Protecting an inheritance from taxes

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 Q. My uncle says he’s leaving his money to me because he doesn’t have any children. I know estate taxes are different if you leave your money to someone who is not a spouse or child. What do we need to know, and can we do something to lower the tax bills that will come?

A. There’s not much you can do about taxes, but it’s possible your uncle can.

New Jersey has both a transfer inheritance tax and an estate tax.

The transfer inheritance tax is assessed upon the transfer by New Jersey resident decedents of all real and personal property in New Jersey and intangibles — for example, bank and brokerage accounts, claims — wherever situated if it’s worth more than $500, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.

In addition, gifts made within three years of death to persons other than a spouse, civil union/domestic partner, grandparents, parents, descendants, and stepchildren are taxed, unless it can be demonstrated that the gift was not in contemplation of death, she said.

Certain property is exempt from the transfer inheritance tax, such as life insurance paid to a designated beneficiary other than the estate or executor, charitable transfers, and certain annuities, Romania said.

“The transfer inheritance tax is not affected by the residence of the beneficiary; however, it is affected by the relationship of the beneficiary to the decedent,” Romania said.

For example, Class A beneficiaries, including spouse, civil union/domestic partner, grandparents, parents, descendants and stepchildren (but not step-grandchildren), are exempt, she said.

Romania said transfers to a sibling or the surviving spouse of a child who are classified as Class C beneficiaries are taxed between 11 and 16 percent on amounts in excess of $25,000. All other beneficiaries (other than charities), including nieces and nephews, are considered Class D beneficiaries and taxed at a rate of 15 percent on amounts up to $700,000 and 16 percent on amounts in excess of $700,000.

“Because gifts made prior to three years before death are not assessed the transfer inheritance tax at death, the transfer inheritance tax can be reduced by making gifts of property during one’s lifetime and not at or within three years prior to death,” Romania said. “However, merely placing a bank account into joint names is not sufficient.”

She said assets passing at death receive a step up in basis, whereas assets passed by gift do not, therefore the income tax consequences also need to be considered before making lifetime transfers.

Then there’s the state’s estate tax, which hits estates that are greater than $675,000. The price tag is assessed at a graduated rate of 4.8 to 16 percent, she said.

“Certain assets exempt from transfer inheritance tax may still be subject to estate tax,” Romania said. “For example, life insurance is subject to estate tax but may not be subject to the transfer inheritance tax.”

She said the estate tax need only be paid to the extent it exceeds the transfer inheritance tax liability. The estate tax is also reduced proportionately where real property is located outside New Jersey, she said.

Finally, a New Jersey resident decedent is also subject to federal estate tax if the estate is in excess of $5.43 million, which is adjusted annually for inflation. Any New Jersey transfer inheritance or estate tax paid is a credit against the federal estate tax, Romania said.

“Although relocating to a different jurisdiction will not avoid the federal estate tax, it may reduce or eliminate state taxes as many states, such as Florida, do not assess death taxes,” Romania said. “Other states have estate tax exemptions greater than $675,000 and/or do not have transfer inheritance taxes.”

Depending on the nature and value of your uncle’s assets, a knowledgeable estate planning attorney may recommend other steps that can be taken now to reduce estate taxes, so that may be a worthwhile investment.

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