New Jersey has been widely recognized as among the more onerous states in terms of transfers at death. While federal and state death tax laws have been loosened over the past many years so as to exempt more and more people from estate and inheritance taxes1, New Jersey has not been among them. New Jersey’s estate tax exemption stands at $675,000 per person. By contrast, the federal estate tax exemption is currently $5,450,000 per person2 ; the New York estate tax exemption is currently $4,187,500 (rising to the federal exemption level in 2019); the Connecticut estate tax exemption is $2-million; and Florida has no estate tax at all.
The federal estate tax regimen encompasses both lifetime gifts and death-time transfers. The federal estate tax exemption is reduced by taxable gifts made during lifetime. For example, an individual making a taxable gift of $100,000 in 2016 would reduce his or her federal estate and gift tax exemption by that amount, leaving a remaining federal estate and gift tax exemption of $5,350,000. An individual making a taxable gift during lifetime does not incur a gift tax liability for federal purposes until the entire federal exemption is exhausted. In 2016, that means one would have to make taxable gifts in excess of $5,450,000 before a gift tax becomes payable. This unified estate and gift tax structure for federal purposes does not differentiate between lifetime and death-time transfers, and consequently for gifts of equal value up to the maximum federal exemption amount there is no intrinsic benefit of a lifetime gift over a death-time transfer3.
In contrast to the federal estate and gift tax regime, New Jersey imposes a tax only on death-time transfers. For policy reasons that are not entirely evident, New Jersey does not impose a tax on lifetime gifts4. This anomaly between the federal and New Jersey tax structures offers a planning opportunity in a number of situations. An example will illustrate the point. Assume that an unmarried individual has a taxable estate with a value of $2-million and that the beneficiaries are children of the individual. Given the federal exemption of $5,450,000, there is no federal estate tax liability, regardless of the identity of the individual beneficiaries. For New Jersey death tax purposes, inasmuch as the beneficiaries are children of the individual, the New Jersey inheritance tax is inapplicable, and the only tax of concern is the New Jersey estate tax. The New Jersey estate tax on a taxable estate of $2-million is $99,600.
Now, assume the same facts, and further assume that prior to death the individual had made a lifetime taxable gift of $1.5-million to children. For federal estate tax purposes, the lifetime gift of $1.5-million requires the filing of a federal gift tax return, but the return merely reports the gift and the reduction of the federal estate and gift tax exemption by $1.5-million, leaving an exemption balance of nearly $4-million to be applied to future lifetime gifts or on death. As such, there is no federal estate or gift tax liability. For New Jersey death tax purposes, the lifetime gift is not included in the New Jersey taxable estate upon death. Although the existence of the lifetime gift will affect the amount of the New Jersey estate tax payable upon death, it is not a one-to one correlation, and the tax will be significantly reduced. After the $1.5-million lifetime gift, the death tax payable on a taxable estate of $500,000 is $10,000, significantly less than the $99,600 payable on a taxable estate of $2-million in New Jersey.
The critical concepts to grasp are: (i) New Jersey does not impose a gift tax; (ii) lifetime gifts do not impact the New Jersey estate tax exemption available at the time of death; and (iii) lifetime gifts can be used to significantly reduce New Jersey estate tax liability.
Despite the tax advantages that can accrue from lifetime gifts, they are not always advisable, and the benefits will depend on particular circumstances. For example, an individual would not want to make lifetime gifts that leave the individual with insufficient resources to maintain his or her lifestyle and meet future expenses. Further, the potential capital gain tax consequence of a lifetime gift is an important consideration in any analysis. As is often the case, there are generally a number of factors to be considered before embarking on any gifting program. A future article will address the potential drawbacks of making lifetime gifts in New Jersey.
Note: In October 2016, Governor Christie and State legislative leadership had announced an agreement to raise the gasoline tax in order to allow the Transportation Trust Fund to provide additional funding for infrastructure and road improvements and maintenance. The bill has not yet been formally approved by the legislature. As part of the agreement, the New Jersey estate tax exemption is slated to increase to $2-million in 2017 before complete repeal as of January 1, 2018. The estate tax repeal, if enacted, will eliminate the benefits of lifetime gift planning to reduce New Jersey estate tax, although the concept will still apply in more limited circumstances until that time.
Footnotes
[1] New Jersey has both an estate tax and an inheritance tax. The New Jersey inheritance tax does not apply to transfers to a spouse, lineal ancestors, lineal descendants, stepchildren, or sons- or daughters-in-law, or to charity. New Jersey inheritance tax applies only to collateral relatives (i.e., siblings, nieces, nephews) or unrelated parties. As such, the New Jersey inheritance tax has increasingly limited application. Estates do not pay both an inheritance tax and an estate tax. Rather, an estate pays the higher of the two, and any amounts due for New Jersey estate tax receive an offset for any New Jersey inheritance tax paid.
[2] The federal estate tax exemption is indexed for inflation. This year’s exemption of $5,450,000 is $20,000 more than the federal exemption of $5,430,000 available in 2015, which was $90,000 more than the $5,340,000 exemption in 2014. In 2017, the exemption will increase to $5,490,000.
[3] There are, of course, benefits that accrue from a lifetime gift, the most obvious being that not only is the gift out of the donor’s New Jersey taxable estate once the gift is made, but also all future appreciation on property given away during lifetime is also removed from the donor’s estate for federal and New Jersey estate tax purposes.
[4] While New Jersey does not tax lifetime transfers generally, there are circumstances where a gift made within three years of death is brought back into an estate and subject to tax. For example, gifts made within three years of death can be considered to have been made “in contemplation of death,” and therefore subject to tax for transfer inheritance tax purposes.