Reasons to Leave New Jersey That Have Nothing to do With Reality TV

As previously discussed on this blog, in addition to the federal estate tax, the State of New Jersey imposes its own estate tax on individual estates larger than $675,000.  In client meetings, we spend a lot of time discussing and developing solutions that revolve around the New Jersey estate tax.  At the end of this discussion, clients usually say something along the lines of “isn’t there an easier way?”  My answer is always simple: “yes, you can become a resident of a state without a state estate tax.”  Now, for most people, leaving the state is not an option, but to be a resident of a state for estate tax purposes, you only have to reside in that state for 6 months and 1 day.  So if you’ve ever considered a beach house in Florida or a ski cabin in Colorado, here’s one more incentive to go for it: you won’t have to pay estate taxes to New Jersey or any other state from the list below.  The only caveat here is that you actually have to live in the state in which you are claiming residency for the 6 months and 1 day.  The New Jersey Division of Taxation has gone to great lengths to determine whether a taxpayer was a resident of another state at the time of his or her death, including looking into phone records, electricity bills, airplane tickets and other similar records.

States that do not impose an estate tax as of this writing*:

1. Alabama                  13. ***Kansas               25. North Dakota

2. Alaska                     14. **Kentucky            26. ***Oklahoma

3. Arizona                   15. Louisiana                 27. **Pennsylvania

4. Arkansas                 16. Michigan                 28. South Carolina

5. California                17. Mississippi               29. South Dakota

6. Colorado                 18. Missouri                  30. Texas

7. Florida                     19. Montana                  31. Utah

8. Georgia                   20. **Nebraska             32. Virginia

9. Idaho                       21. Nevada                    33. West Virginia

10. **Indiana              22. New Hampshire      34. Wisconsin

11. ***Illinois             23. New Mexico           35. Wyoming

12. **Iowa                  24. ***North Carolina           

* Please be advised that with the future of the federal estate tax uncertain, some states may alter their state estate tax laws once the federal estate tax situation is resolved.

** These states do not collect a state estate tax, but do collect a state "inheritance tax."

*** Estate taxes in these states were repealed on January 1, 2010 due to the repeal of the federal estate tax and are may return once the federal estate tax uncertainty is resolved.

The New Jersey Inheritance Tax - the lesser known New Jersey death tax

I find that clients often use the terms "estate tax" and "inheritance tax" interchangeably. Usually, that isn't a problem, and I know exactly what they are talking about. However, in New Jersey there really is a distinction between the "estate tax" and the "inheritance tax." This is New Jersey, after all -- so we have two taxes. Go figure!

The New Jersey Estate Tax is the better known of the two taxes. The tax is imposed on estates of over $675,000. However, amounts passing to a surviving spouse are exempt from the tax. While the tax rates imposed in New Jersey are lower than the Federal estate tax rates which most of use are familiar with, they can still be quite significant. In fact, through a strange quirk in the law, the rates start at a rate as high as 37% on the first $52,174 over the exemption, and, thereafter, the rates range from 4.8% to 16%. So, for example, the following taxes will be imposed on New Jersey estates:

• $1,000,000 $ 33,200
• $1,500,000 $ 64,400
• $2,000,000 $ 99,600
• $3,500,000 $ 229,200
• $10,000,000 $1,067,600

The New Jersey Inheritance Tax is less a tax based upon value as it is a tax based upon the relationship between the deceased and the beneficiary. All beneficiaries are assigned to a certain "class." There are four classes of beneficiaries: Class A, Class C, Class D and Class E. I didn't forget Class B -- this Class was eliminated in 1963. Depending upon the Class that a beneficiary falls into, there may or may not be a New Jersey Inheritance Tax.

Class A beneficiaries include the decedent's spouse, civil union partner, children, grandchildren, great-grandchildren, step-child, mother, father or grandparents. Bequests to Class A beneficiaries are wholly exempt from New Jersey Inheritance Taxes.

