Why Repeal of the NJ Estate Tax Means Married Couples Should Update Their Wills
(Note: this guest post was written by Kevin A. Pollock, J.D., LL.M. Kevin is an attorney and the managing partner at The Pollock Firm LLC. Kevin's practice areas include: Wills Trusts & Estates, Guardianships, Tax Planning, Asset Protection Planning, Corporate and Business Law, Business Succession Planning & Probate Litigation. Kevin Pollock is licensed in NJ, NY, PA and FL. Kevin's contact information can be found on his website: https://pollockfirm.com/)
Effective January 1, 2018, New Jersey repealed its estate tax. The question then become how does this affect you and do you need to do anything about it? For most people the change is a positive one because it means their heirs pay less taxes and they do not need to do anything to update their documents.
Generally, You are Unaffected by the Repeal of the NJ Estate Tax If...
1) You do not have children and plan on leaving money to siblings, nieces, nephews, friends or charity.
2) You are NOT married but have surviving descendants.
3) You are married couples with children and you plan to leave everything outright to your surviving spouse on the first to die.
In all three situations above, the repeal of the New Jersey estate tax should not affect you, and you generally will not need to update your Will or Revocable Living Trust.* In the first situation, if you are leaving money to siblings, nieces, nephews and friend, be aware that NJ did NOT repeal its inheritance tax, so you still are affected by that.
For married couples who have a Disclaimer Trust plan, your documents are also generally unaffected.
Repeal of the NJ Estate Tax Can Dramatically Affect Married Couples Who Set up a Trust for the Surviving Spouse
To understand why the repeal of the New Jersey Estate Tax can adversely affect married couples who set up a trust for the surviving spouse, I will take a step back to discuss why we often recommend a trust be created for a surviving spouse.
Reasons to Create a Trust for a Surviving Spouse
1) The first spouse to die wants to ensure that if the surviving spouse gets remarried, the children are protected from future spouse and still receive an inheritance.
2) You have children from a previous relationship and want to ensure that upon the death of your spouse, your children receive whatever is left over.
3) The surviving spouse isn't good with money and needs assistance managing the wealth.
4) Estate Tax Efficiency - Prior to 2017, New Jersey had a ‘use it or lose it’ state estate tax exemption of $675,000.
Why Was It Tax Efficient to Create a Trust for a Surviving Spouse
Protecting money for the benefit of the your children or from a spendthrift spouse are still very valid reasons to set up a trust, so I will spend the rest of the article talking about how trusts for a surviving spouse in older Wills and Revocable Trusts are usually no longer tax efficient.
Let's presume it's 2016 and we have a married couple with $1,350,000 of assets. One spouse dies leaving everything to survivor outright. The surviving spouse then dies shortly after leaving everything to the children. In this scenario, we would lose the NJ estate tax exemption of the first spouse to die and the children would only benefit from the $675,000 NJ estate tax exemption of the Surviving Spouse. Assuming no growth in assets, the children inherit the full $1.35M, but $675,000 would be subject to a tax of almost $55,000.
To minimize the NJ estate tax, attorneys would advise clients to set up a trust for the surviving spouse instead of having funds go outright. So, in the example above, when one spouse dies, he could leave everything to a trust for the survivor. The surviving spouse then dies shortly after leaving everything to the children. In this scenario, by funding a trust for the surviving spouse, we are utilizing each spouse's NJ estate tax exemption. Upon the death of the surviving spouse, children would receive $675,000 from the trust tax free and the other $675,000 from the surviving spouse tax free. This type of planning could easily save $55,000 in NJ estate taxes.
Funding a Trust for the Surviving Spouse May Be Tax Inefficient after the Repeal of the NJ Estate Tax
Now that you know why it was advisable to set up a trust for a spouse and why it was tax efficient, you need to know why most older trusts should be amended. Basically, now we can make it even MORE tax efficient. This time, however, we are not talking about estate tax efficiency - now we are trying to make the trusts more efficient for income tax and capital gains tax purposes. Let me give you two examples again:
Let's presume it's 2010 and we have a married couple with $1,350,000 of assets. Dad dies leaving everything to Mom. Mom lives another 20 years before dying and leaving everything to the children. Since Mom lived another 20 years, let's presume the assets grew by $1M and were now worth $2,350,000. We do not have to worry about the NJ estate tax anymore, so the assets would go to the children completely free tax. Additionally, when the children receive their inheritance, it is eligible for a step-up in basis. This means that the children can effectively sell their inheritance the day after Mom dies and pay no capital gains tax on the $1M+ of appreciation. (Please read this post to better understanding basis.)
Now, let's presume the same facts as above except that when Dad died, he left $675,000 to Mom in trust. Let's also presume that the trust received the benefit of all the appreciation, so that when Mom died, she had $675,000 in her own name and $1,675,000 in trust. The children would still receive a step-up in basis from the $675,000 in assets that came from Mom, but the basis in the trust fund assets would only be $675,000 (the value on Dad's date of death). So when the children sold the assets that were in the trust, there would be a capital gains tax (up to 23%) on the $1M.
Most older Wills and Revocable Trusts used this formula for a trust for a surviving spouse, so hopefully it is easy to see why it is no longer tax efficient to continue using it.
Do I Need to Update My Estate Planning Documents?
If you have a Will or Trust created prior to 2017 leaving money in trust to a surviving spouse, the short answer is probably yes. The one major exception to this is if you have a Disclaimer Trust plan. If money goes outright to the surviving spouse, and the survivor has to make an affirmative election to fund a trust, then the plan most likely is fine the way it is written.
How You Can Fix Your Older Trusts
If you have an estate plan that automatically leaves money in trust for the surviving spouse, there are two easy ways you can fix it so that it is more tax efficient.
1) Option one is to get rid of the trust for the surviving spouse and leave everything to the survivor outright. This is an easy solution when the estate isn't very large or complex. However if you are in a second marriage situation or if you are concerned about the surviving spouse getting remarried or spending away the children's inheritance, then you should consider the second option.
2) Option two is to revise the formulas in the Will or Trust so that it gets a step-up in basis when the surviving spouse dies. (There are hundreds of ways to do this which are far beyond the scope of this post.)
To further complicate things, most tax attorneys like me will also build in a fail-safe so that if the NJ estate tax comes back, we can have the option of funding an old-style trust.
If you have an older Will or trust that leaves money to a surviving spouse in trust - have it looked at.
* Regardless of whether you have a trust for a surviving spouse, always have your own estate planning documents reviewed by your attorney just to be sure it matches your wishes and still complies with state law. The purpose of this blog post is to discuss who is most likely to be affected by the repeal of the New Jersey estate tax.