Glenn A. Henkel authored the following article “New Jersey Estate Tax Repeal: What You Need to Know!” which has been featured in the March 2017 (Vol. 65, No. 7) issue of The Barrister, a monthly circular published by the Camden County Bar Association.
Last October, Governor Christie signed legislation raising the state’s gas tax to help replenish the state’s expired transportation trust fund. As a tradeoff to tax increases, the law took tax reduction steps to encourage residents to remain in the state after retirement. It phases out the estate tax, effective January 1, 2018, and provides an enhanced retirement income exclusion that is phased in between now and 2020. If the changes actually happen, it could have a profound impact on the manner that our New Jersey clients will plan for their estates.
The major highlight in this new legislation is the repeal of the estate tax after 2018. Since it is a “phase out,” there is always the potential that the tax may not, in fact disappear. Recall that as part of the November 8, 2016, ballot “Public Question 2,” a majority of New Jersey voters approved a constitutional amendment that dedicates all gas tax revenue to transportation projects (not the tax relief.) Thus, whether the State will be financially able to forgo the estate tax revenues in 2018 and thereafter will be an issue for a future legislature and a future Governor. The lost revenue effects for the estate tax repeal alone are huge, almost $500 million in fiscal 2020 and more than $500 million fiscal 2021 and fiscal 2022.
Under the legislation, the rules for 2017 decedents allow a $2 million exemption per decedent, including a change in the manner that the tax is computed. The 2017 tax computation could be a precursor to future rules so they are worth study. The way the law is drafted allows an easy fix to retain the tax if the state later decides to keep the 2017 tax format. The pre-2017 tax law was a “cliff,” meaning that the tax applied on all estates subject to tax, but the new law provides a “credit” providing a tax benefit even on larger estates.
What does this mean for those living in New Jersey? What changes to planning and documents might be advisable to consider for New Jersey domiciliaries? Will it bring back former New Jersey residents who “changed” their domicile to a no-tax state? For many, it has been the INCOME tax that has caused clients to leave from New Jersey (maybe climate too). Because the pre-2017 law only allows a meager $20,000 pension exclusion (married filing joint), the new law adds an increased pension exclusion that is likewise phased in and makes New Jersey more competitive regionally. It increases the thresholds from $20,000 in 2016 to $40,000 in 2017, $60,000 in 2018, $80,000 in 2019 and to $100,000 for 2020 and thereafter (all married filing jointly). For single taxpayers, the current $15,000 exclusion goes to $30,000 (2017), $45,000 (2018), $60,000 (2019) and $75,000 (2020). However, this benefit is provided only to taxpayers who are below the gross income threshold. Under current law, the pension exclusion is denied if the persons New Jersey taxable income is more than $100,000. Even a mere $1 of gross income over the exemption, denies the taxpayer of the benefit. Thus, while the law is a step in the right direction, it is not that attractive to high net worth individual.
For the estate tax, New Jersey law provides that there are no estate tax changes for 2016 decedents (leaving in place the $675,000 exemption threshold based upon the 2001 provisions in IRC Section 2011) and there is no tax for 2018 decedents. For 2017 decedents, the tax is imposed based upon the prior I.R.C. Section 2011 “credit” rate chart as it existed in 2001 that is now incorporated into the statute, but the computed tax is reduced by a “credit” of $99,600, the tax that would have been imposed on a $2,000,000 estate.
The new New Jersey tax computation for 2017 decedents is keyed to the definition of “taxable estate” contained in Internal Revenue Code Section 2051. That reference has raised an interesting interpretive question. When the existing New Jersey tax was keyed to the 2001 tax code, there was no deduction for state estate tax. (IRC Section 2058 that allows a state estate tax deduction is only effective for decedents passing after 2005). Now, because of the reference to the current tax code, the state tax to be paid is a deduction in arriving at the tax- thus, there is a circular computation to arrive at the tax. Maybe this will be fixed in a technical correction. However, as of now, the computation is a “circular,” meaning you deduct the tax against the tax and need a computer or algebraic formula to determine the amount owed. The allowance of a deduction could also raise questions about taxes paid to other jurisdictions where an estate could attempt to claim both a credit for tax paid and a deduction.
One major benefit is that this definition of the tax base in IRC Section 2051 starts with the “gross estate” less deductions, which is before adding back prior gifts made. Thus, like it was for the pre-2017 rules, gifting still reduces the estate and thereby, using a gifting strategy reduces the estate tax.
Before gifting however, advisors should make sure that the assets being given away do not result in a higher income tax cost. When assets are gifted, the donee receives “carryover” income tax basis rather than the “step up” that can occur at death. It is usually not a good idea to save estate tax at a cost of and increased income tax, unless the tax is lower (analysis is needed before the gift) or the asset will not be sold (e.g., a vacation home or a family business). Another consideration with gifting is that under the old rules, the gifts escaped estate tax. However, there was still a tax on the assets remaining in the estate, so there would be some tax due. To avoid any tax at all, a donor had to gift all the way down to a retained asset base of just $100,000. Now, because of the “credit” on the first, $2,000,000, a retained asset base of $2,000,000 will escape the tax entirely. This is a great opportunity for deathbed planning however, while there is generally no “3-year” rule for estate tax, there remains a rule for inheritance tax that will impose an inheritance tax on all gift within three years of passing.
The first caveat is that the New Jersey inheritance tax is retained (a significant trap for unwary). The New Jersey inheritance tax does not generally apply to transfers to a spouse, child, or grandchild who are referred to “Class A” beneficiaries. Unfortunately, the New Jersey Inheritance tax subjects transfers to siblings, and children in law at a rate of 11% (on an amount over $25,000) known as Class “C” beneficiaries. This rate rises on transfer above $1.1 million reaching a high of 16%. Others non relatives are taxed at a 15% rate (16% over $700,000). While a “step child” is a preferred “Class A” beneficiary, the transfer to a “Step grandchild” causes a 15% tax. The New Jersey inheritance tax remains a costly trap for unsuspecting taxpayers. Unlike the rules for the New Jersey estate tax, in inheritance tax carries with it a three-year inclusion of gifts in the tax base.
The second caveat, the potential repeal of the FEDERAL estate tax by the Trump administration, could create more confusion in the way that clients will plan their estates. In the end, the New Jersey estate tax change is welcome relief, but for clients with estate above the $2 million exemption amount, prudence would suggest that they retain their existing plans. With the potential that the Trump administration will repeal or modify the federal estate tax, many clients will be eager for simplification to their planning however, let’s not act too quickly for our New Jersey residents.