New Jersey Estate Tax phase out and repeal becomes official

New Jersey Estate Tax phase out and repeal becomes official: Governor signs new measures into law. Gas tax increase, increase in the retired income tax exclusion, decrease in sales and use tax rate, new veteran’s exemption, and increase in the earned income tax credit are also part of the legislation.

On Friday, October 14, 2016, Governor Christie signed into law New Jersey’s controversial gas tax increase (23 cents a gallon, effective November 1, 2016) in order to replenish the Transportation Trust Fund.  As part of the new legislation, the New Jersey Estate Tax, as I wrote in my October 9, 2016 blog post, is to be phased out and eliminated. Specifically, the New Jersey Estate Tax exclusion amount is going to rise from an equivalent of $675,000.00 in 2016 to a “true” exclusion amount of $2,000,000.00 on January 1, 2017 for the estates of year 2017 decedents.  The New Jersey Estate Tax is repealed for the estates of decedent’s dying on or after January 1, 2018. The New Jersey Transfer Inheritance Tax was not affected by this new legislation, and remains in place. 

Aside from the gas tax increase which motorists will encounter every time they go to the pump, retired New Jersey residents should look favorably upon the pension and retired income tax exclusion which will see an increase phased in over four years:

Filer Type        Present       2017          2018         2019          2020

Joint                 $20,000     $40,000     $60,000     $80,000    $100,000

Individual        $15,000     $30,000     $45,000     $60,000    $  75,000

Separate          $10,000      $20,000     $30,000     $40,000    $  50,000

The New Jersey sales and use tax rate will decrease from 7% to 6.875% effective on January 1, 2017 and then from 6.875% to 6.625% on January 1, 2018.

The legislation provides for a new $3,000.00 annual personal exemption under the New Jersey gross income tax for any individual New Jersey gross income taxpayer who is a veteran honorably discharged or released under honorable circumstances from active duty in the Armed Forces of the United States, a reserve component thereof, or the National Guard of New Jersey in a federal active duty status.

The New Jersey Earned Income Tax Credit (NJ EITC) under the gross income tax will increase from 30% to 35% of the federal benefit amount beginning in Tax Year 2016.

October 15, 2016                                                     Barry M. Benson, Esq.

Q-TIP Trusts and Portability: The upside of Rev. Proc. 2016-49

Q-TIP Trusts and Portability: The upside of Rev. Proc. 2016-49

Back in 2001, the IRS issued Rev. Proc. 2001-38, an important procedural announcement concerning Q-TIP elections treated as a nullity.  That Revenue Procedure, as explained below, was modified and superseded by Rev. Proc. 2016-49, effective September 27, 2016.  The specifics:

Under the federal estate tax, there is allowed what is called the “marital deduction” (a dollar for dollar deduction under IRC Section 2056) for property passing to a surviving spouse either outright or in certain types of trusts (which I will generically refer to as a “marital trust”). One particular type of marital trust, called a Qualified Terminable Interest Property Trust (“Q-TIP Trust”) basically requires that all of the net income of the trust be payable to the surviving spouse for life, and that the spouse be the sole beneficiary of the trust during his or her lifetime.  Further, it is required that an election be made on Schedule M of the federal estate tax return of the decedent spouse’s estate to qualify that trust, or the desired portion thereof, for the marital deduction.  Upon the surviving spouse’s death the trust would be included in his or her gross estate under IRC Section 2044. 

In Rev Proc 2001-38 the IRS addressed whether there could be relief for a surviving spouse when a Q-TIP election was made for a trust on the deceased spouse’s federal estate tax return, when owing to the size of the decedent’s taxable estate, and the available credit amount, no federal estate tax would be imposed on the deceased spouse’s estate regardless of whether or not a Q-TIP election was made.  In ruling that the QTIP election would be treated as a nullity, the IRS reasoned, under logic which seemed appropriate at the time, that no-one would make an unnecessary election to qualify for the marital deduction in the first spouse’s estate and cause the trust to be included in the surviving spouse’s estate, if a marital deduction was not needed to reduce the federal estate tax to $0.00. 