Class C beneficiaries include the decedent's siblings, half-siblings, son-in-law, daughter-in-law, widow of a deceased son, and widower of a deceased daughter. Bequests to Class C beneficiaries are taxed on amounts in excess of a $25,000 exemption to each. The first $1,075,000 over the exemption, received by a Class C beneficiary, is taxed at 11% and the amount in excess of that figure is taxed at rates from 13% to a maximum of 16%.

Class E beneficiaries include tax exempt entities such as charities and not-for-profit organizations. Bequests to Class E beneficiaries are wholly exempt from the New Jersey Inheritance Tax.

Class D beneficiaries include anyone who is not a Class A, C or E beneficiary. So, for example, a nephew, niece, cousin, fiance, best friend, or non-civil union partner are all Class D beneficiaries. Bequests to Class D beneficiaries are taxed on the first dollar (unless the bequest is less than $500) at rates of 15% up to $700,000 and 16% in excess of that amount.

While an estate will receive a dollar-for-dollar credit against New Jersey Estate Taxes for amounts paid as Inheritance Taxes, the tax can be extremely onerous. While this tax is generally not a concern for most "nuclear families", for individuals without children, it can be the most unkind tax of all.

The Inheritance Tax also proves far more difficult to plan around than estate taxes because, in most cases, clients are more reluctant to embark on a lifetime gifting strategy when the intended beneficiaries are not their spouse or children. However, with some careful planning the effect of the tax can be reduced.

Roth IRA Conversion

Lost among all of the talk about Federal estate tax repeal, is one of the greatest opportunities that Congress has given to many of my clients in years -- the uncapped Roth IRA conversion opportunity. Until 2010, a Traditional IRA could only be converted to a Roth IRA by a taxpayer with adjusted gross income of less than $100,000. However, starting this year, anyone can convert a Traditional IRA to a Roth IRA, regardless of the amount of adjusted gross income earned in the year. In analyzing the benefits of a Roth IRA conversion, I have found that most of my clients will achieve significant benefits from converting. Among the benefits achieved are:

(i) no required minimum distribution rules for the original owner of the Roth IRA;
(ii) the ability to pay income taxes from non-tax-deferred assets which, in effect, results in increased deferral opportunities; and
(iii) paying income taxes with dollars that might otherwise have been subject to estate taxes (effectively paying your kids future income tax liability with pre-estate tax dollars).

Of course, a Roth IRA conversion may not be right for everyone, but everyone should, at a minimum, consider whether it is right for their individual situation.

Please Hold Your Applause

So the day that we thought would never get here, is here. On January 1, 2010, the Federal estate tax was repealed. Yes, you heard me right. There is no longer a Federal estate tax. So let's assume that when Bill Gates gets a look at the new Apple tablet computing device, he is so overcome with fear that he drops dead. Even though in real life he is an extremely philanthropic guy, assume that he has a will that leaves his entire fortune to his children. So the kids inherit $50,000,000,000 tax free in 2010, and the IRS receives nothing. If Bill had the same plan and died in 2009, the IRS would have received over $22,000,000,000 (all those zeroes mean we are talking about billions of dollars). If Bill dies in 2011, anything over $1,000,000 (these zeroes mean one million dollars) will be subject to Federal estate taxes at rates as high as 55%. Yes, you read that correctly, the Federal estate tax repeal is temporary -- it comes back in 2011. But wait -- there's more -- there is a very real possibility that the Federal estate tax could come back in 2010 and may even be made effective retroactively back to January 1, 2010. Of course, you and I know how insane this is. But Congress has only known about this for eight years. Certainly, they could not have been expected to deal with these issues over that short a period of time. What this means is that it is a very interesting time to be practicing in the area of estate planning. It also means that everyone should revisit their estate plan to determine whether or not changes are necessary. You might also think of writing to your member of Congress and suggest they get off their "keisters" and figure this thing out.