What Can the Boss Teach New Jersey Residents About Estate Tax Planning?

New Jersey’s legendary troubadour just completed a triumphant return to MetLife Stadium in the swamps of Jersey. We know that Bruce and Miami Steve learned more from a three-minute record than they ever learned in school. But, perhaps you didn’t know that the Boss’s classic lyrics can also remind us to show a little faith as there is still some “magic in the night” for New Jersey residents who want to avoid or reduce the New Jersey Estate Tax.

“Don’t give me my money, honey  . . . I don’t want it back”

The New Jersey Estate Tax is a tax that can be eliminated or reduced by lifetime gifts.  Instead of leaving two grand sitting in your pocket, a New Jersey resident can make gifts without triggering federal gift tax by using available annual exclusions (currently $14,000 per donee) and the lifetime gift tax exemption of $5,450,000.  Because New Jersey does not impose a state gift tax, these federal exemptions offer “tramps like us” an opportunity to stay and avoid getting out while we’re young.

New Jersey’s estate tax law is based on the former credit for state death tax, which was repealed in 2005.  These are better days, it’s true, because under the current rules, lifetime gifts are not “pulled back” when considering the New Jersey taxable estate.  In other words, a New Jersey resident is only taxed on the assets that the decedent still owned at the time of his or her death – not the assets that have been gifted.

Note, before trying to make it good somehow, there are some other taxes to consider before a substantial gift is made.  If appreciated assets are gifted, the donee receives the transferor’s basis.  In an instance where the capital gains tax which would be triggered by a donee’s sale exceeds the anticipated New Jersey Estate Tax, it is more tax-efficient for the individual to retain the asset until death (and pay the New Jersey Estate Tax) because assets subject to the Estate Tax will receive a “step-up” in basis.  The step-up can work to avoid the higher capital gains tax when the beneficiary ultimately sells the asset.  Also, when the donor intends to benefit individuals who are not a spouse, parent or descendant, those lifetime transfers can be subject to a New Jersey Inheritance Tax of up to 16% when the transfers are made “in contemplation of death” to non-exempt beneficiaries.

“This boardwalk life for me is through .  . . you know you ought to quit this scene too”

New Jersey imposes a state estate tax on estates valued in excess of $675,000.  Many clients change their “domicile” to a different jurisdiction to avoid the state estate tax.  Florida is a frequent destination, but more recently, clients will cross the river from the Jersey side to New York to take advantage of the current $4,187,500 state estate tax exemption available to New York residents.

A person can have multiple residences, but for purposes of state estate taxation, an individual has only one “domicile.”   While there is no universally adopted definition of domicile, many states (and the IRS) share a general understanding that domicile means the place where a person has a fixed residence and the present intention of making it his or her permanent home. Once a domicile is established, “she’s the one” until superseded by a new one.

When clients have multiple residences and they want to change their domicile from New Jersey to Waynesboro County, Darlington County or some other jurisdiction, advance planning is recommended. Although there is no one fact that establishes a decedent’s legal domicile, when a change is considered, some of the following actions are recommended:

  • Filing a Declaration of Domicile in the new domicile state
  • Changing of vehicle and voter registrations
  • Filing state income or personal property taxes in the new domicile state
  • Executing new estate planning documents
  • Changing registrations for places of worship or club memberships

“The times are tough now, just getting tougher . . .  cover me”

Many New Jersey estate planning clients choose to maintain their house up in Fairview or take a good look around and refuse to leave their hometown.  The reason is often not tax motivated – clients want to be close to their family, grandchildren, shore homes and friends.  Also, gifting strategies to reduce the estate tax may not be viable or tax efficient.

For those who have learned to sleep at night knowing the price to pay by staying in New Jersey, there has been renewed activity in the purchase of single life and second-to-die life insurance to “cover” the New Jersey Estate Tax that will be incurred.  Many clients are coupling the life insurance with a Long Term Care rider to help preserve family assets in the event of a long-term illness.  Advice from a qualified or visionary planner, perhaps dressed in the latest rage, should be sought regarding the ownership and beneficiary designation of such policies, the tax considerations when an LTC rider is involved and the benefits of an irrevocable trust to own the policy.

