Much has been written about the pending repeal of the New Jersey Estate Tax in 2018. As is usually noted, the repeal of the estate tax does not have an effect on the New Jersey inheritance tax, which will remain in effect. The New Jersey inheritance tax will not apply to many families because transfers to a spouse, child, grandchild or step-child are exempt from the application of this tax. Unlike the estate tax, the inheritance tax applies to both residents and non-residents, however, for non-residents, the tax is only imposed upon New Jersey real estate.
While the inheritance tax does not apply in many situations, a disposition to a non-family member or even a non-lineal descendant relative such as a child-in-law, sibling, or niece/nephew is subject to the tax. A sibling or child-in-law is a “Class C” beneficiary and is generally subject to a tax rate of 11% imposed on the excess inheritance over $25,000. This tax rate changes beginning at $1,100,000. The more common application of this tax occurs where a disposition is made to a non-familial heir such as to a friend/niece/nephew or unrelated companion. In this circumstance, the inheritance tax rate is imposed at a rate of 15% and, at a dollar value of $700,000, that rate rises to 16%. Thus, where applicable, the tax can be expensive.
Another important nuance to the New Jersey inheritance tax is that it not only taxes transfers at death, but it also taxes transfers made within 3 years of death. There is a narrow exception for transfers not made in “contemplation of death.” In the Estate of Van Riper the New Jersey Tax Court reviewed clever arguments made by the taxpayer’s family to try to limit the New Jersey inheritance tax.
In Van Riper, a husband and wife transferred a home to an irrevocable trust in 2007. The husband passed away three months later and the wife passed away 6 years later in 2013. Under the terms of the trust, the home was to be held for the benefit of Mr. and Mrs. Van Riper until both of their
deaths at which point it would pass to their niece, a Class D beneficiary. The court considered the requirements for the application of N.J.S.A. 54:34-1.1 which has been in law since 1955. In effect, this rule provides that a transfer of property by deed or gift “shall not be deemed a transfer intended to take effect at or after the transferor’s death if the transferor, three years prior to death, shall have executed an irrevocable and complete disposition of all reserved income, rights, interest and powers in and over the property.” The family argued that the irrevocable creation of the trust more than 3 years before death meant that the tax should not apply.
The Court looked to the quoted statutory provision and considered three elements: 1) that there is a transfer of property by gift; 2) that the transferor is entitled to some income right or interest or power in the property transferred; and, 3) that the transferor must, three years prior to death, execute an irrevocable and complete disposition of all reserved income rights, interest and powers in the property transferred. In this case, the Court noted that the transferor’s retention of the right to use the property effectively postponed the niece’s benefits and, therefore, the receipt was “at or after death” and thus subject to the tax.
The estate argued that the statutory requirements were met because the trust was irrevocable. The transfer and disposition were more than three years before death and the estate argued the Court should read the terms “transfer” and “disposition” synonymously. However, the Court agreed with the Division of Taxation and concluded that the legislative history militate against reading the two terms together. In other words, because the retained interest prevented the niece from receiving the property until after death, the Court concluded that statute was intended to subject a transfer as noted to the application of the inheritance tax. Accordingly, the Court found that inheritance tax should apply in this situation.
The three-year rule can create a trap for wary New Jersey taxpayers who believe that the tax should not apply. For federal purposes, it is clear that the retention of such an interest would cause the “income tax basis” of the property to be “stepped up” to the fair market value at the date of death, thus eliminating some of the income tax exposure. It would appear from reading the case that the purpose of the creation of the irrevocable transfer was to allow for some needs based “Medicaid” type planning. This would have rendered the home an “inaccessible” resource for Medicaid purposes if the Van Ripers were both out of money and were in need of long term custodial care. However, the rule enunciated by the Tax Court is that the inheritance tax would still apply in this circumstance notwithstanding the irrevocable nature of the gift more than three years before death. The case appears headed for appeal to a higher court, possibly only on a secondary issue. The case still is noteworthy as the New Jersey inheritance tax is slated to remain a planning obstacle even in the absence of an estate tax.
Glenn A. Henkel, Esquire is a shareholder in the firm. Mr. Henkel earned his J.D. degree at Rutgers University School of Law, where he graduated with honors and was awarded the Prentice Hall Award for outstanding performance in the area of taxation, and earned He earned his LL.M. in Taxation at New York University. His particular areas of expertise include complex estate planning, tax-exempt organizations and Probate, Trust and Estate Law.