Under prior New Jersey law, a person may leave an unlimited amount to a spouse or charity. However, any money going to anyone else above $675,000 (the "exemption amount") is subject to an estate tax. This rule will remain in effect for the rest of 2016.
For calendar year 2017, the estate tax exemption amount for NJ will increase to $2,000,000. The tax rate will generally start at about 7.2% and go up to 16% on estates over $10,000,000.
There will be a full repeal of the NJ Estate Tax starting January 1, 2018.
We have confirmed that New Jersey will NOT be repealing its inheritance tax. Accordingly, money that is left to a non-class A beneficiary will still be subject to a tax. In other words, there will still be a tax if you leave money to anyone other than a spouse, your descendants, your ancestors or a charity upon your death.
So the big question for many might be how does this affect you. I will break this down into 5 categories:
1) People who have prepared existing estate planning documents;
2) People with assets between $675,000 to $5,450,000 (for individuals) and married couples with assets less than $10,900,000;
3) Married couples with assets in excess of $10,900,000;
5) Widows and widowers who are the beneficiary of a credit shelter trust; and
6) People who wish to consider Medicaid planning.
1) For people who have already prepared their estate plans, most likely this will not adversely affect your plans. However, the modification of the tax law likely gives you the opportunity to simplify your documents. In particular, it is common practice in New Jersey to create a trust for a surviving spouse (often referred to as a Family Trust, Bypass Trust, Credit Shelter Trust or A-B Trust) to double the $675,000 exemption among spouses.
There still may be other reasons to have a trust for a surviving spouse (such as in second marriage situations), but starting 2018, doubling the NJ exemption amount will no longer be necessary.
2) For New Jersey domiciliaries who have assets above $675,000 (the NJ estate tax exemption limit in 2016) and below the federal estate tax exemption limit ($5,450,000 for individuals and $10,900,000 for married couples in 2016), it was a common part of estate planning for a person to make deathbed gifts to minimize the NJ estate tax liability. Once the NJ estate tax gets repealed, it will generally be much more beneficial for a person to keep all of their assets until their death rather making substantial gifts during lifetime.
Until 2018, deathbed gifting can be very tax efficient because New Jersey has an estate tax but it does not have a gift tax. Accordingly, there is the opportunity to substantially minimize the estate tax. The problem however, is that many people make the mistake of gifting substantially appreciated assets such as stock or real estate. You often want to keep appreciated assets until death to obtain a step-up in basis.
So before you make a gift, you would need to weigh the potential NJ estate tax consequence of keeping an asset versus the potential capital gains tax if an asset is sold after the gift is made.
Now with the repeal of the NJ estate tax, unless a person is likely to die prior to 2018, you don't need to worry about making the calculation as to whether the NJ estate tax or the capital gains tax will be higher. It will almost always be better to keep the asset.
3) For married couples with assets in excess of the federal estate tax exemption amount, I have read a number of studies that indicate that a couple can usually transfer wealth in a more tax efficient manner by establishing a credit shelter trust for the surviving spouse rather than relying on portability.
There are few reasons why wealthier clients may want to continue to use traditional credit shelter trust planning. The first is that while the estate tax exemption is portable, the generation skipping transfer tax (GST Tax) is NOT portable to a surviving spouse. Many wealthy clients often wish to make sure the money goes not just to their children, but also to more remote descendants.
Another benefit to traditional credit shelter trust planning is that it acts as freeze for the assets inside the trust. Specifically, let's assume that we have a married couple with exactly $10,900,000. If we put half of those assets in trust on the first to die, then regardless of how much that goes up or down, it passes tax free on the surviving spouse's death. So if the value of the trust goes up at faster rate than the inflation adjustment on the exemption amount, the beneficiaries are basically saving about $0.23 on the dollar because the estate tax is a 40% tax and the capital gains on the appreciation is only taxed at 23%.
While none of this planning will be different after the NJ Estate gets repealed compared to now, it makes the planning much easier to justify because right now we have a dilemma as to "HOW MUCH" we fund the credit shelter trust with. To avoid any tax on the first to die, a credit shelter trust can only be funded with $675,000. For some, this hardly makes it worth setting up. However, as the estate tax in NJ goes away, we no longer have this concern.