Fast forward to 2016. The federal exclusion amount is $5,450,000.00 and let’s say that under the decedent’s Will, his or her estate of the same size is all left in a trust for the surviving spouse who is entitled for life to all of the net income from the trust and so much of the principal as determined necessary for the spouse’s health, maintenance, support, and education.  If the executor filed a federal estate tax return, and made a QTIP election and a portability election, the executor could chose to pass on to the surviving spouse the deceased spouse’s unused exclusion amount under IRC Section 2010(c). So the executor would like to make a QTIP election for the entire trust to qualify for the marital deduction (all $5,450,000.00) so that all of the decedent’s unused $5,450,000.00 exclusion amount could be passed on to the surviving spouse, who would then have the decedent’s unused exclusion amount ($5,450,000) as well as his or her own exclusion amount ($5,450,000.00 in 2016).  And by making a Q-TIP election for the trust, that would cause the trust to be included in the surviving spouse’s gross estate at his or her death.  And that means that the assets in the trust, under current law, would receive a step up in basis equal to their value on the date of the surviving spouse’s death.  On the other hand, if Rev. Proc. 2001-38 applied and rendered the Q-TIP election in the first spouse’s estate a nullity because no portion of the trust needed to be elected to qualify for a marital deduction in order to reduce the first decedent’s federal estate tax to $0.00, then there would be no unused exclusion amount to pass on to the surviving spouse, and there would be no trust included in the surviving spouse’s estate upon his or her subsequent death. Therefore, and accordingly, the trust assets would not get a basis adjustment on the surviving spouse’s subsequent death.  Thus, the question in Rev. Proc. 2016-49 basically involved whether an executor can file an estate tax return in order to make a portability election and also make an otherwise unnecessary federal estate tax Q-TIP marital deduction election.  The bottom line answer is that yes it can be done for federal estate, gift, and generation-skipping transfer tax purposes. That is, more particularly:

Rev. Proc. 2001-38 provides a procedure by which the IRS will disregard and treat as a nullity for federal estate, gift, and generation-skipping transfer tax purposes a Q-TIP election made in cases where the election was not necessary to reduce the estate tax liability to zero.  Thus, we had a case come into the office where, in the estate of the first spouse to die, an improper QTIP election had been made on the deceased spouse’s federal estate tax return, even though no such election was needed in order to reduce the federal estate tax for the deceased spouse's estate to $0.00.  As a result, the trust in question would have been included in the surviving spouse’s estate when the survivor later died. By asserting the applicability of Rev. Proc. 2001-38, however, we were able to exclude the trust from the surviving spouse’s estate, and thereby save a significant amount of federal estate taxes which would otherwise have been due and owing on the survivor's death. 

Rev. Proc 2016-49 takes into account what happens if the executor of the first estate not only makes what would otherwise appear to be an unnecessary QTIP election, but also makes a portability election under IRS Section 2010(c).  Recall that under Rev. Proc. 2001-38 the QTIP election would be a nullity. However, under Rev. Proc. 2016-49, the procedure treats as void certain QTIP elections, while treating as valid certain others. More particularly:

Pursuant to Section 3.01, Rev. Proc. 2016-49 treats as void QTIP elections made in cases where all of the following requirements are satisfied:

(1)  The estate’s federal estate tax liability was zero, regardless of the QTIP election, based on values as finally determined for federal estate tax purposes, thus making the QTIP election unnecessary to  reduce the federal estate tax liability;

(2)  The executor of the estate neither made nor was considered to have made the portability election as provided in Section 2010(c)(5)(A) and the regulations thereunder; and

(3)  The requirements of Section 4.02 of the revenue procedure are satisfied.

Pursuant to Section 3.02, Rev. Proc. 2016-49, however, does not treat as void QTIP elections made to treat property as QTIP in cases where:

(1)  A partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero;

(2)  A QTIP election was stated in terms of a formula designed to reduce the estate tax to zero. See for example Section 20.2056(b)-(7)(h), Examples 7 and 8;

(3)  The QTIP election was a protective election under Section 20.2056 (b)-7(c);

(4)  The executor of the estate made a portability election in accordance with Section 2010(c)(5)(A) and the regulations thereunder, even if the decedent’s DSUE amount was zero based on values as finally determined for federal estate tax purposes; or

(5)  The requirements of Section 4.02 of the Revenue Procedure (2016-49) are not satisfied.

To be noted, QTIP elections for which relief has been granted under the procedures of Rev. Proc. 2001-38 are not within the scope of Rev. Proc. 2016-49.

