New York practitioners should be aware of the New Jersey Inheritance Tax. This tax, in place since 1892, imposes a tax on the right to inherit property. It can apply to non-residents of New Jersey who own real or tangible property in New Jersey at the time of death. This article explains the New Jersey Inheritance Tax in greater detail.

Classified Beneficiaries

New Jersey tax law classifies beneficiaries generally by their relationship with the decedent.

• Class A beneficiaries include spouses, domestic partners, civil union partners, lineal ancestors (e.g., parents), lineal descendants (e.g., children), and stepchildren. 
• Class C beneficiaries include siblings and spouses or civil union partners of the decedent's children (e.g., sons-in-law, daughters-in-law, and civil union partners after Feb. 19, 2007).
• Class E beneficiaries are charities and governments.
• Class D is all other beneficiaries.
  

Inheritances to Class A and E beneficiaries are not taxed. The first $25,000 to each Class C beneficiary is tax-free. Inheritances above $25,000 are taxed at rates of 11 percent to 16 percent.   

Inheritances to Class D beneficiaries under $500 are tax-free. Inheritances of $500 or more per beneficiary are taxed from the first dollar at rates of 15 percent or 16 percent.        

Additional Aspects

Three additional aspects of the Inheritance Tax are of particular importance for non-residents: the add-back of gifts made within three years of passing, the compromise tax, and the New Jersey basis rules.

New Jersey assumes that all gifts made within three years of death were made in contemplation of death. Those gifts must be added back to the estate.

However, this is a rebuttable presumption. The executor can show that gifts were not made in contemplation of death. If the executor is successful, the gifts will not be added back.

There is a question on the Inheritance Tax return concerning gifts and a place for the executor’s explanation.

The compromise tax is imposed when there are life and contingent beneficiaries, typically associated with a trust or life estate. This tax is calculated using life expectancy tables and is based, in part, on the time value of money. The executor can suggest a compromise tax for the state’s approval or ask the state to propose a tax for the executor’s approval.   

New Jersey has various methods by which the tax can be computed if the decedent was a non-resident of New Jersey. Care should be exercised in selecting a method because of the complexities involved.

New Jersey gives the beneficiaries of IRAs, retirement accounts, and annuities basis in those accounts equal to the date-of-death value if Inheritance Tax was paid on the accounts.  The effect is that New Jersey income tax is owed only on the additional value in the accounts accruing after death.

This basis step-up is significant for New Jersey residents, but it is equally important for non-residents who owe New Jersey income tax on New Jersey-source income. New Jersey calculates income tax for non-residents by starting with the tax they would have owed as New Jersey residents, then prorating it based on their New Jersey-source income. 

If a New Jersey resident has income from an inherited IRA, for example, on which New Jersey Inheritance Tax was paid, the resident could exclude from taxation the proportionate amount of basis recovered that year. Similarly, a non-resident with income from the same IRA would also be able to exclude that same amount from taxation.

It’s necessary to first determine if a non-resident of New Jersey is the beneficiary of an IRA, retirement account, or annuity on which New Jersey Inheritance Tax could have been paid—that is, an account received from someone for whom the taxpayer would be a Class C or Class D beneficiary. Then, it must be determined if Inheritance Tax was paid. This will usually require contacting the executor.

If the taxpayer does have basis in the account, New Jersey has an established methodology to calculate the amount taxable each year.

This process is complex, but it can save significant tax dollars.