If there is one thing we have an abundance of in New Jersey, it is taxes. We pay tax on our income, real estate, cigarettes, and at this writing we still have the second lowest gas tax in the nation. But the topic of the day is taxes we pay when we die. Or more accurately, the taxes paid by those friends and loved ones we leave behind. There are two types here in New Jersey: estate tax and inheritance tax. The federal government also has an estate tax, and if you fall into the category of a federally taxable estate then you’d best consult with our firm about some form of estate plan But for the purposes of this page we are sticking with taxes payable here in the Garden State.
In order to calculate inheritance tax we divide the people or entities inheriting your assets into classes. Once we know the class, then we can determine the tax rate which usually falls between 11 and 16 percent. But usually your direct descendants (i.e. your kids) fall into a class which is tax exempt. Life insurance proceeds payable to any individual beneficiary is also tax exempt. So your beneficiaries may not be subject to inheritance tax. But sisters, brothers, nieces, nephews and friends are not exempt. So consult with an attorney as you make your last will to figure out whether you are better off giving some of your beneficiaries proceeds of life insurance instead of leaving money directly to them.
In New Jersey the value of your estate must be $675,000 or higher for your estate to be subject to estate tax. If your spouse survives you, your assets can pass to him or her free of estate tax. The issue arises for most people upon the death of the second spouse, or if you are either single or divorced. But to avoid the tax you’ll usually want to set up your estate plan before either spouse dies. There are tools we can create, commonly known as trusts, which can safely isolate some of your assets from estate tax while still keeping them accessible to your trustee to pay for your medical needs or other important expenses.
So how much tax will your estate pay? The first step is to add up what you die holding. Then we have to look at what you gave away within three years of death. Next we simply subtract the first $60,000 right off the top. Then you get to deduct a number of expenses such as the cost of your funeral, legal fees and other costs. Whatever amount remains behind is subject to tax based on a table which is similar to the tables you may be familiar with when you file a federal income tax return.
Just by way of example, if your estate is worth $1,000,000 (after you deduct all the legitimate expenses), you’d pay $33,200. That’s a bit more than 3%.
Clearly it would be nice to preserve that $33,200 for your beneficiaries if you could. Now say you were married and you die leaving a spouse behind. The entire million (in our example) could pass to your spouse estate-tax free. But if your spouse has sources of income, such as social security or a pension, there is some chance she would not spend down the million she inherited from you. So when the second spouse dies, that’s when the estate tax kicks in. In order to avoid that consequence, both spouses can set up trusts while still alive–which can shelter money in such a way to legally avoid the estate tax.
If you want to discuss these topics further please call my office to set up a consultation. I’d be happy to discuss how estate taxes may (or may not) affect you.