How to Avoid Inheritance Tax in New Jersey

The New Jersey Inheritance Tax is a state-level tax applied to the value of assets a person receives from a deceased individual’s estate. Unlike an estate tax, which is paid by the estate itself, this tax is the responsibility of the beneficiary. The tax rate and any potential exemptions are determined by the familial relationship between the deceased and the individual inheriting the assets. New Jersey’s separate estate tax was officially phased out for individuals who died on or after January 1, 2018, leaving only the inheritance tax in effect.

Who Pays the New Jersey Inheritance Tax

The obligation to pay New Jersey’s inheritance tax is determined by a classification system that categorizes beneficiaries based on their relationship to the decedent. These classes range from fully exempt to fully taxable, with specific rates and exemptions for each category.

Class A Beneficiaries

Class A beneficiaries are completely exempt from the New Jersey Inheritance Tax. This group includes a surviving spouse, domestic partner, civil union partner, parents, grandparents, children, stepchildren, and any other direct lineal descendants. Because of this exemption, assets transferred to these individuals do not trigger any inheritance tax payment.

Class C Beneficiaries

Class C includes siblings of the decedent, as well as a child’s spouse or civil union partner. For these beneficiaries, the first $25,000 of their total inheritance is exempt from the tax. Amounts above this exemption are taxed at rates beginning at 11% and increasing to 16% for inheritances over $1.7 million.

Class D Beneficiaries

Class D is a catch-all category for any beneficiary not in Classes A, C, or E, including nieces, nephews, cousins, and friends. Transfers valued under $500 are not taxed, but there is no initial exemption for larger amounts. For an inheritance of $500 or more, the tax rate is 15% on the first $700,000 and increases to 16% for any amount above that threshold.

Class E Beneficiaries

Class E beneficiaries are also completely exempt from the New Jersey Inheritance Tax. This category is reserved for qualified charitable organizations, religious institutions, educational institutions, and government entities for public or charitable purposes.

Primary Strategies to Reduce or Eliminate the Tax

Careful planning can significantly reduce or even eliminate the New Jersey Inheritance Tax for beneficiaries who would otherwise be subject to it. The most effective strategies revolve around the beneficiary classification system, the timing of asset transfers, and the use of specific financial instruments.

Lifetime Gifting

Giving assets away during one’s lifetime can reduce the value of an estate subject to inheritance tax. However, New Jersey law includes a “contemplation of death” provision. Under this rule, any significant gifts made within the three years prior to death are presumed to have been made to avoid taxes. Consequently, the value of these gifts may be pulled back into the estate for calculating the inheritance tax, and the estate has the burden of proving the gift was not made with death in mind.

Structuring Your Will

The way a will is written can have profound tax implications. A primary strategy is to prioritize leaving the bulk of an estate to Class A beneficiaries, like children or a spouse, who are exempt from the tax. Another tool is the use of a disclaimer, where a named beneficiary formally refuses to accept an inheritance. This can be strategic if the disclaiming beneficiary is in a taxable class and the inheritance would then pass to a beneficiary in an exempt class per the will or state law.

Utilizing Trusts

Trusts can be used for managing assets and reducing tax liability. An Irrevocable Life Insurance Trust (ILIT) is a particularly effective instrument for this purpose. When a life insurance policy is placed within an ILIT, the trust becomes the owner and beneficiary of the policy, removing the proceeds from the decedent’s taxable estate. As a result, when the death benefit is paid out to the trust, it is not subject to the inheritance tax, providing a tax-efficient way to pass wealth.

Life Insurance Planning

Even without a trust, life insurance can be an effective way to transfer wealth tax-free in New Jersey. Life insurance proceeds that are paid directly to a named beneficiary, rather than to the estate itself, are exempt from the state’s inheritance tax. This makes life insurance a useful tool for providing for beneficiaries in taxable classes, such as siblings or friends, by naming them directly on the policy.

Changing Domicile

A definitive strategy is to change one’s legal domicile to a state that does not have an inheritance tax. To successfully change domicile, a person must demonstrate a clear intent to make the new state their permanent home and sever most major ties to New Jersey. This includes actions like registering to vote, obtaining a new driver’s license, and filing income tax returns as a resident of the new state.

Required Tax Forms and Filing Process

When an inheritance tax is due, specific procedures must be followed to ensure compliance with the New Jersey Division of Taxation. The responsibility for this process falls to the executor or administrator of the estate, who must gather information, complete the correct forms, and submit the package to the state.

Information and Documents Needed

Before filing, the executor must collect several documents and pieces of information, including:

• The decedent’s full name, Social Security number, and date of death
• A complete inventory of all assets with their fair market value on the date of death
• A list of all beneficiaries, their relationship to the decedent, and the assets they will receive
• A copy of the decedent’s will
• The decedent’s last full year’s federal income tax return

Completing the Required Forms

The primary form for a resident decedent is the New Jersey Inheritance Tax Return, Form IT-R, which can be obtained from the Division of Taxation’s website. The gathered information is used to complete the various schedules within the return. It is important to accurately report the beneficiary class for each individual to determine the applicable tax rate and exemption.

The Submission Process

Once Form IT-R is completed, it must be filed with the New Jersey Division of Taxation. The return, along with any tax payment, should be mailed to the address specified in the form’s instructions. The filing package must include the completed tax return, a check made payable to “NJ Inheritance Tax,” and copies of all supporting documents. The return and any tax owed are due within eight months of the decedent’s death to avoid interest penalties.

Post-Submission Expectations

After the return is filed, the Division of Taxation will review it and assess the final tax. Upon satisfaction that all tax has been paid, the state will issue tax waivers. These waivers are official documents required by banks, brokerage firms, and county clerks to release assets and transfer property titles to the beneficiaries. The process of receiving waivers can take several months, and the state may contact the filer if there are questions about the return.