New Jersey is one of the few states in this country with its own estate tax. Fewer than twenty of the fifty states in the United States have an estate tax. The estate of a New Jersey resident is subject to estate tax if the value of the gross estate exceeds $675,000. (The federal government has an estate tax as well; the credit against the federal estate tax is $5,340,000.)
The gross estate includes all assets the individual owns, including the proceeds of life insurance. So, for instance, if Mr. Smith owns a home worth $300,000, cash of $100,000, and life insurance with a death benefit of $500,000, for a total of $900,000, his estate would be subject to the New Jersey estate tax.
The rate of tax of the New Jersey estate tax is roughly 10%. So, for instance, if a decedent’s estate is worth $1,000,000, his estate exceeds the $675,000 credit by $325,000 and would pay approximately $33,000 in estate tax.
When I meet with a married couple, each spouse comes to my office with a credit of $675,000 against the estate tax. There is no estate tax between spouses. So, if Mr. and Mrs. Smith have an estate worth $1,000,000, and Mr. Smith dies leaving his entire estate to Mrs. Smith, Mrs. Smith will not have to pay an estate tax; however, when Mrs. Smith dies, she will only have one $675,000 credit against the New Jersey estate tax. Her children will then have to pay $33,000 in estate tax on the $325,000 by which her estate exceeds the $675,000 credit.
If Mr. Smith were to leave his estate to someone or something other than his wife, he would use his $675,000 credit to the extent he passed his estate to a non-spouse beneficiary. For instance, if Mr. Smith devised $100,000 to his children, he would use $100,000 of his $675,000 credit.
The problem is, Mr. Smith probably wants to leave his entire estate to his wife, and Mr. Smith’s wife probably wants to receive Mr. Smith’s entire estate. While the couple ultimately wants to benefit their children, both Mr. and Mrs. Smith want to benefit each other first and foremost.
The solution I offer my clients, a solution that has existed for several decades, is a trust in each spouse’s last will and testament for the benefit of the surviving spouse. Because we have no idea which spouse will die first, we place a trust in each spouse’s Will. The surviving spouse is the primary beneficiary of the trust and can even be the trustee of the trust if the trust is drafted appropriately.
Essentially, when one spouse dies, the surviving spouse will be holding an inheritance that her spouse left her in a trust for her own benefit. This trust goes by many names—credit shelter trust, by-pass trust, A/B trust. Personally, I like to call it a credit shelter trust because that’s what the trust is doing—sheltering the credit of the first spouse to die.
So, assume that Mr. Smith dies leaving $500,000 to a trust in his Will for Mrs. Smith’s benefit. Mrs. Smith is the trustee of the trust. By doing this, Mr. Smith used $500,000 of his $675,000 credit against estate tax. Mrs. Smith can continue to use the money in the trust for the remainder of her life, and when she dies, the money that remains in the trust will pass to the Mr. and Mrs. Smith’s children. Mrs. Smith will also leave her estate to her children.
Instead of dying with an estate worth $1,000,000, Mrs. Smith dies with an estate worth $500,000. Since neither Mr. nor Mrs. Smith left more than $675,000 to someone (or something) other than his/her spouse, neither estate is subject to estate tax.
By employing a very simple trust that does not interfere at all with the surviving spouse’s life and finances, the couple saved $33,000 for their children.
Many couples think about taxes only when it is time to file a return. In reality, some of the most important tax decisions happen throughout the year as assets are acquired, transferred, inherited, or sold. Looking at the bigger picture often reveals planning opportunities that would otherwise go unnoticed.
Estate tax planning is often less about avoiding taxes today and more about preserving exemptions that may otherwise be lost when the first spouse dies. A properly drafted credit shelter trust can allow a surviving spouse to maintain financial security while reducing the tax burden ultimately borne by the family.