So what’s the difference between New Jersey Estate Tax and New Jersey Inheritance Tax?
Many clients incorrectly assume that the “estate tax” is now reserved only for multi-millionaires such as the Hiltons and Trumps of the world. While that’s true with respect to Federal Estate Tax (which begins at 5.25 million for 2013), not so for New Jersey residents, who are subject to the New Jersey Estate Tax, which begins at estates valued over only $675,000. The Garden State remains an extremely expensive place to die.
NJ is also one of only two states that impose an Inheritance Tax as well as an Estate Tax. This blog post will cover & explain only the NJ Inheritance Tax. The estate tax will be covered in an upcoming post.
Before addressing this issue, let’s first clear up some “death tax” terminology. Many people use the words “inheritance tax” interchangeably with “estate tax,” when in reality they are 2 separate and distinct taxes (yes folks, New Jersey really gets you coming and going- I’m surprised they haven’t yet come up with a “birth tax.” ).
Inheritance tax is levied against one who receives an inheritance. However, it is the responsibility of the executor of the decedent’s Will to file the Inheritance Tax Return with the State of New Jersey Division of Revenue within 8 months of the decedent’s death, or else the estate may be subjected to additional interest and penalties.
Note that life insurance proceeds payable to a named beneficiary (regardless of the decedent’s relationship to the named beneficiary) are completely exempt from NJ Inheritance Tax. A “named beneficiary” is a specific person or persons.
Life insurance proceeds that name the decedent’s estate as beneficiary of the policy’s may be subject to NJ Inheritance Tax depending on the class of beneficiaries whom the decedent has made bequest to in his or her Will. We’ll further examine and explain New Jersey’s “beneficiary class structure’ below.
Although the executor of the Will typically files the return and “pays” the inheritance taxes, the “payment” of inheritance taxes comes out of the taxable portion of the recipient’s share of the estate. For example, if Adam dies and leaves his niece Barbara $10,000 and his niece Carol $10,000 in his Will, Barbara & Carol would each actually receive only $8500, since each owes 15% (i.e, $1500) in inheritance tax on their respective shares.
Now, some good news: if you inherit/receive money under a Will, and have one of the following family/spousal relationships to the decedent (i.e., the person who died), you are exempt from paying NJ Inheritance Taxes on the money you inherit under their Will, regardless of its amount:
Father, mother, grandparents, child, grandchild, great-grandchild, spouses, civil union partners, or domestic partners.
The above persons are categorized as “Class A” beneficiaries under the NJ Tax code. The reason why Class A beneficiaries are not levied with NJ inheritance tax is because of the presumed “closeness” of the family relationship. The wonks who craft government tax policy also fear the uproar if inheritance tax was imposed on parent-to-child inheritances (especially if a large portion of the estate’s value is tied to a continuing family business, such as a mother/daughter restaurant, father/son plumbing company, etc.).
Oddly, brothers and sisters of the decedent are not included in “Class A.” Nor are they included in Class B, because there is no Class “B” (NJ eliminated it many years ago).
Rather, brothers and sisters (including step-brothers & step sisters) of the decedent are considered “Class C” beneficiaries. Class “C” also includes the decedent’s son-in-laws and daughter in laws. It also includes the widow of a deceased son and widower of a deceased daughter. However, a bequest to a son-in-law or daughter-in-law is only taxed: (1.) if their spouse is deceased, or (b) a separate gift is made to them specifically by name in the Will.
Confused? This is easier to understand with an example:
Mr. Apple dies at age 85. His estate is worth $100,000 at the time of his death. Mr. Apple is survived by his only daughter, Bea, who is married to a fellow named Chris.
Under Mr. Apple’s Will, Bea takes the full $100,000 free and clear of any inheritance tax. Chris does not factor into the NJ inheritance tax question because he is not individually named as a separate beneficiary in Mr. Apple’s will (although, as husband and wife, Bea and Chris will likely share the inherited money as a practical, spousal matter). No matter from a tax standpoint: the money all passes to Bea free of inheritance tax.
OK. Now let’s change the facts a bit:
Suppose Mr. Apple dies and leaves the same $100,000 gross estate, but sadly his daughter Bea had pre-deceased him by 5 years, so Mr. Apple changed his Will a year before his death and named his son-in-law Chris as sole beneficiary of the $100,0000. Chris will now be subject to the New Jersey inheritance tax, as he was the spouse of a child of the decedent (i.e, Bea’s husband, and Mr. Apple’s son-in-law.).