4) For snowbirds and other people who wish to avoid a "death tax", very simply, starting 2018 the tax incentive to move will be dramatically reduced. Back in 2009, I wrote a post discussing the tax benefit of relocating to Florida. Once the NJ estate tax gets repealed, for many it will make little difference from a tax perspective where their domicile is.
That being said, there are still significant differences between being domiciled in New Jersey vs. Florida. After all, if you own real estate in both places, you still will need to pay property tax in both locations. The biggest differences that people should be aware of are:
- Florida does not have a state income tax, whereas NJ does. (Note NJ will start exempting a substantial portion of retirement income from the state income tax);
- Florida property has homestead protection only if you are a domiciliary of Florida. This can provide asset protection and it usually stops the property tax from increasing; and
- NJ is keeping its inheritance tax. So if you plan to leave your assets to nieces, nephews, friends or other non-class A beneficiaries, there could be a substantial tax savings upon your death.
5) If you have a husband or wife who passed away leaving money to you in trust, come 2018 it may be beneficial to consider options for terminating the trust. Imagine a scenario where husband dies in in 2004 leaving $675,000 in a credit shelter trust (often called a Family Trust or Bypass Trust) for his surviving spouse. It is likely that these assets in trust have appreciated to over $1,000,000. If these assets stay in trust until the surviving spouse's death, it will not receive another step-up in basis. However, if the trust is terminated and assets are distributed to the surviving spouse after 2018, it could be very beneficial from a tax perspective.
There are many caveats to this plan. First, you would not want to terminate the trust if the first spouse to die wanted to protect the money in trust for his/her surviving children - so you would not want to terminate the trust in second marriage situations. Second, you may not want to terminate the trust if the surviving spouse has substantial assets or debts. It may also not be beneficial to terminate a trust if the value of the trust assets have gone down in value.
Nevertheless, it would be advisable to consider terminating a trust to make life easier for the surviving spouse and avoid the hassle of having to file an extra income tax return for the trust.
Please note that a trust can only be terminated if the trust allows it, so you should have the trust looked at to see if the document allows the trust to be terminated. If the trust does not allow for termination, consider whether it should be modified under the New Jersey Uniform Trust Act.
6) While I don't do Medicaid planning, I do engage in tax planning, and tax planning just got much easier. The problem with Medicaid planning is that there is so much bad information out in the public sphere.
I frequently get clients with millions of dollars who want to do Medicaid planning. They don't realize that to do this type of planning, they actually need to give away most of their assets. This might work well with someone who has a few hundred thousand dollars. However, the more money you have, the less sense it usually makes to do this type of planning.
For example, if you have a $500,000 IRA, stock with a basis of $100,000 and worth $400,000, and a house with a basis of $50,000 and now worth $600,000, let's talk about the tax impact of most Medicaid planning. In order to "give away" everything to qualify for Medicaid (a total of $1.5M here), the person would have to withdraw their entire IRA, causing a federal and state income tax of over $175,000. Additionally, the transfer of the stock and real estate now would be subject to a built in capital gains of $850,000, resulting in about another $175,000 in capital gains taxes when sold.
All told, this planning will likely cause about $350,000 in taxes. This does not even factor in the planning fees and the loss of opportunity to grow the IRA in a tax deferred form. At $10,000/month in a nursing home, that is about 3 years in a nursing home. According to the non-profit Life Happens, the average stay in a nursing home is almost 2 and half years and about 70% of the population winds up spending some time in a nursing home. A $350,000 tax could have paid for 3 years of nursing care home... and in a non-Medicaid facility.
Prior to the change in the estate tax law, an argument could be made that the increase in income taxes was somewhat offset by a decrease in estate taxes. Until the end of 2016, with an estate of $1.5 million, there was the potential estate tax of over $60,000. Repeal of the estate tax obviously changes the equation. Under the new tax law, it is generally more prudent to keep assets in your name rather than giving them away ahead of time. So while Medicaid planning can certainly be appropriate for some, the larger your estate, the less financial sense it makes to engage in this type of planning.