The phase-out and subsequent repeal of the New Jersey Estate Tax has been highly publicized and celebrated, but lost in the euphoria is the fact that New Jersey still has an Inheritance Tax.
The much maligned Estate Tax applied generally to estates in excess of $675,000 at a rate as high as 16%. Effective January 1, 2017, the exemption increased to $2,000,000, and effective January 1, 2018, the tax will be repealed in its entirety (absent future legislative action to the contrary). While the repeal of the Estate Tax is a universally-welcomed development, the Inheritance Tax lurks as an unpleasant surprise.
The Inheritance Tax applies to gifts to certain “non-exempt” beneficiaries which occur either: (1) at death, or (2) in contemplation of death or which are intended to take effect at or after death. While the Estate Tax is not concerned with the identity of the beneficiary (other than, generally, a spouse or charity, transfers to whom are generally exempt from tax), the Inheritance Tax applies only to transfers to individuals other than a spouse, an ancestor (i.e. parents, grandparents, etc…) or lineal descendants (children, grandchildren, etc…). When applicable, the tax is not insignificant: 11%-16% on transfers to siblings and in-laws, and 15%-16% on transfers to everyone else. Plus, unlike the Estate Tax, the tax is imposed on the first dollar, with no exemptions other than a $25,000 exemption for siblings and in-laws and an exemption for transfers of less $500.
While it’s easy enough to understand the concept of the tax applying to transfers at death, whether under a will, through intestacy, or as a result of being a named beneficiary of a retirement account or life insurance policy (although the Inheritance Tax does not apply to life insurance benefits paid to a named beneficiary other than an estate), the application of the tax to gifts made “in contemplation of death” or “intended to take effect at or after death” is more likely to take beneficiaries by surprise.
Any gift made within three years of death to a non-exempt beneficiary, such as siblings, nieces, nephews, in-laws or friends, is presumed to be made in contemplation of death and therefore subject to Inheritance Tax. That presumption can be overcome, but it’s not easy. The bottom line is that if someone intends to make a gift and decides to make it while they are alive rather than at death (for example, by Will), then the presumption will most likely not be overcome.
However, if it is a question of whether to make a gift at all, not simply when to make it, it’s possible that the presumption can overcome. For example, father wants to transfer property to son, an exempt beneficiary for Inheritance Tax purposes, but son asks that the property be put in his wife’s name. If father dies within three years of making the gift, the transfer to the daughter-in-law, a non-exempt beneficiary, is presumed to be in contemplation of death and subject to Inheritance Tax. However, a good argument can be made that the transfer was not in contemplation of death because father did not originally intend to make a gift to his daughter-in-law, particularly if father’s Will provides that the property passes to his son at death.
A recent New Jersey Tax Court case, Estate of Mary Van Riper v. Director, Division of Taxation, highlights the applicability of the tax to transfers intended to take effect at or after death. In that case, Mr. and Mrs. Van Riper transferred their home to an irrevocable trust in 2007 and retained the right to live there for the rest of their lives (a “life estate”). The trust provided that when they both died, the home would go to their niece. Mr. Van Riper died three months after the trust was formed, and Mrs. Van Riper died in 2013.
The niece argued that the Inheritance Tax did not apply because the trust was created more than three years prior to Mrs. Van Riper’s death. The court disagreed, holding that even though the transfer of the property to an irrevocable trust was more than three years prior to death, the Van Ripers retained life estate in the home postponed the niece’s enjoyment of the property until the death of both transferors. Therefore, the Inheritance Tax applied because it was a transfer “intended to take effect at or after death.”
Note that while the niece was undoubtedly disappointed with the court’s decision, the Inheritance Tax may have been partially or entirely offset by a hidden income tax benefit. While the retained life estate resulted in Inheritance Tax, it also bestowed an income tax basis “step-up” in the property to fair market value as of the date of death, thereby protecting all pre-death appreciation in the property from federal or New Jersey income tax.