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Disclaimers May Solve an Estate Tax Conundrum


In light of indeterminate tax consequences, a flexible estate plan may be a married couple’s best option:

Recent changes in federal and New Jersey law have placed estate planners in a taxing dilemma; a New Jersey resident’s estate may be exempt from federal estate tax but subject to New Jersey estate tax.

For wealthy married persons, an estate plan may be drafted that exempts the estate of the first spouse to die from both federal and New Jersey estate taxes. But this strategy may ultimately lead to a greater tax liability for the estates of both spouses.

As explained below, disclaimer provisions included in married couples’ estate plans can provide the flexibility needed to minimize the combined tax burden their estates may incur.

Elimination of ‘Death Tax’

The Economic Growth and Tax Relief Reconciliation Act of 2001 was enacted on June 6, 2001. The 2001 Tax Act reformed existing estate, gift and generation skipping transfer taxes, increased available exemptions, decreased tax rates and for a one year period (2010) entirely eliminated estate and generation skipping transfer taxes (the tax returns with a $1,000,000 exemption in 2011).

The 2001 Tax Act also provided for the reduction and eventual elimination of the state death tax credit. The credit is reduced from 2001 levels by 25 percent in 2002, 50 percent in 2003 and 75 percent in 2004, and is entirely eliminated in 2005, when the credit is replaced with a deduction.

Projections indicate the 2001 Tax Act would cause New Jersey to lose significant tax revenue. The New Jersey Office of Legislative Services (OLS) estimated that in the 2001 fiscal year approximately 45 percent of state receipts labeled inheritance taxes were actually attributable to estate tax collections, with the balance derived from inheritance taxation.

The OLS further estimated total inheritance tax collections at $500 million in fiscal year 2002 and $530 million in fiscal year 2003. Based on these estimates the OLS projected a loss of estate tax collections of approximately $60 million in fiscal year 2003, $120 million in fiscal year 2004, $180 million in fiscal year 2005 and $240 million in fiscal year 2006 and thereafter.

New Jersey Counters

In an effort to neutralize the effect of the 2001 Tax Act on its estate tax collections, New Jersey enacted legislation on July 1, 2002, amending existing tax law. N.J.S.54:38-1 et seq. For persons dying on or after January 1, 2002, New Jersey estate tax would be based upon the maximum allowable state death tax credit as of December 31, 2001, without regard to later federal estate tax law revisions.

This change meant that taxable estates in excess of $675,000 would be subject to New Jersey estate tax regardless of federal exemption levels. For example, in 2004 an unmarried New Jersey resident will be able to leave a $1.5 million taxable estate to children free of federal estate tax. However, the same estate will be subject to New Jersey estate tax in the amount of $64,400.

Married persons may plan to eliminate the New Jersey estate tax upon the death of the first spouse, although that approach may prove costly in the long-term. The following fact patterns are illustrative.

Two New Jersey couples, each with $3 million of assets, want to implement new estate plans. Assets are divided evenly between the spouses, each having an estate of $1.5 million. The spouses want to provide for each other and eventually leave assets to children of their marriage while minimizing estate taxes.

Couple one adopts a plan that establishes, upon the death of the first spouse, a nonmarital trust is funded with $675,000, the amount that can pass as exempt from both federal and New Jersey estate tax. Remaining assets are left to the surviving spouse. In a non-marital trust, assets are set aside for the lifetime benefit of the surviving spouse with restricted access to principal — the restrictions allow the trust principal to be excluded from the estate of the surviving spouse and thus be considered “non-marital.” Upon the death of the second spouse, all assets pass to the couple’s children.

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