What Taxes Will My Family Pay?

What taxes will my family pay after I die? Many of my clients are concerned about the taxes their family will have to pay after their death, so I hear this question quite often.

In recent years, the potential of estates paying a death tax has been reduced dramatically.  Through 2017, New Jersey had an estate tax.  If the gross value of the estate exceeded $675,000, then the estate was subject to New Jersey estate tax.

The $675,000 threshold was very low.  Many of my clients who were far from “rich” were subjected to this tax.  As of January 1, 2018, New Jersey effectively repealed its estate tax.

There is still a federal estate tax, but unless your estate has a value greater than $12,920,000, it will not be subject to the federal tax.  When I ask my clients, “Is your estate greater in value than $13,000,000?” the universal reaction is a laugh followed by “I wish.” If your estate were worth more than $13,000,000, you would officially be within the top 1% of estates in America.

As odd as it may seem, New Jersey has a second, death tax—the New Jersey Inheritance Tax.  The inheritance tax is primarily assessed based upon the relationship of the estate beneficiary to the decedent.  Spouses, children, or grandchildren of the decedent do not pay inheritance tax.  More distant relatives (siblings, nieces and nephews, cousins) and friends are subject to the tax.

In recent years, I have seen a dramatic increase in the number of clients who are in a second marriage.  Second marriages raise an important issue.  Stepchildren, like biological children, are not subject to inheritance tax; however, step-grandchildren, unlike biological grandchildren, are subject to inheritance tax.

Assume that Mr. Smith married Ms. Jones.  Mr. Smith has two children and Ms. Jones has two children. Mr. Smith and Ms. Jones consult with an attorney who drafts Wills for them.  The Wills are mutual Wills through which both leave their estates to the other then to their four children equally. If a child passes away before Mr. Smith or Ms. Jones, that child’s share of the estate will pass to that child’s children, that is, to grandchildren.  Many people refer to this distribution pattern as “per stirpes,” which is a Latin phrase that means “by the branch.”

Assume that one of Mr. Smith’s children passes away before Mr. Smith and Ms. Jones and one of Ms. Jones children passes away before them.  In other words, a portion of the Smith/Jones estate will pass to grandchildren/step-grandchildren.  Whether Mr. Smith dies before Ms. Jones or vice versa will determine which of these beneficiaries pay inheritance tax.  If Mr. Smith dies first, then her biological grandchildren will not be subject to inheritance tax and his grandchildren (her step-grandchildren) will be subject to inheritance tax.  If Ms. Jones dies first, then the opposite will be true.

Now, this set of facts is unlikely to happen—two children predeceasing Mr. Smith and Ms. Jones rarely occurs—but one of the many things I have learned in practicing law for the past thirty years is, you can never discount life. Just when you think something will never happen, it happens.  Mr. Smith’s Will and Ms. Jones’s Will could address this issue.  The Wills could contain a tax clause that assesses any death tax to the individual beneficiary who caused the tax or a tax clause that assesses the tax to the entire estate, meaning that all the beneficiaries of the estate would bear a portion of the tax.

The final tax is income tax. There are too many issues with income tax to summarize those issues here, but the receipt of an inheritance, in and of itself, is not income.  For instance, if you receive an ordinary bank account as an inheritance, you do not have to claim the value of the bank account as income; however, if you inherit a qualified account—such as an IRA, 401(k)—then you will have to pay income tax on the account as you remove assets from the account.  The decedent never paid income tax on this account, so you, as the recipient of the account, will have to pay income tax.