07 Feb Estate tax? Inheritance tax? A primer for NJ

Q. What is the difference between the estate tax and inheritance tax?
— Alive and kicking

A. This has been a popular question since New Jersey made changes to its estate tax. That was part of the same bill that hiked the gas tax in the state.

The estate tax and the inheritance tax are two different taxes, both falling under the informal category of “death taxes.”

They’re both very different, so it’s important for you to understand those differences and assess what exposure, if any, you have to one or both taxes.

For starters, the federal government imposes an estate tax, but not an inheritance tax, said Frederick Schoenbrodt, an estate planning attorney with Bressler Amery Ross in Florham Park.

He said under current law, in 2017, New Jersey has both an estate tax and an inheritance tax.

“In 2018, the estate tax is scheduled for repeal, but the inheritance tax will remain,” he said. “Some other states just have an estate tax, while other states just have an inheritance tax. Some states have neither an estate tax nor an inheritance tax.”

That’s why New Jersey, before the estate tax was changed, was one of the most expensive states in which to die.

Schoenbrodt said an estate tax is payable by a decedent’s estate and generally is based on the fair market value of the decedent’s assets on the date of death, reduced by certain liabilities, debts and expenses.

Also, he said, certain deductions apply to reduce the taxable estate, most notably the unlimited marital and charitable deductions.

“In 2017, the federal estate tax exemption is $5.49 million and the New Jersey estate tax exemption is $2 million, so tax will only apply if the taxable estate exceeds these amounts,” he said. “The estate tax rate is then applied to the taxable estate and the tax is paid on the decedent’s estate tax return.”

The federal rate is 40 percent and the top New Jersey estate tax rate is 16 percent, he said. But that’s scheduled for repeal on Jan. 1, 2018.

An inheritance tax is different in that it applies a tax based on the relationship of the beneficiary to the decedent and the amount that beneficiary receives, Schoenbrodt said. There is no federal inheritance tax.

He said certain states, like Pennsylvania, do not have an estate tax but apply an inheritance tax.

“While New Jersey has both taxes, they are structured in a way to essentially offset one another so that the total tax paid is no greater than the greater of the separately calculated estate tax or inheritance tax,” he said.

Under New Jersey’s inheritance tax law, beneficiaries are placed in classes depending on their relationship to the decedent, Schoenbrodt said. Class A beneficiaries include spouses and descendants, and they’re exempt from inheritance tax. Class D beneficiaries include nephews, nieces, friends and others, is the least favorable class for inheritance tax purposes, he said. The inheritance tax on assets passing to a Class D beneficiary can be 15 or 16 percent depending on the amounts involved.

“For people who are leaving their estates to someone other than a spouse or descendant, it is wise to review the inheritance tax consequences of the estate plan with a knowledgeable practitioner,” Schoenbrodt said. “The estate tax receives so much coverage that the inheritance tax can be a big surprise to people who are subject to it.”

If you want to learn more, here’s a helpful chart from the state’s Treasury department.

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This post was first published in February 2017.