Van Riper v. Director, Division of Taxation: New Jersey Supreme Court Hears Important New Jersey Inheritance Tax Matter
On October 8, 2019, the Supreme Court heard oral arguments in the case of Van Riper v. Director, Division of Taxation, 2018 WL 4761357 (App. Div. October 3, 2018). This case involves an inheritance tax dispute in which the New Jersey State Bar Association (NJSBA) filed an Amicus (Friend of the Court) brief which supported the taxpayer’s position. Kulzer & DiPadova shareholder Glenn Henkel (author) as well as Andrew DiMaio, of Neff Aguilar in Red Bank, and Jill Liebowitz of Norris McLaughlin in Sommerville, assisted on the legal arguments for the brief submitted to the New Jersey Supreme Court. Andrew DiMaio presented the NJSBA arguments to the Court at oral argument.
In a nutshell, this case turns on a trust that was created by Walter and Mary Van Riper in 2007. Apparently, for Medicaid planning purposes, in 2007 Walter and Mary irrevocably conveyed their home into a trust. The trust provided that they would each retain an interest in the home for their lifetime. Upon the demise of the surviving spouse, the home would pass to their niece.
Shortly after the creation of the trust, Walter passed away. In connection with the administration of his Estate, his executor filed an inheritance tax return and disclosed the creation of the trust. The executor also reported on the return that Walter transferred to the trust his 50% interest in the home. Because Walter’s 50% interest in the home was, upon his death, partially gifted to Mary (because she retained the right to live in the home for her lifetime), and then ultimately gifted to the niece (through her remainder interest in the trust), inheritance tax could have been implicated. Under New Jersey Inheritance tax law, a gift to a spouse is exempt from taxation because a spouse is referred to as a “Class A” beneficiary, and therefore Walter’s gift to Mary was not subject to tax. However, the niece is a “Class D” beneficiary and would be subject to a 15% tax on everything she received. Because Walter reserved an interest for his life, the tax would be imposed at his passing and not at the creation of the trust.
Under normal inheritance tax principles, at Walter’s passing the trust could have given rise to a “compromise tax” on the “remainder interest” in the trust which was being conveyed to the niece. The New Jersey statutes allow for the actuarial value of Mary’s interest to be free from tax because, as noted above, a spouse is an exempt beneficiary. However, the actuarial value of the niece’s interest would have been subject to a 15% tax. Under the New Jersey rules, the 15% tax would be imposed on the value of the niece’s interest at Walter’s death but, in addition, the trust provided that the trustee could sell the home and use the proceeds for Mary’s care. Thus, since the Trustee could have consumed the trust corpus for Mary during Mary’s lifetime, the regulations permit further reduction in the tax (called “compromise”) due to the contingency that the corpus of the trust passing to the niece could have been used up. On the return, the executor left the compromise tax line blank (or asserted zero tax due.) Sometimes, the Division will make an offer for the compromise tax although recently, in practice, the Division will ask the executor to make the first offer. Nevertheless, in the review of the New Jersey Inheritance tax return in Walter’s estate, the State did not audit the return and no taxes were paid.
Subsequently, Mary passed away in 2013. When Mary passed away the home was valued at $935,000 and the Division of Taxation sought to impose a 15% tax on the entire value of the home which, under the trust, was being transferred to the niece. Both the New Jersey Tax Court and the Appellate Division agreed with the position of the Director of the Division of Taxation. In contrast, the taxpayer as well as the NJSBA and the New Jersey Land and Title Association objected to the Division of Taxation’s position. The Division and the court concluded that the fact that both Walter and Mary could use the trust, Mary (or presumably Walter if he had survived) should be taxed on the entire “joint” interest. The taxpayer and both amicus participants objected on the grounds that each spouse should only be subject to tax on the 50% interest he or she conveyed to the trust, not the entire joint interest. The State position ignores not only the fact that the inheritance tax is on individuals, not spouses, but also that the State had the opportunity to consider Walter’s estate and the statute of limitations had passed.
Mary’s transfer of her interest in the home to her niece is subject to inheritance tax at Mary’s death because it was a transfer “intended to take effect” at Mary’s death. The tax is imposed on “transfers” (as a “transfer inheritance tax”.) However, Mary was the transferor of only her one-half interest in the home. The other 50% interest in the home was transferred by Walter and properly reported for tax purposes. Thus, in the view of the taxpayer and both parties arguing as Friend of the Court, the tax should not be imposed on the trust which was effectively created by Walter’s conveyance of one-half interest in the trust.
The NJSBA believes that this is an important case because Mary is effectively being subject to taxation even though she was a beneficiary of Walter’s gift to the trust. Many trusts are created for a variety of reasons and the concern of the Bar is that the State is blurring the rules concerning trust taxation. Historically, a beneficiary of a trust is not taxed and while this case presents an unusual fact pattern, an adverse position from the court could create difficult precedent.
Another technical legal issue involves a manner of holding real property known as “tenants by the entireties.” With “tenants by the entireties,” there is a legal fiction that a husband and wife each own 100% of any property when title is held in that fashion. Thus, one could think that Walter and Mary each conveyed 100% of their “entirety” interest. The legal concept of “tenants by the entireties” requires “four unities” of time, title, interest and possession. Also, only spouses can retain ownership as tenants by the entirety. Transfer of the property to the trust therefore breaks the “entireties” nature. The NJSBA pointed out that affirming the the holdings in the lower courts could lead to the conclusion that New Jersey law allows “tenants by the entireties” to exist even after conveyance to the trust. Some other states allow that approach, but they have statutes to permit it, and New Jersey does not have such a statute. Moreover, when spouses hold property as “tenants by the entireties” the nature of the “entirety” interest must stop at the death of the first spouse. Thus, clearly the property could not retain its entireties status after Walter’s death while being held as a part of the trust for Mary’s continuing life interest.
In sum, it will be several months before the New Jersey Supreme Court renders its final decision in this case. If the lower court decision is upheld, there could be some circumstances which a beneficiary of a trust may be subject to tax. It is unfortunate that the Division of Taxation has treated a husband and wife as a single unit when they should each be treated as their own transferor for their one-half interest of the home into the trust.