Don’t Forget About State Estate or Inheritance Tax

By Joseph Goldman, Esq.

As most of you already know, the federal estate tax exemption in 2012 is $5,120,000, an all time high.  The exemption is currently scheduled to return to $1 million (and the tax rate scheduled to increase to 55% from 35%) on January 1, 2013 if no new legislation is enacted.

In a previous blog, I urged taxpayers to take advantage of this unique opportunity by making gifts prior to year end. Gifting can be especially effective when the asset gifted is a limited partnership interest or a membership interest in an LLC which allow taxpayers to take advantage of recognized discounts for lack of marketability and lack of control. Also, if the gift is made to a Grantor Retained Annuity Trust or Qualified Personal Residence Trust, it allows a taxpayer to take into account the value of the retained interest, thereby reducing the amount of the gift.

Strategies designed to reduce a taxpayer’s estate can often result in estate tax savings even when a taxpayer’s estate is under the federal estate tax exemption.  This is because many states have “decoupled” their own estate tax rules from the federal estate tax.  In New Jersey, the estate tax exemption is currently only $675,000.  In New York, it is currently $1 million.  Although a married taxpayer is generally able to defer the estate tax on account of the marital deduction, an unmarried individual or a surviving spouse who dies in 2012 with a taxable estate of $5,120,000 could pay a state estate tax in New Jersey or New York that exceeds $400,000. Additionally, New Jersey imposes an inheritance tax on transfers to someone other than a surviving spouse or lineal descendant, even if no New Jersey estate tax is due.

As a further inconvenience, New York requires a federal estate tax return to be prepared in order to calculate the New York estate tax return even if no federal return is required.  New Jersey requires a 2001 federal estate tax return in order to calculate the New Jersey estate tax using the “706” method (as an alternative to the simplified method).

Additionally, although under current law “portability” allows a surviving spouse to benefit from a predeceased spouse’s unused estate tax exclusion, neither New Jersey nor New York permit “portability” for state estate tax purposes.

So what can you do to reduce your state estate tax liability?  You could move to another state, one that doesn’t have an estate tax, like Florida.  But you have to be careful to sever your ties to New Jersey or New York or they can claim that you’re still “domiciled” here and subject to estate tax.  And if you continue to own real estate or other tangible property in New Jersey or New York you will be subject to estate tax on that property even if you don’t live here anymore.

Perhaps a better way to avoid or at least minimize state estate tax brings us back to gifting.  Neither New Jersey nor New York currently impose a gift tax.  In these states, you can even make a “death-bed” gift and drastically reduce your New Jersey or New York estate tax.  New Jersey does have a look-back period for inheritance tax purposes, but it doesn’t affect a gift to a spouse or lineal descendant.

New Jersey and New York residents should be conscious of state estate tax consequences and not just federal estate tax consequences when considering their estate plans.  The gifting strategies touted for 2012 for federal estate tax purposes can also result in significant state estate (and inheritance) tax savings.

January 1, 2013 will be here before you know it.  So get to gifting now!

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