Q: Do you pay tax on an inheritance?

A: New Jersey is one of only three states that has both inheritance and estate taxes. A new Jersey estate tax return must be filed if the decedent's gross estate plus adjusted taxable gifts as determined in accordance with the provisions of the Internal Revenue Code in effect on December 31, 2001 exceeds $675,000. It must be filed within nine months of the decedent's death (nine months plus 30 days if the Form 706 method is used). New Jersey imposes a transfer Inheritance Tax, at graduated rates, on property having a total value of $500 of more which passes from a decedent to a beneficiary. Generally, an inheritance tax return must be filed and the tax paid on the transfer of real or personal property withing eight months after the death of a decedent. Property passing to a decedent's surviving spouse, parents, grandparents, children, stepchildren or grandchildren is entirely exempt from the tax. 

Q: Do you pay tax on inheritance money? If I live in New Jersey and inherit money from a grandfather in Florida, what is the tax rate/percentage that I would have to pay on it? And would we only pay New Jersey an inheritance tax? What about estate taxes for New Jersey and Florida?

A: First, inheritances are not subject to state or federal income taxes. However, they are still subject to inheritance and estate taxes. If your grandfather's estate was worth less than $3.5 million, there is no federal estate tax due. Florida does not have any estate taxes. If your grandfather was a Florida resident, nothing is due to the State of Florida.

New Jersey, on the other hand, has two different "death' taxes. First, the state imposes an estate tax on estates where the total value of all of the assets exceeds $675,000, even though the federal limit is $3,5 million. Currently, there is no New Jersey estate tax on estates of non-residents. It doesn't matter tht the beneficiaries live in New Jersey. If the person who died did not reside in New Jersey, there is no New Jersey estate tax.

But, New Jersey has another way of getting its hands in your pockets. The state has an inheritance tax, the application of which depends on who inherits the property. For example, there is an up to 16 percent inheritance tax on transfers to certain relatives and non-relatives, e.g. a niece or nephew, a friend or a son-in-law. If the person who died was a New Jersey resident, then it does not matter what type of property is transferred to such relative. But in your case, there are two independent reasons why there is not tax. First, if the person who died was a non-resident of New Jersey, then the New Jersey inheritance tax only applies to transfers of real estate and tangible personal property such as furniture or furnishing located in New Jersey. Since this is cash, there is not tax. Secondly, because the transfer is to a direct descendant (grandson), there would be no inheritance tax anyway.

Q: Should I convert to Roth IRA in 2010?

A: Estate planning amidst an uncertain future for transfer taxes (click here to read the article)

Q: A State of Estate Tax in 2010

A: Since the estate tax repeal come in effect on January 1, 2010, lawyer offices have not stopped buzzing with question and speculations of what to do next. The Congress was expected to amend the laws by end of 2009 to prevent the repeal to ever become law, but this hasn't happened. 

So, what should clients do? While it is nearly impossible to predict the final outcome of the repeal saga, there seems to be some consensus among the professionals both in lawyer offices and advisory firms for nigh net worth individuals. First, if gifting of some assets is contemplated, there has not been a better time than during 2010. The current law taxes gifts made this year at 35%, versus a 55% rate should the pre-2001 rates return for years 2011 and forward. In other words, there could be a potential 57% rate increase in gift tax rates if the congress fails to act on the issue. 

Second, there is still a window of opportunity, albeit a smaller one, to remove wealth from the taxable estate without incurring any taxes at all, by using a transfer of discounted FLP/LLC interests via a grantor retained annuity trust, or GRAT. The IRS has been fighting this technique for years, with mixed results. Attorneys in lawyer offices and private advisory firms have been watching and studying the IRS moves for over a decade developing and refining the GRAT techniques. However, the Congress has been trying recently to give teeth to the Service in such controversies. Various bills were introduced in both Houses that purport to limit usefulness of grantor-anjuity trusts. While these changes are cropping up in almost every large bill introduces in Congress, they have yet to make it into the legislation passed by both Houses. While it is likely that this new anti-GRAT law will eventually pass this year, so far none of the bills seek retroactive application of these changes. Of course, anything can happen in today's political environment, but there is a strong case to be made about the opportunity to enjoy a short-term zero-out GRAT before they are gone forever. 

Another attractive technique, discounts on intra-family transfers of investment partnership interests, is also under Congressional scrutiny. The IRS has become increasingly hostile to such transfers and made some progress recently attacking these estate transfer vehicles under a step-transaction doctrine, whereby the government argues that funding a family partnership and the subsequent gifting of a limited interest to the next generation is a single transaction in substance, albeit not in form. As a result, valuation discounts are not allowed for lack of marketability or minority interest, without which the technique loses most, if not all. of its tax advantages. Earlier this year, one of the mega-bills incorporated a long-sought provision that codified an economic substance doctrine by making it a part of the Internal Revenue Code. It remains to be seen how that codification will impact popular estate planning techniques, as the Service has yet to publish any guidance on how to comply with the new law. However, there is pending legislation in both Houses that would sound a death knell for all sophisticated wealth transfers vehicles involving discounts on liquid assets that pass to family members. If you consider gifting an ownership interest in a family partnership, the time act is now before discounts are taken away forever. If done by a good attorney in respectable lawyer offices, these transfers are still likely to achieve the intended estate planning results, even under a higher level of government scrutiny.

The temporary estate tax repeal also posed a tremendous challenge on tax practitioners in lawyer offices and CPA firms and their clients as it relates to testamentary bequests. Most will include a marital deduction formula that breaks down the decedent's estate into a spousal portion (which passes tax-free) and a so-called credit shelter portion that utilizes the deceased spouse's tax exemption. Most wills by design leave the maximum allowed tax-free amount to the credit-shelter trust, thereby achieving the most tax-efficient result. Under the current law, no estate tax applies to an estate of the decedent who passed away in 2010. The tragic result of this law is that  a spouse may not have any wealth pass to her or her trust. unless the will has been updated this year to account for this contingency. As we get more and more frustrated with Congressional inaction, you may wish to speak to your trusted advisor in lawyer offices or your CPA about updating your current Will to reflect the special language that will avoid this harsh result. 

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