What Every Pennsylvania Estate Planner Needs to Know about the New Jersey Estate Tax

In 2002, the Commonwealth of Pennsylvania, like the State of New Jersey, “decoupled” the state estate tax from the federal state death tax credit amount allowed by 2011 of the Internal Revenue Code.  This may be where the similarity between the two states ends.  After the Economic Growth Tax Relief Recovery Act of 2001 (EGTRRA 2001), many states “decoupled” their state estate tax from the state death tax credit amount.

Before EGTRRA 2001, the federal government provided a dollar-per-dollar credit against the federal estate tax in an amount allowed by I.R.C. 2011.  This tax collection represented “easy money” for states because the federal government administered the tax and the home “state” of a decedent merely received a specified dollar amount based upon the federal rate structure. In addition, in any state where a decedent held real property, the state treasury received a ratable portion of the tax.

EGTRRA 2001 made two significant changes for the states.  First, the increase in the federal estate tax exemption (from then, $675,000 to now $5,000,000) limited the number of estates that would be subject to federal estate tax (thus, cutting state revenue).  Further, over the years 2002 to 2004, the federal government “phased out” the benefit of the tax allowed by §2011.  This loss in revenue (together with declining state revenue from income tax) caused many state legislatures to act – New Jersey and Pennsylvania among them.

One of the first differences between the Pennsylvania and New Jersey structure is that the Pennsylvania Constitution Article VIII, Section 1, contains a “uniformity” clause meaning that there was doubt over constitutionality and it was retroactively repealed (Act No. 46 of 2003, 12/23/2003). Many practitioners in Pennsylvania believed the Pennsylvania version of the tax to be unconstitutional due to the graduated rate structure keyed the estate tax exemption to the amounts in effect before EGTRRA was passed.

Second, Pennsylvania’s version of the estate tax keyed the exemption to the increasing exemptions brought about by the 1997 Tax Relief Recovery Act, thus the Pennsylvania version would have risen to $1 million by 2006.  New Jersey, on the other hand, treats all decedents dying after December 31, 2001 as if they had died on December 31, 2001.  This has the effect of fixing the state estate tax “exemption” at a fixed-sum of $675,000. See N.J.S.A. 54:38-1(a)(2).  As such, New Jersey resident decedents must be mindful that the state exemption remains intact notwithstanding the future of the federal estate tax exemption.

Both New Jersey and Pennsylvania enacted legislation in late June 2002 in connection with their fiscal year budgets.  New Jersey, however, made this tax retroactive to decedents dying December 31, 2001. The New Jersey Courts have held the retroactive application of the estate tax to be constitutionally permitted; however, in one case, the New Jersey Supreme Court has recently granted certification.  See, Oberhand v. Director, Div. of Taxation, 388 N.J.Super. 239, 907 A.2d 428 (N.J.Super. A.D. Sep 29, 2006) Certification Granted by 190 N.J. 255, 919 A.2d 849 (N.J. Mar. 20, 2007).

Unlike the Pennsylvania “uniformity clause”, the New Jersey Constitution bears no similar language regarding the imposition of pro-rata taxes.  An argument can be made that this law is unconstitutional under Article 4, Section 7, paragraph 5 of the New Jersey Constitution which prohibits a law from being enacted by reference to a title of another act only.  Also, any part of an act which relies on an existing law (or part) must restate the entire law relied upon at length in the New Jersey Statutes.  The theory seems to be designed to give citizens access to the entire provisions of the law relied upon without an “incorporation by reference” of the other law. While it has been held that statutory references in New Jersey law to I.R.C. 501(c)(3) organizations is constitutionally permitted, it remains unclear whether, or to what extent, this provision will have any merit if the New Jersey estate tax is challenged on a constitutional basis.  See, Princeton Tp. v. Bardin, 147 N.J. Super. 557, 371 A.2d 776 (A.D. 1977), certification denied, 74 N.J. 281, 377 A.2d 685.   The author is aware of no New Jersey challenge on this point and since more than a decade has passed, a challenge seems unlikely.