As a New Jersey Inheritance Tax “Class C” beneficiary, the first $25,000 of Chris’s inheritance is exempt from NJ inheritance tax. The remaining balance of his inheritance ($75,000) will be taxed at a rate of 11%. Thus, Chris will have an inheritance tax liability of $8250 (11% of $75,000).
Let’s change the facts one more time, okay?
Suppose Mr. Apple has the same $100,000 gross estate, and that Mr. Apple dies in 2013. Mr. Apple has an older Will that he executed back in the early 1980s. This Will left everything to his daughter Bea.
Sadly, Bea was killed in a car accident in 2007, and a year later Chris was diagnosed with cancer and passed away. Mr. Apple never got around to changing his Will after Bea died, nor after Chris died.
The only surviving family member of Mr. Apple was his nephew David, who lived in Hawaii and who Mr. Apple had not seen in over 40 years. Under New Jersey’s Laws of Intestate Succession, David inherits the entire $100,000 of Mr. Apple’s estate.
As a nephew, David is a “Class D” beneficiary under the New Jersey Inheritance Tax statute. As such, he is taxed on any inheritance amount over $500. No exemptions. Thus, Chris will pay a 15% tax (this is the rate assessed to Class D beneficiaries) on the entire $100,000, thus a $15,000 NJ inheritance tax liability.
Question: What if I leave money to charity?
Charities who are registered under section 501(c)3 under the Internal Revenue Code (as most legitimate non-profit charities are) are wholly exempt from paying NJ inheritance taxes on any bequest they receive, regardless of the amount. NJ labels such charities as Class “E” beneficiaries.
OK, let’s recap the NJ Inheritance Tax “class structure” one more time:
Class A beneficiaries have one of the following relationships to the decedent: father, mother, grandparents, children/grandchildren, spouses, and civil union partners. No NJ Inheritance Tax is imposed on “Class A” beneficiaries regardless of how much they inherit from the decedent.
Class B: There is no “class B” in NJ- it was eliminated by statute in 1963 !
Class C: brother or sister of decedent; the husband, wife, or widow/widower of a child of decedent (i.e, the son-in-law or the daughter-in-law of decedent); and half-brothers or half-sisters of the decedent. (Note that the terms “half-brother & half sister” refer to a sibling with whom the decedant shares one common biological parent. “Step-brothers and step-sisters” of the decedant are Class D beneficiaries.
Class C beneficiaries are taxed at rates of 11%–16%, with the first $25,000 exempt from taxation. Here is the progressive rate table for Class C beneficiaries:
First $ 25,000 Exempt
Next 1,075,000 11% inheritance tax rate
Next 300,000 13%
Next 300,000 14%
Over 1,700,000 16%
Class D: stepbrother or stepsister of the decedent, niece, nephew, cousin, other “distant” relatives such as 2nd cousins, and everyone else without a family relation to decedent (i.e, friends of decedent.) Class D beneficiaries pay no inheritance tax if their gift is less than $500. If in excess of $500, they are taxed at a rate of 15% on the entire amount of their gift up to $700,000, and at 16% on any amount over the first $700,000. Thus, the classic “million-dollar inheritance” from one’s long-lost uncle is in New Jersey a net, after-tax gift of only $847,000. How?
15% tax on the first $700,000 = $105,000 Inheritance Tax liability
16% tax on the next $300,000 = $48,000 Inheritance Tax liability
$1,000,0000 gift minus $153,000 Class D inheritance tax= net after-tax gift to nephew of $847,000. (Actually, the net gift would be less than $847,000 because NJ Estate Tax would also be owed, as the total estate is in excess of NJ’s $675,000 exemption. We’ll discuss NJ Estate Tax in an upcoming blog post and re-examine this example).
Class E- Gifts to charitable organizations, churches etc- all gifts to to charities and entities below are 100% exempt from NJ Inheritance Tax:
Gifts to The State of New Jersey or any political subdivision thereof, or any educational institution, church, hospital, orphan asylum, public library or Bible and tract society or to, for the use of or in trust for religious, charitable, benevolent, scientific, literary or educational purposes, including any institution instructing the blind in the use of dogs as guides, no part of the net earnings of which inures to the benefit of any private stockholder or other individual or corporation; provided, that the exemption does not extend to transfers of property to such educational institutions and organizations of other states, the District of Columbia, territories and foreign countries which do not grant an equal, and like exemption on transfers of property for the benefit of such institutions and organizations of this State.
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Hopefully this blog post was helpful in explaining the NJ Inheritance Tax. If you have further questions, feel free to call us at 908-782-5313.
*Our next blog post will address the NJ Estate Tax, and ways to avoid and/or minimize your exposure to it.