Q. Must the value of a 529 plan be reported on the New Jersey inheritance tax filing? My brother-in-law died in Eatontown in April. He had two 529 plans for two grandnephews who live in another state.
— Figuring it out
A. Here’s what you need to know.
A 529 plan is an investment account established thanks to Section 529 of the Internal Revenue Code and state law.
Initially, 529 plans were a popular way for a family to save for college or other post secondary education. The recent 2017 Tax Act expanded such plans to include saving for elementary and high school education.
The 529 plan earnings are exempt from income tax provided they are used for qualified education expenses, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.
Qualified education expenses include tuition, fees, books, supplies, equipment, room and board at eligible institutions.
Generally, distributions for other than qualified education expenses will result in the earnings being taxed to the recipient plus a 10 percent penalty.
A contribution to a 529 plan is considered a gift by the contributor to the beneficiary, Romania said, even though the custodian on the account has the ability to withdraw the funds in the account subject to tax consequences.
Additionally, she said, the custodian may transfer all or a portion of an account to another beneficiary without tax consequences, provided the subsequent designated beneficiary is a member of the prior beneficiary’s extended family as defined in the Internal Revenue Code.
“Generally an interest in a 529 plan is not included in a decedent’s gross estate for federal estate tax purposes, although there are a few specific exceptions to this rule,” Romania said.
But still, it may be subject to New Jersey inheritance tax.
“Pursuant to the New Jersey Division of Taxation, the general rule is that the plan is subject to New Jersey inheritance tax unless the relationship between the owner/custodian and the beneficiary is Class A, which includes grandparents, parents, spouses, descendants or stepchildren,” she said.
In this case, as a great uncle to a grandnephew, the relationship is considered Class D, which is taxed at 15 to 16 percent, Romania said.
The executor would need to get an inheritance tax waiver from the New Jersey Division of Taxation before the financial institution should release the entire account, she said.
“With respect to the payment of the tax, if nothing is stated in the will, the New Jersey inheritance tax will be allocated to and paid by the beneficiary of the 529 account,” Romania said. “However, it is possible that the will directs the executor to pay any inheritance tax from the estate before distributing the residuary, and not from the individual beneficiary’s account.”
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