In the case of a QTIP election within the scope of Section 3.01 of Rev. Proc. 2016-49, the IRS will disregard the QTIP election and treat it as null and void for purposes of IRC Sections 2044(a), 2056(b)(7), 2519(a), and 2652. The property for which the QTIP election is disregarded under the Rev. Proc. will not be includible in the gross estate of the surviving spouse under Section 2044, and the spouse will not be treated as making a gift under Section 2519 if the spouse disposes of part or all of the income interest with respect to the property. Finally, the surviving spouse will not be treated as the transferor of the property for generation-skipping transfer tax purposes under Section 2652(a). Conversely, if the QTIP election is valid, then the opposite shall apply. That is the property will be includible in the gross estate of the surviving spouse under Section 2044, and the spouse will be treated as making a gift under Section 2519 if the spouse disposes of part or all of the income interest with respect to the property, and the surviving spouse will be treated as the transferor of the property for generation-skipping transfer tax purposes under Section 2652(a) (unless as to GST, a reverse QTIP election is made under Section 2652(a)(3)).

Section 4.02 of Rev Proc 2016-49 sets out the procedural requirements for relief to treat a QTIP election as void.

Thus, an executor could in an appropriate estate administration file a federal estate tax return for the first spouse to die, making a QTIP election for marital deduction purposes and a portability election for DSUE purposes. 

Finally it should be noted that there is renewed interest amongst estate planners in utilizing general power of appointment trusts as an alternative way to cause inclusion of the marital trust in the surviving spouse’s estate, preserve unused exclusion for portability purposes, and get a step up in basis of the trust assets on the surviving spouse’s death.  With the New Jersey Estate Tax scheduled for repeal on January 1, 2018, the use of general power of appointment trusts may gain more traction in marital deduction estate planning as a basis adjustment mechanism where a trust is desired. 

Should you wish to discuss the impact of Rev. Proc. 2016-49 upon an estate you may be administering, or the import of the procedure on your estate planning, please do not hesitate to call me at the office, (908) 359-8000, or to send me an email at bmblaw@ymail.com.

October 12, 2016                                                        Barry M. Benson, Esq.

A few words about: Elimination of the New Jersey Estate Tax

Phaseout and Elimination of the New Jersey Estate Tax

          As many of you know, New Jersey has two death taxes that are imposed at the time of a resident decedent’s death.  One is the New Jersey Transfer Inheritance Tax; the other is the New Jersey Estate Tax.  As discussed below, the New Jersey Estate Tax is being phased out and eliminated assuming Governor Christie signs the State Senate and Assembly passed legislation; the New Jersey Transfer Inheritance Tax remains.

          At present, (2016), the excludable amount for New Jersey Estate Tax purposes is $675,000.00. I contrast that with the applicable exclusion amount for federal estate tax purposes which for a year 2016 decedent is $5,450,000.00 (to the extent not offset by lifetime gifts in excess of the annual exclusion, and excluding any Deceased Spouse Unused Exclusion amount (where applicable) received from a deceased spouse).  New Jersey’s $675,000.00 amount has historical ties to the federal estate tax credit amount which was in place back on December 31, 2001. But that is about to change. Thus, assuming Governor Christie signs the legislation:  

          Effective January 1, 2017, the New Jersey Estate Tax excludable amount is going to increase to $2,000,000.00.  That figure, of course, still pales in comparison to the federal exclusion.  However, come January 1, 2018, the New Jersey Estate Tax will be eliminated, repealed.  That will leave just the New Jersey Transfer Inheritance Tax in place, which often results in a $0.00 tax in many instances (where, for example, the assets are passing to a spouse, or children or grandchildren, or certain trusts for their benefit, or to charities).

          From a planning standpoint, for a married couple, the format of the estate plan most frequently centers on (i) whether to set up the estate plan so that the entire residuary estate passes to the surviving spouse subject to the spouse being able to disclaim assets into what we call a contingent Disclaimer Trust, or (ii) whether to devise to the surviving spouse an optimum amount or portion of the estate designed to reduce the federal estate tax to $0.00, with the balance then going into a Family Trust (or Credit Shelter Trust or By-Pass Trust as it is also frequently called). In both cases, the Disclaimer Trust or the Family Trust are typically set up for the sole benefit of the surviving spouse, designed to provide the spouse with all of the net income from the trust assets, and so much of the principal as needed for the spouse’s health, maintenance, support, or education (which are considered to be what are referred to as “ascertainable standards”).  In both cases, the two types of Trusts are designed to keep the assets in the subject trust out of the estate of the surviving spouse for death tax purposes when he or she later dies.  Thus, this type of planning is most often utilized to provide for the surviving spouse in a tax advantageous manner.

