Minimizing estate taxes when you have non-child heirs

Photo: Dodgerton Skillhause/

 Q. I don’t have any children, and I plan to leave my estate equally to my sister and a friend. Will they owe any estate taxes?

A. Estate taxes can be an ugly surprise for your heirs.

Your sister and friend won’t specifically owe “estate taxes,” but they will have to pay “inheritance taxes” to the state of New Jersey.

“The inheritance tax is a tax on transfers of assets to certain classes of persons,” said Mary Scrupski, a Robbinsville-based estate planning attorney.

For example, there is no tax on transfers to Class “A” beneficiaries, which include a spouse, children and parents. However, if you leave assets to your sister, because she is a Class “C” beneficiary, she will have to pay inheritance tax on what she receives, Scrupski said. The first $25,000 is exempt, but anything over that will be taxed at rates that range from 11 to 16 percent.

The part of your estate that you are leaving to your friend will also be subject to inheritance tax, Scrupski said. A friend is considered a Class “D” beneficiary, and the calculation is slightly more complicated because there won’t be any tax if your friend only receives $499. If she receives $500 or more, then the entire amount will be subject to tax, Scrupski said. The rate is 15 percent on inheritances up to $700,000, and anything over that amount will be taxed at 16 percnet.

Scrupski said you should note that the tax is imposed on all transfers, not just what you leave under your will.

“For example, If you name your sister or friend as a beneficiary of your retirement plan, there will still be inheritance tax due,” she said. ” Likewise, if you make an account `payable on death’ to either of them, there will be tax due.”

Scrupski said putting your bank accounts in joint names will not help reduce the tax if the money in the bank account was yours to begin with.

“The State of New Jersey takes the position that all of the money in the account belongs to the first joint owner to die unless you can prove otherwise,” she said. “Actually putting someone else’s name on a bank account can cause problems if the first person to die is the person who never contributed to the account.”

She said because the state assumes that it all belonged to the first person to die, it can get very complicated if the first person to die did not contribute to the account.

There is one important exception to the New Jersey inheritance tax: life insurance that is paid to a named beneficiary.

“If you name your sister or friend as beneficiary of one or more life insurance policies, they will not have to pay any inheritance tax on the life insurance proceeds,” she said. “However, if you name your estate as the beneficiary, there will be tax due, when your estate passes to the beneficiaries.”

You should also know that under New Jersey law, the beneficiary is liable for the tax unless the will provides otherwise. In many cases, an individual states in his or her will that all taxes are to be paid from the “residue” of the estate, Scrupski said.

“This means that all inheritance tax is paid before the balance is distributed, even if the tax rates are different,” she said.

She offered this example: If you leave $125,000 to your sister, the $100,000 (after the $25,000 exemption) is taxed at 11 percent, so there is $11,000 in tax due. If your sister was liable for the tax, she would receive $114,000. If you also left $125,000 to your friend, he or she would pay $18,750 (15 percent of $125,000) in tax, and receive $106,250.

But if instead, your will instructs that taxes be paid from the “residue” of the estate and the “residue” is $250,000, the total tax of $29,750 would be paid first. Then the balance of $220,250 would be divided equally between your sister and your friend, Scrupski said, with each receiving $110,125.

“As you can see, if the tax is paid from the residue, your sister will receive a little less and your friend a little more,” Scrupski said. “If you prefer that each receive the exact same amount, then having the tax paid from the residue is fine, but if you want each to bear the burden of the tax, then the will should specify that each beneficiary is liable for his or her share of the tax.”

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This story was first posted in December 2014. presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.