Another difference between the Pennsylvania and New Jersey structures is in treatment to non-residents.  The New Jersey estate tax (at this time) does not apply to non-residents.  As a consequence, a multi-millionaire resident of Pennsylvania with a multi-million dollar beachfront house in New Jersey would not be obligated to pay any New Jersey estate tax, not even its ratable share as the value of the home relates to the total amount of estate death tax credit.  See N.J.S.A. 54:38-1(a) (2) which begins, “Upon the transfer of the estate of every resident decedent…” (Emphasis added).  By contrast, other states have imposed an estate tax on the ratable share of the state death tax credit amount under I.R.C. 2011. Pennsylvania residents with New Jersey property should be diligent to make sure that their Pennsylvania domicile is clear after death.

Recently, several astute New Jersey taxpayers challenged the imposition of New Jersey tax on real property situated outside of New Jersey.  (For a discussion of this issue, see Evans, The Constitutionality of Decoupling, ABA Probate and Property, July/August 2005 at page 22).  For example, if the tax on a $2,000,000 estate is $99,600 but is made up including a condominium in Florida worth $500,000, shouldn’t the tax be imposed on “only” the other $1,500,000?  Alternatively, since one quarter of the estate was outside New Jersey, maybe only one quarter of the tax should be due (e.g., $74,700).  Nevertheless, it is reported that the NJ Division of Taxation has recently capitulated in several cases involving not only out of state real property but also, trusts established by predeceased spouses that were not NJ residents (QTIP trusts originated in located out of New Jersey).

Like Pennsylvania, New Jersey also imposes an inheritance tax on all transfers.  New Jersey has enacted a “waiver” rule for the estate tax similar to the waiver provisions under the New Jersey inheritance tax.  By way of background, in order to transfer property from an estate of a New Jersey decedent, the permission of the New Jersey Division of Taxation is needed.  This is provided in a form called a “New Jersey Inheritance and Estate Tax Waiver” issued by the Division.  However, since 1988, inheritance tax transfers between decedents and “Class A beneficiaries” (spouse, children, grandchildren, etc.) are subject to tax at a zero (0%) percent rate, and thus are exempt.  See N.J.S.A. 54:34-2.  As such, for many transfers before 2002 subject to inheritance tax only, waivers could be obtained through a “self-executed” format.  This was a simple affidavit of a beneficiary indicating that no New Jersey inheritance tax was due.

The New Jersey Division of Taxation has adopted new forms for the estate tax.  These forms can be obtained in the New Jersey Division of Taxation website (www.state.nj.us/treasury/taxation).  The computation of the estate tax can be based upon two alternate methods – the “simplified” method and the “706” method.  Do not let the name of the “simplified” method fool you, it is no simpler than the “706” method (based upon an actual 2001 version of the federal IRS Form 706).  The genesis of this “simplified” provision was that taxpayers (including the New Jersey State Bar Association) objected as the legislation was being created.  A concern was raised about the returns to be filed for taxpayers who did not meet the federal filing threshold (those estates between $675,000 and $1,000,000 in 2002 and 2003 and between $675,000 and $1,500,000 beginning January 1, 2004).  The statute called for a “simplified” method to be adopted.  See N.J.S.A. 54:34-1(c).

In implementing this new method, the Division of Taxation merely based the estate tax computation on the New Jersey inheritance tax.  The New Jersey inheritance tax form (Form NJ-ITR) must be completed and the figures on the form are used to complete the “simplified” method for the estate tax.  Of course, many estates would not be concerned about the filing of the New Jersey inheritance tax return because, while filing is required, no tax would be due if property passed to “Class A” beneficiaries (spouse and children).  Nevertheless, estates in excess of the federal exemption amount must use the “706 method” which requires that the estate information merely be carried over to the state return.

The waiver provisions were revised after the passing of the New Jersey estate tax to require an additional affirmation that the estate value is less than $675,000. As a consequence, the “self-executing” waivers no longer apply to many larger estates. Thus, in order to obtain clearance for distribution of estate assets, an estate tax return must be filed, tax paid and the “inheritance tax waiver” must be received from the Division of Taxation. For a large estate, a Pennsylvania taxpayer may need to obtain a New Jersey inheritance tax waiver on the basis of the exemption granted to non-residents. Many New Jersey title companies will forego the necessity of a waiver if they are convinced that the decedent was not a New Jersey resident. The Forms for non-residents are Form 0-14-F and Form L-9-NR.

While the New Jersey estate tax is no longer new, many questions remain unanswered.  However, due to the significant differences between the New Jersey and Pennsylvania taxes, Pennsylvania practitioners should be cautious.