For estates of New Jersey residents dying on or after January 1, 2002, the New Jersey Estate Tax (“NJET”) can come as an unwelcome surprise. Since then, the NJET has been “decoupled” from the Federal Estate Tax (“FET”), which means that estates previously exempt from all death taxes are exempt no longer. The reason is simple: the NJET is payable if the decedent’s taxable estate exceeds $675,000, no matter what year the death occurs, whereas the FET is payable only if the taxable estate exceeds the federally exempt amount, which has been increasing for several years and is currently at $2 million per person.
A simple example will illustrate the point: Mr. Smith dies in 2006 with a taxable estate of $1.5 million. Since this amount is less than the FET exemption amount of $2 million, the estate is not subject to FET. But the estate’s value is well in excess of the NJET exempt amount of $675,000, so a NJET in the amount of $64,400 is due.
Most of the estate planning during the years prior to decoupling revolved around how to avoid or minimize the FET; since then, however, the emphasis has shifted, of necessity, to planning for the impact of both federal and New Jersey taxes. One way to avoid the NJET (but not the FET) is to take up residence in a state which is constitutionally prohibited from decoupling (Florida and Arizona are two of the handful of states that fall into this category).
Even for those who plan to remain in New Jersey, there is hope. By utilizing one or more of the techniques described below, a taxpayer can mitigate the impact of the NJET. Suppose, for example, that a single person has $1 million of assets. If he or she dies owning them, the NJET would be $33,200. However, if pre-mortem gifts totaling $325,000 were made, the NJET would be avoided, since the base for computing the tax generally does not include such lifetime transfers. These lifetime gifts can be made in amounts up to $1 million (the FET lifetime ceiling). The downside to making this type of transfer is that the basis of the gifted property is carried over from the donor, so that a subsequent sale could trigger an income tax. To avoid this outcome, cash and cash equivalents could be selected for transfer.
Another way of depleting the taxable estate is to make “Annual Exclusion” gifts (currently up to $12,000 per year per donee; $24,000 with “gift-splitting”) on a continuing basis. Over time, the value of these transfers (including post-transfer appreciation) can be considerable.
Finally, lifetime deductible gifts, such as transfers to charitable and like organizations, will reduce both the federal and New Jersey tax base on a dollar for dollar basis. To the same effect, the creation of an Irrevocable Life Insurance Trust would reduce the federal and New Jersey taxable estates on a dollar for dollar basis, to the extent of the face value of the policies used to fund the trust.
Joseph M. Jacobs, a trusts and estates attorney, has offices at 5 Independence Way, Suite 300, Princeton. 609-514-5137.