The Failure to Coordinate the Provisions of Your Current Will with Documents Referenced in that Will Can Have Costly Consequences

A recent decision of the New Jersey Superior Court, Chancery Division, highlights the importance of reviewing your estate plan to ensure that it meets your current objectives and that lifetime trusts or charitable foundation documents referenced in your estate plan remain in force. In a decision entitled In the Matter of the Estate of Muhammed Belal Hussain, deceased, members of a decedent’s family sought to invalidate a charitable bequest to a foundation that was identified in the decedent’s last will and testament. The heirs argued that the bequest to the charity lapsed because the referenced foundation was never established. The decedent’s Will was signed in December, 2008, almost five years before the testator died in 2013. The court ruled that the charitable bequest failed because the charitable foundation did not exist at the time of the decedent’s death.

Although in certain instances a court can invoke the cy pres doctrine or the doctrine of probable intent to save an intended charitable bequest, the chancery judge refused to do so in this instance. The decision noted that the executor of the estate attempted to create a foundation after the testator’s death. The court rejected this post-mortem tactic and declined to permit the testamentary bequest to a foundation that never existed.

The decision highlights the importance of reviewing your estate plan to ensure that it meets your current objectives and that any trust or charitable foundation referenced in your most current Will is in full force and effect. In the decision summarized here, the decedent’s failure to establish the charitable foundation in the five years after signing the Will led to the delay, expense and uncertainty of a probate litigation.

An estate plan is not a boilerplate Will or trust that a client signs and stores in a file. On the contrary, a coordinated estate plan is necessary so as to ensure that you preserve your assets and business interests for those beneficiaries or charities you presently intend to benefit. It is essential to have your estate plan reviewed periodically to ensure that your plan is coordinated with the titling of your assets, your beneficiary designations and the documents referenced in your Will. Equally important, the plan should be reviewed to confirm that it addresses current estate and inheritance tax laws.

The New Jersey Uniform Trust Code Becomes Effective July 17, 2016

On January 19, 2016, New Jersey joined over 30 other states when it enacted its version of the Uniform Trust Code, P.L. 2015, c.276 (“the NJUTC”). The objective of the legislation is to provide predictability, transparency and fairness for parties involved in the establishment and management of trusts, as well as those charged with their administration.

The NJUTC, which is effective July 17, 2016 applies retroactively, with certain exceptions. It’s advisable that parties to existing trusts, as well as legal practitioners and other advisors confirm the impact of the new law and review planning opportunities now available. To highlight some of the important provisions of the new law:

  • Many provisions of the NJUTC can (and, if inconsistent with a Grantor’s wishes, should) be overridden by a trust agreement.  Other provisions of the law, however, cannot. For example, if a beneficiary older than 35 so requests, the trustee must provide the beneficiary with copies of both the trust instrument and information regarding the investment and management of the trust assets;
  • Non-judicial settlements, designed to minimize or eliminate altogether costs and delays inherent in obtaining approval from the court in matters of trust administration are permitted, subject to limited public policy exceptions. Matters that may be resolved by a non-judicial settlement agreement include the interpretation or construction of the terms of the trust, the approval of a trustee’s accounting, direction to a trustee to refrain from performing a particular act or the grant to a trustee of any desirable power, the resignation or appointment of a trustee,  the determination of a trustee’s compensation, the transfer of a trust’s principal place of administration and the liability of a trustee for an action relating to the trust;
  • The NJUTC also allows for the modification of a trust if the trustee and all interested beneficiaries agree. There are several instances when the terms of a trust as envisioned by the trust’s creator no longer meet the intended purpose of the trust. For example, a provision directing a trustee to make distributions at certain pre-set ages may no longer be appropriate if the beneficiary is not sufficiently mature enough to handle the asset distributed, if the beneficiary is experiencing dependency issues or if there are potential creditors that could attach the trust funds distributed.  Similarly, a beneficiary in a strained marital relationship may prefer that mandatory distributions be eliminated;
  • The NJUTC also addresses the relationship between a trustee and an investment advisor, as a result of a new section on powers to direct investment functions. Although the provisions of the NJUTC defining the trustee/investment advisor relationship are clearly defined, such provisions are not within the scope of the mandatory rules and, consequently, can be modified to better conform to a grantor’s objectives. For example, under the default provisions, a fiduciary who has delegated investment functions to an investment advisor has no duty to monitor the conduct of the investment adviser, provide advice to the investment adviser or consult with the investment adviser, communicate with or warn or apprise any beneficiary or third party concerning instances in which the fiduciary would or might have exercised the fiduciary’s own discretion in a manner different from the manner directed by the investment adviser. Grantors should consider whether these provisions are acceptable. It is anticipated that investment advisors will also update their policies as a result of the NJUTC, and those policies should be reviewed by a Grantor who is considering taking advantage of the NJUTC’s new section on powers to direct investment functions.