          For those couples who live in New Jersey, and who utilized the optimum marital deduction, balance to the Family Trust approach in their Wills, we would frequently also include language which basically said that if the decedent spouse was a New Jersey resident and if the New Jersey Estate Tax was decoupled from the federal estate tax, which it has been since 2002, that in such event, the optimization of the marital deduction amount to pass to the surviving spouse, and conversely the balance to pass to the Family Trust, would be optimized for New Jersey Estate Tax purposes rather than for federal estate tax purposes. Previously this would mean that, in effect, the Family Trust would be funded with upwards of $675,000.00 (with an eye on the above mentioned New Jersey Estate Tax excludable amount), and the balance of the estate would pass to the surviving spouse either outright or in a type of trust designed to qualify for the marital deduction (a “Marital Trust”).

          With the upcoming changes to the New Jersey Estate Tax, for a year 2017 decedent, however, a New Jersey optimized Family Trust would be funded with upwards of $2,000,000.00 rather than just $675,000.00. But then starting in 2018, with repeal of the New Jersey Estate Tax, there would be no New Jersey optimization, and the language optimizing for federal purposes would once again rule.  In a Will where the entire residuary estate was devised to the surviving spouse, but with the inclusion of a contingent Disclaimer Trust in the document, the amount the surviving spouse might disclaim in year 2017 would increase to upwards of $2,000,000 with an eye on New Jersey Estate Tax, (and again that being up from $675,000.00 under present law).  In year 2018 the surviving spouse might disclaim upwards of the full federal exclusion amount (which in tax year 2016 would be $5,450,000.00 and increases with inflation).  The surviving spouse in 2018 would not have to worry about disclaiming an amount permissible for federal estate tax purposes, but too large for New Jersey Estate tax purposes and thereby trigger the imposition of New Jersey Estate Tax. For example: in year 2016 if the surviving spouse disclaimed $5,450,000.00 the amount he/she disclaimed over $675,000.00 would be subject to New Jersey Estate tax.  But as I said, come year 2018, this type of problem for a New Jersey resident should be eliminated. 

          From a planning standpoint, for a married couple, depending upon the couple’s estate size, the planning choice going forward will still come down to, in many instances, whether (i) to choose to optimize the marital deduction with the balance going into the Family Trust versus (ii) whether to leave the entire residuary estate to the surviving spouse with a contingent Disclaimer Trust in place. In the latter scenario the surviving spouse would determine whether he/she wants to keep the entire residuary estate or whether to disclaim some of it and have it go into the Disclaimer Trust and thereby keep the assets in the Disclaimer Trust out of his/her subsequent estate for federal estate tax purposes. The decision would be made by the surviving spouse basically within the first 9 months after the death of the first spouse to die.  In contrast, under a Will that utilizes a formula optimization approach, the funding of the Family Trust will occur because of the terms of the Will itself – it will not require the surviving spouse to disclaim assets.  However, in the optimization situation, unless the deceased spouse’s estate is large (say over $5,450,000.00), the surviving spouse would not receive any portion of the probate estate outright (assume assets passing under the Will, aside from, for purposes of this discussion, tangible personal property).  Rather, the entire estate (below the federal exclusion amount) would pass into the Family Trust. 

          Over the past 15 years since the changes made to the federal estate tax laws in 2001, it has been my observation that more and more married couples are utilizing Disclaimer Trust wills, other than in the largest estates.  I do not think, looking forward, that the upcoming repeal of the New Jersey Estate Tax, will mark a change in that trend.  With that said, however, non-tax factors still need to be considered: for example, the health of the surviving spouse; is this a second marriage with children by prior marriages; is the surviving spouse comfortable with managing the investments; and are there assets located in another state. Two tax factors in particular should also be considered in making the formatting decision: that is, (i) is it desired that the assets be included in the surviving spouse’s estate at his/her subsequent death in order to get a step up in basis for those assets at the surviving spouse’s death, and (ii) is generation-skipping planning important or not.  Further, I note that even in a Will designed to create a Family Trust, it is not unusual to also include a contingent Disclaimer Trust in case insufficient assets are passing through the Will to enable full funding of the Family Trust, and thereby make likely the need to possibly disclaim non-probate assets, that is, assets passing outside the Will.

          As with all major changes in the estate tax laws, the passing of new legislation, federal or state, is often an appropriate time to review your estate plan and see what impact the new legislation may have on your plan and whether an update to your documents is advisable. Assuming Governor Christie signs the new law into effect, this is one of those appropriate times. If we may be of assistance to you in this regard, please do not hesitate to call us at (908) 359-8000 or email us at:  bmblaw@ymail.com.

October 13, 2016                                                         Barry M. Benson, Esq.