest possible credit shelter trust produces a much smaller total of combined federal and New Jersey death taxes in 2002 and 2003 and only slightly higher taxes in years 2004-2009 compared with a plan that attempts to minimize the New Jersey estate tax by creating a credit shelter trust funded with only $675,000. And in 2011 and later years, the maximized credit shelter trust again produces substantially lower combined tax. The reason is that the larger credit shelter trust (which is not minimized for the New Jersey estate tax) avoids more and substantially higher federal estate tax at the second death - even when that second death is projected to take place up to 10 years later.
Bear in mind, however, that careful asset allocation between spouses remains very important in obtaining the lowest possible death tax result, and couples with combined assets between $1,350,000 and $2,000,000 may want to examine whether minimizing tax for New Jersey estate tax purposes is worthwhile.
For couples with more significant family wealth (and, again, assuming the current federal estate tax regime), it will invariably make sense to maximize the credit shelter trust and pay the New Jersey estate tax. For example, assuming combined assets of $5,000,000, the difference in combined death tax due is far lower using the maximized credit shelter trust. The reason is that, again, while some New Jersey estate tax is avoided, the price of that avoidance is a larger federal taxable estate for the surviving spouse, so that - even after discounting the future tax payment at the death of the surviving spouse to present value in the year of the initial death - the increased federal tax due more than makes up for the New Jersey estate tax savings.
Given our highly unstable estate tax environment, and the varying consequences of these tax law changes, you may want to consider revising your will so that it affords sufficient flexibility to allow for post-mortem adjustments to minimize the overall state and federal estate tax consequences.
For some (but not all) estate plans, adding certain "disclaimer provisions" to the wills may afford some tax protection for a plan that otherwise calls for full use of the federal estate tax exemption at the death of the first to die of a husband and wife. By prudent use of the disclaimer, the surviving spouse would be able to revisit the estate tax situation after the first death when more of the relevant factors would be known - e.g., the federal state death tax credit amount, the federal estate tax exemption amount, the size of the estate, and the life expectancy of surviving spouse, etc. With knowledge of those factors, the surviving spouse would then be able to make a more informed decision as to whether to pay the New Jersey estate tax at the first death in order to get the full benefit of the federal estate tax exemption (and so minimize possible federal estate tax at his or her later death) or to forgo the full federal benefit in order to avoid state death tax at the first death (and risk possible increased federal tax later).
1 As the federal credit against the estate tax rises in future years, estate plans that take advantage of that credit to the maximum extent will face even larger New Jersey estate tax bills. Estates that, under the prior New Jersey estate tax law, would have paid zero New Jersey estate tax would now pay the following amounts: in 2004-2005, $64,400; in 2006-2008, $99,600; and in 2009, $229,200. In 2010, if the federal estate tax disappears as currently scheduled to do and with proper drafting, the New Jersey estate tax could be zero. But in 2011, if the federal estate tax reappears as it is scheduled to do, the New Jersey estate tax would again be $33,200.