14 Jul How to avoid the inheritance tax

Q. I’m very close with my niece. She has serious financial and medical problems and a teenage daughter to put through college. I’ve left $50,000 to her in my will but I didn’t consider the inheritance tax. Is there anything I can do to lessen the burden on her? Would it be better if I gave her $14,000 annually instead?
— Auntie

A. New Jersey remains one of the few states that imposes an inheritance tax.

The tax is not based on the size of the estate but on who receives the proceeds, and you’re right — your niece will get stuck with a tax bill.

There is no inheritance tax imposed on transfers to a parent, grandparent, spouse, domestic partner, child or step-child, called Class “A” beneficiaries, said Richard Miller, an attorney and chair of the elder law department at Mandelbaum Salsburg in Roseland.

But, he said, an inheritance tax is imposed on transfers to a niece or nephew, who are considered Class “D” beneficiaries.

“The tax rate is between 15 and 16 percent depending on the amount transferred,” Miller said.

Using gifts during your lifetime so your niece can avoid the inheritance tax may be a smart idea, but it’s not without possible risks.

“Transfers made within three years of death are presumed to be `in contemplation of death’ and, may, also, be subject to inheritance tax,” Miller said. “In addition, transfers intended to take effect at or after death are included in one’s estate for inheritance tax purposes.”

Still, Miller said, it would be financially advantageous to gift funds to your niece during your lifetime.

He said this could be accomplished by outright gifts or the payment of your niece’s medical costs or her daughter’s educational expenses.

“Inheritance tax can also be avoided through the use of an irrevocable trust under certain circumstances,” he said. “The trust can be used to pay expenses for the benefit of your niece or her daughter as well.”

This, however, requires giving up control and use of the assets placed in trust, Miller said. You cannot have the right to revoke, amend, modify or regain a beneficial interest in the trust. Also, the transfer of the trust property to your niece cannot be specifically triggered by your death.

Miller said an individual is entitled to make annual gifts of $14,000 per person without having to report the gift.

If the annual gift exceeds $14,000, the excess amount will utilize a portion of the individual’s estate and gift tax exemption which is currently $5.49 million, he said.

“By way of example, if you give $50,000 to your niece in a lump sum, your estate and gift exemption will be reduced by $36,000 to $5.454 million,” he said. “Unless your estate exceeds or is likely to exceed this amount, it does not matter if you give the money to your niece all at once or in $14,000 increments each year.”

Moreover, he said, there is no limit on gifts used to pay for someone’s medical or educational expenses if payment is made directly to the medical provider or educational institution.

Another thought is to use life insurance.

“Life insurance paid directly to your niece — or any beneficiary, including a testamentary trust — is not subject to inheritance tax,” Miller said. “As a result, if you designate your niece as a beneficiary of your life insurance in the amount of $50,000 rather than bequeathing this amount to her in your will, no inheritance tax will be imposed.”

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This post was first published in July 2017.