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Considering death taxes in financial planning

| Nov 24, 2020 | Estate Planning

When it comes to estate planning, people sometimes get confused about what will get taxed and how it will affect their estate once they are gone. No matter how well-intentioned you are about bequests, not considering all tax angles beforehand can lead to a smaller estate distribution after death.

New Jersey used to have both estate and inheritance taxes, but now it is one of only six states in the nation to have an inheritance tax. When planning for the future, it is very important to get informed advice on making an estate plan that is mindful of current New Jersey tax laws.

Estate and inheritance taxes

The main difference between estate and inheritance taxes is who pays for it. With an estate tax, all liabilities are subtracted from the estate at death to arrive at a net value that is then taxed. For an inheritance tax, the beneficiaries pay a tax that is calculated from the value of the individual bequests.

At one time, all states had an estate tax. There was a federal tax credit on the estate tax return that was applied to offset state estate taxes, but this changed in 2001 when new amendments to federal law eliminated that tax credit. Fortunately for smaller estates, as of 2019 the exemption on the federal estate tax is $11.4 million.

Inheritance tax in New Jersey

New Jersey finally repealed its estate tax in 2016, but the inheritance tax remains. And it is hefty, ranging anywhere from 11% to 16%. Beneficiaries are put into different classifications which determine the tax rate that will fall due (the list below is not complete):

  • Class A: Exempt and includes spouses and children, grandchildren, grandparents and others.
  • Class C: No tax on the first $25,000, then graded from 11% to 16%, includes siblings, sons and daughters-in-law and others.
  • Class D: 15% to 16%, includes nieces, nephews, friends and others.
  • Class E: Exempt and includes charities, religious and non-profit organizations and others.

Avoiding death taxes

There are many strategies for avoiding estate and inheritance taxes, including setting up an irrevocable trust, gifting, converting an IRA to a Roth and making a life insurance trust for non-exempt beneficiaries. But it is best to plan early, as gifts made within three years of death will be added back into the estate.