(What you don’t know can cost your heirs a lot in taxes)
Did you know that over one-half of all Americans do not have a basic estate plan which includes a will, living will, health care proxy and power of attorney? Many people put off doing any estate planning because they find the law to be so confusing. In my estate planning practice, I have noticed that clients share certain common misunderstandings about the estate tax laws which could cost their heirs a lot in taxes.
Common Fallacy #I – Beware Of Making Annual Gifts Exceeding $14,000 Per Year – Many clients are under the misconception that they will be subject to large tax penalties if they make gifts in excess of $14,000 per year. The Internal Revenue Code provides that a donor can make gifts of up to $14,000 per year, per beneficiary, which do not have to be reported for federal gift tax purposes. In addition, qualified gifts used to fund school tuition and medical related expenses do not have to be reported for gift tax purposes, regardless of the amount expended. A taxpayer does not incur a federal gift tax liability until the aggregate taxable gifts made over the taxpayer’s lifetime exceed $5,430,000. So, if you made a gift to your child of $50,000 to help make a down payment on a new home, the gift would need to be reported on a federal gift tax return, but there would not be any gift tax owed. New Jersey does not impose a gift tax.
Common Fallacy #2 – All Gifts Made Within Three Years Prior To Death Will Be Subject to a New Jersey Death Tax When The Decedent Dies – Some states such as Florida do not have any estate tax whatsoever. Many states, including New York, Pennsylvania and Connecticut, have one form of death tax. New Jersey is virtually the only state which imposes TWO separate forms of death tax.
New Jersey has an Inheritance Tax which is based on the relationship of the beneficiary to the decedent. The Inheritance Tax is levied on transfers to all beneficiaries other than to a decedent’s parents, spouse, children and grandchildren. A bequest of a little as $500 made to a niece, nephew, cousin or friend will be subject to an inheritance tax starting at 15% tax rate. A bequest exceeding $25,000 made to a brother or sisters will be subject to inheritance tax starting at 11%. There is no inheritance tax on bequests made to a spouse, child or grandchild.
New Jersey also imposes an Estate Tax which is calculated based on the size of the estate rather than based on the relationship of the beneficiary to the decedent. Transfers to a surviving spouse qualify for a marital deduction and are not subject to an estate tax. Transfers made to all other beneficiaries, including children and grandchildren, are subject to estate tax when the aggregate amount transferred exceeds $675,000. New Jersey’s $675,000 estate tax threshold is the lowest in the nation. The following examples illustrate the cost of the estate tax:
Net Estate New Jersey Estate Tax
$1 million $ 33,000
$2 million $100,000
$3 million $190,000
$5 million $400,000
For inheritance tax purposes, there is a presumption that gifts made within 3 years before the decedent died were made “in contemplation of death.” These gifts are brought back into the estate and taxed as if the transfers were made on the decedent’s death.
Gifts made before death are not brought back into the estate for New Jersey Estate Tax purposes. A person can transfer his entire estate to his children or grandchildren prior to death, regardless of the size of his estate, and totally avoid the New Jersey Estate Tax.
Common Fallacy #3 – It Always Makes Sense To Make Gifts Before Death To Avoid The New Jersey Estate Tax – If we had a magic ball and knew when we were going to die, then we could give our assets away right before we die and totally avoid the New Jersey Estate Tax. However, that might not be the best tax planning. Beneficiaries who inherit assets on death receive a tax basis equal to the property’s fair market value as of decedent’s date of death. The beneficiary who inherits property can sell the property the day after the decedent’s death without incurring any income tax liability. However, a beneficiary who receives a lifetime gift assumes the donor’s income tax basis. If the beneficiary receives property with a low tax basis, the sale of the property could result in a federal capital gains tax (20%), Obamacare Tax (3.8%) and New Jersey income tax (6%) when the property is sold. The income tax on the gifted property can exceed the amount of New Jersey Estate Tax!
Common Fallacy #4 – You Should Procrastinate in Updating Your Estate Plan – NO!! You should contact us now to discuss your estate plan.