31 Oct How can I avoid the inheritance tax for step-grandchildren?

Q. Do step-grandchildren qualify as Class A beneficiaries? If they’re not, what can I do to avoid the inheritance tax for them?

— Planning ahead

A. Taxes in New Jersey are no pretty thing, and after you die, the state will once again try to get its cut the inheritance tax.

The New Jersey Inheritance Tax is a tax imposed on inheritances based upon the relationship between the deceased and the inheritor, or beneficiary, said Gary Botwinick, an estate planning attorney and chair of the taxation/trusts and estates department at Einhorn Barbarito in Denville.

He said the relationship between the deceased and the inheritor are broken up into four different categories, and depending upon the category, a tax may be imposed.

Most inheritors fall into Class A, which includes a spouse, child, parent, grandparent, stepchild and grandchild, Botwinick said. The next most common category is Class C, which includes a sibling and daughters-in-law or sons-in-law, including the surviving spouse of a deceased child. Class E beneficiaries include charities, religious institutions and other exempt organizations. And then there are Class D beneficiaries, which basically includes anyone who is not a member of another class. There is no longer a Class B.

Class A beneficiaries face no inheritance tax. For Class C, the first $25,000 is exempt and the rate on amounts in excess starts at 11 percent and increases to 16 percent. Class D rates range from 15 to 16 percent, and there is no inheritance tax for Class E.

“So the answer to your question as to whether step-grandchildren are Class A beneficiaries is clear – they are not,” he said. “Step-grandchildren are considered Class D beneficiaries, even though grandchildren and stepchildren are Class A beneficiaries.”

So how can you avoid the tax?

One way is to leave life insurance death benefits to the step-grandchild because these benefits are not subject to New Jersey’s Inheritance Tax, Botwinick said.

Another option, if the step-grandchild is the step-child of your child or the child of your step-child, then simply leave the bequest to your child or your step-child and make an unenforceable request that he or she use the bequest for that step-grandchild, he suggested.

“You might also make a gift to the step-grandchild while you are living,” Botwinick said. “If the gift is made more than three years before your death, then the gift will not be subject to the inheritance tax, but if it is within that three-year period, there is a presumption that the gift was made in contemplation of death, and will be subject to inheritance tax.”

Likewise, Botwinick said, you could avoid this by making a lifetime gift to your child or stepchild – even within the three-year period preceding death – and request that they use it for the benefit of the step-grandchild. The only problem here is that it’s not an enforceable obligation. Otherwise, the gift will be deemed to have been made to the step-grandchild and, thus, subject to the three-year gift in contemplation of death rule, he said.

“Finally, if you have real estate outside of New Jersey, you may wish to leave a portion of that asset to the step-grandchild as out-of-state real estate is not subject to New Jersey’s inheritance tax,” he said.

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This story was originally published on Oct. 31, 2019.

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