The New Jersey "Soak-up" Tax

The New Jersey Transfer Inheritance Tax is imposed on the beneficiary's right to receive and the decedent's right to dispose of property. The amount of tax is a function of the value of the transmitted shares and the relationship of the transferee to the decedent. When the date of death occurs on or after January 1, 1985, no inheritance tax is imposed on property passing from a decedent to a surviving spouse. When the date of death occurs on or after July 1, 1988, the full value of all property transmitted from a decedent to a class "A" beneficiary is exempt from tax. Class "A" beneficiaries are defined as children (including step and adopted and their respective issue, grandparents and parents) (see R.S. 54:38-1 et seq).

The state's right to impose the inheritance tax on transfers vests at the moment of a decedent's death, so that the law prevailing at the time of death controls the transfers subject to the tax and the rates. In the case of a life estate passed to the testator's spouse, coupled with a power of appointment that creates contingent remainder interests, the tax rates in effect at the date of decedent's death, still control.

The New Jersey Estate Tax is imposed upon the transfer of an estate of every resident decedent which is subject to a Federal Estate Tax under the IRC in effect as of the date of death of the decedent. The amount of tax is the difference between the maximum credit allowable against any Federal Estate Tax under Sec. 2011 (based on the "Adjusted Taxable Estate") and all estate, inheritance, succession or legacy taxes actually paid to any and all states, including the District of Columbia (see R.S. 54:38-2 et seq).

An Example

The total state death taxes paid in New Jersey and New York for the Estate of Bar, a New Jersey resident decedent, was $62,767.72. (See Schedule I, appendix). The maximum tax credit on a Federal Adjusted Taxable Estate of $661,194 is $19,017 ($18,999 + $1,017). Accordingly, no New Jersey Estate Tax is owed because total state death taxes exceed the maximum credit by $43,750.72. Mr. Bar's will provided that after the payment of debts, funeral expenses and costs of administration amounting to $62,985, his personal New Jersey residence was to be devised to his girlfriend, the New York real estate to be devised to his son, and all remaining assets of the gross estate were shared equally between the two beneficiaries. R.S. 54:38-2 provides as follows:

" . . . In any estate where no

inheritance, succession or legacy tax is due

this state under the provisions of said

Chapters 33 to 36 or under authority

of any subsequent enactment

imposing taxes of a similar nature, but an

estate tax is due the United States

under the provisions of any federal

revenue act in effect as of the date of

death, wherein provision is made for

a credit on account of taxes paid the

several states or territories of the

United States, or the District of

Columbia, the tax imposed by this chapter

shall be the maximum amount of such

credit less the aggregate amount of

such estate, inheritance, succession or

legacy taxes actually paid to any state

or territory of the United States or the

District of Columbia . . . "

To illustrate the mechanics of the New Jersey Estate Tax assume that the portion of the estate that passed to the Class "D" Beneficiary (girlfriend) had in fact passed to Mr. Bar's son. Accordingly, under this will provision (assuming the New York property passed to the surviving son), no New Jersey Transfer Inheritance Tax would be owed.

The federal maximum credit would exceed the actual taxes paid to New York State by $11,721.93. If the executor were to file federal Form 706 and take the maximum credit to reduce the federal tax liability to $25,825, then under Federal and New Jersey state law, a New Jersey Estate Tax Liability would be triggered amounting to $11,721.93. No New Jersey Estate Tax Liability would be imposed if the executor reported $7,295.07 on Line 13, federal Form 706, and paid $37,546.93 to the federal government. (See Schedule II.)

To illustrate further, assume that the executor contested the value of the New York real property during the probate proceeding but received a determination after the federal Form 706 was filed. Assume further that the Executor conservatively computed a lower valuation and accordingly utilized a $5,000 credit on Form 706, Line 13. Once the actual tax determination by the New York State Surrogate Court is received, the Executor has 4 years from the date the Form 706 estate tax return was filed in which to claim the additional credit of $2,295.07.

Alternatively, had the executor utilized a higher valuation by projecting an unfavorable determination and reported a $10,000 estimated tax credit when he originally filed the Form 706 return in 1989, under Regulation 20.2016-1, notice must be given to the IRS within 30 days of the receipt of the actual State Surrogate findings. However, under New Jersey State law, failure to notify the IRS could technically result in a New Jersey Estate Tax amounting to $2,704.93, in the case of the son. Moreover, the Executor could avoid interest owed to the federal government by paying the New Jersey state estate tax as a substitute for the federal tax.

Instead of a valuation problem, assume the will was silent as to the source of the payment of state death taxes, or perhaps, the ownership of personal property within the residence was contested, for example, valuable artwork. Discovery proceedings in the New York Surrogate Court could delay the winding up of all estate tax matters. R.S. 54.38-2 provides as follows:

" . . . If subsequent to the

determination of the tax due under this

chapter, an additional or increased estate

tax shall become payable to the

United States by reason of any

redetermination or additional or corrected

assessment as to a portion of which

the estate is entitled to a credit on

account of estate, inheritance,

succession or legacy taxes paid to any state

or territory of the United States or the

District of Columbia, then an

additional estate tax shall be due and

payable to this state to be assessed in

the same manner as provided by

Section 54:38-1 of this title."

Additional Assumptions

Assume further that the entire property comprising the whole estate was located in New Jersey and was completely devised to a Class "A" beneficiary (i.e., other than the wife), after the son disclaimed his interest. Any devisee, beneficiary or legatee may renounce a testamentary gift or disclaim the right of succession to any property including a future interest. An instrument of disclaimer must be timely filed with the State Surrogate or Superior Court for information purposes, under New Jersey State regulations. Because Mr. Bar died on October 28, 1988, no New Jersey State Inheritance Tax would be owed, nor would any State Death Tax be owed to any other state of the Union. However, a Federal Estate Tax Liability would still exist.

As noted, the allowable maximum federal credit is $19,017, but in this case the total amount of state death taxes actually paid is zero. Accordingly, the New Jersey State Estate Tax is the amount of the allowable credit minus the actual taxes paid or $19,017 minus zero or $19,017. Lastly, assume that the entire property comprising the whole estate was located in New Jersey and was completely passed to the wife. Under the will, the marital deduction was taken for the entire amount that was passed to the wife so that no Federal Estate Tax is owed, then no maximum allowable credit is used and no estate tax applies.

The payment of state death taxes in the State of New Jersey directly effects the computation of the Federal Estate Tax Liability. Where an estate contains property across several states and/or distribution to Non-Class "A" Beneficiaries, the executor is faced with potentially at least four different death tax computations. Lastly, the interpretation of will provisions and property law disposition concepts directly affects these computations.

In a recent per curiam opinion, the Supreme Court of New Jersey modified the ruling of the Committee on the Unauthorized Practice of Law to allow a limited exception that permits CPAs, licensed in New Jersey, to prepare and file Inheritance Tax Returns. No supervision of an attorney is required as long as the client is notified in writing, before the CPA commences work on the return, that a review of the return by a qualified attorney may be desirable because of the possible application of legal principles to the preparation of the tax return. Tabular Data Omitted

J. David Golub, CPA, Rayfield & Company