In his most recent State of the State message, Gov.Chris Christie called for the abolition of the New Jersey estate tax. He noted that that “[F]ourteen states currently have estate taxes, and six have inheritance taxes. But only New Jersey and Maryland have both. We're outliers. And we also have the lowest exemption threshold in the country. It makes New Jersey unfair and uncompetitive.”
All true. New Jersey is indeed an “outlier” among states when it comes to death taxes, and this dubious distinction has made us “uncompetitive.`” If you don’t believe Christie, just ask any tax advisor. They know and will admit that a failure to warn clients against the pitfalls of New Jersey’s death taxes is arguably malpractice. Indeed, a 2011 survey of financial advisors conducted by the New Jersey Treasury’s Office of the Chief Economist found that New Jersey’s death-tax system was the third-most cited factor spurring migration from the state, only exceeded by income and property taxes.
Christie’s speech rekindled sporadic if desultory Trenton rumors over the possibility of a compromise that would trade off an increase in motor fuels taxes (dedicated to transportation projects) with a face-saving reduction or outright repeal of the estate tax. Although we would strongly recommend an increase in the estate tax’s low exemption threshold to something closer to the regional norm, we urge our leaders to leverage the lion’s share of whatever political momentum there is on repealing the New Jersey transfer inheritance tax, the estate tax’s little-appreciated but more-than-equal partner in contributing toward New Jersey’s “outlier” and “uncompetitive” status.
Understanding why repealing the transfer inheritance tax should be a higher priority than repealing the estate tax requires a little technical background, so please bear with us.
As Christie noted, New Jersey imposes two interlocking taxes in relation to death: a tax on transfers of property from a decedent to certain classes of beneficiaries (the transfer inheritance tax, enacted in 1892) and an additional tax on decedents’ estates (the estate tax, enacted in 1934). The Fiscal 2016 state budget anticipates approximately $755 million from the two taxes combined.
Although both taxes impose a top rate of 16 percent, there are complex but important distinctions.
First, as the word “additional” implies, the estate tax is imposed in addition to the inheritance tax; however, contrary to myth, there is no “double taxation” because any transfer inheritance tax liability is netted against any estate tax liability. There is a need, though, to file multiple returns.
Second, while the estate tax applies to the estates of resident decedents only, the transfer inheritance tax applies to transfers of property from both resident and nonresident decedents. In the case of resident decedents, the inheritance tax applies to transfers of real property and tangible personal property located in New Jersey, as well as the decedent’s intangible personal property, no matter where located. In respect of nonresident decedents, the inheritance tax applies to real property and tangible personal property located in New Jersey only.
Third, the taxes have very different exemption and deduction structures. Although the estate tax generally applies to all estates with a gross value of more than $675,000, the transfer inheritance tax can apply to transfers of property of as little of $500. Further, while the estate tax imposes a graduated tax rate up to 16 percent (with one bizarre exception described below) on estates but provides a 100 percent deduction for amounts left to spouses, the applicable transfer tax varies depending on the relationship of the beneficiary to the decedent and the value of the property received. Specifically, the transfer tax exempts all transfers to spouses as well as grandparents, parents, and children. All other transfers of $500 or more are taxable, except that the first $25,000 on transfers of property to a sibling’s or a child’s spouse or widow(er) is exempt.
In sum, although the estate tax and transfer inheritance tax are related and complementary, they are not the same. Repealing the former without reference to the latter would have significant policy implications. For example, because the inheritance tax applies to lower values and is imposed before the estate tax, repeal of the estate tax alone would leave some of the most regressive, “unfair,” and “uncompetitive” features of New Jersey’s death tax firmly in place.
For example, a modest $10,000 bequest to a friend by any decedent will result in an inheritance tax liability. Repeal of the estate tax will leave this liability in place for both small and large estates (indeed, large estates will have less of a burden, since the inheritance tax payment can be deducted from federal estate tax). Similarly, the inheritance tax’s low thresholds for taxing transfers to non-lineal relatives acts as a powerful incentive to concentrate wealth within immediate families. Repealing the estate tax alone could accentuate the notoriety of this anachronistic underlying feature of New Jersey law.
We understand that the rhetorical focus on the estate tax reflects the public’s relative familiarity with its federal counterpart. Nonetheless, instead of abolishing the estate tax, we recommend repealing the transfer inheritance tax together with a phased-in increase in the estate tax exemption amount to match the federal exemption amount, currently $5.45 million, or at least the applicable exemption in New York, which is phasing up to the federal amount as of 2019.
Along with this change we believe New Jersey should reform the estate tax’s rate schedule to eliminate a quirk, mentioned above, that results in an astonishing 37 percent marginal rate on the first $52,175 of the taxable amount of the estate, before dropping to 4.8 percent on the next $172,825. This bizarre feature is apparently a remnant of previous federal law that allowed estates to take a credit for state estate taxes.
Repealing the inheritance tax would result in a revenue reduction of several hundred million dollars per year, a significant amount in relation to the state’s $34 billion budget. The state’s fiscal capacity should therefore inform the timing of transfer inheritance tax repeal and the phase-in schedule for increasing the estate tax exemption.
Christie is absolutely right: When it comes to state-level tax policy, it’s all about avoiding “outlier” status. Dollar-for-dollar, repealing the transfer inheritance tax will do more to make New Jersey competitive, fairer, and closer to the tax-policy mainstream than repealing the estate tax. Opportunities for reaching a compromise on tax policy in New Jersey don’t come along all that frequently. Let’s not waste this one.