Take Advantage of Estate Planning Techniques that Thrive in a Low Interest Rate Environment

Current interest rates, which remain near historic lows, present several income, estate and gift tax planning opportunities. A number of estate planning techniques, including a grantor retained annuity trust (“GRAT”), an intra-family loan, an installment sale of a closely-held family business interest and a charitable lead annuity trust (“CLAT”), are more beneficial during periods of low interest rates.

A GRAT remains a viable estate planning technique

A GRAT allows the transfer of property with appreciation potential to an irrevocable trust whereby the grantor retains the right to receive a fixed annual annuity payable for a term. At the end of the annuity term, the trust property passes to the trust’s beneficiaries. If the grantor survives the term, the value of the trust assets are not included in the grantor’s gross estate for estate tax purposes.

The IRS requires the use of published interest rates to value the annuity and remainder interests. Under Section 7520 of the Internal Revenue Code, the IRS uses a rate based on 120 percent of the Mid-Term Applicable Federal Rate (“AFR”) to discount the value of an annuity, an income interest for life or a term of years, or a remainder or reversionary interest in a trust to present value (the “7520 Rate”). The 7520 Rate (which varies from month to month) for June, 2016 is 1.8%. When the value of the trust property transferred to a GRAT appreciates at a rate exceeding the 7520 Rate the grantor will have successfully passed wealth to the GRAT’s beneficiaries outside the transfer tax system.

The transfer of the property to the GRAT is a gift for gift tax purposes to the extent that the initial value of the trust property exceeds the present value of the grantor’s retained annuity interest for the month the GRAT is created. A “Walton” GRAT is a technique that effectively permits the grantor to “zero-out” the gift to the GRAT. This technique is often used when a grantor has fully utilized his or her lifetime gift tax exemption.

The Department of the Treasury’s Green Book for Fiscal Year 2017, which provides explanations of the President’s budget proposals, attempts to impose some downside risk in the use of a GRAT. For example, a proposal would require that a GRAT have a minimum term of ten years and a maximum term of the life expectancy of the annuitant plus ten years. The administration has long targeted GRATs, and it is important that the legislative landscape be monitored in this regard to ensure the GRAT remains a viable estate planning technique.

Intra-family loans remain attractive planning tools

Consideration should also be given to the making or renegotiation of existing intra-family loans. Utilizing the current low interest rates in connection with an intra-family loan, a borrower can effectively retain the earnings on the borrowed funds which exceed the interest due on the debt.

Note that in order to avoid assessment of “imputed income,” the Code requires that the borrower pay interest on the loan. In order to avoid imputed interest on an intra-family loan, interest must be paid at the AFR. In June, 2016, the AFR for Short-Term Loans (3 years or less) is .64%; 1.41% for a Mid-Term Loan (greater than 3 years but less than 9 years); and 2.24% for Long-Term Loans (greater than 9 years). A demand loan which is payable in full at any time on demand of the lender typically requires an interest rate equal to the Short-Term AFR, compounded semiannually, for the period during which the loan is outstanding.

Consider an installment sale of a closely-held family business interest

Another estate planning technique which can afford a significant opportunity to transfer wealth outside the transfer tax system involves the sale of a closely-held business or family partnership which has appreciation potential to a family member under an installment sale. The sale is generally made in exchange for a promissory note which bears interest over a term of years at the current AFR. In many instances, the note requires an annual interest payment with a balloon payment due at the end of the term.

This technique effectively permits the seller to “freeze” the value of the asset sold at the balance due under the promissory note. Future appreciation in the asset’s fair market value above the note and interest due is not includable in the seller’s taxable estate. This technique works especially well when a low interest rate environment coincides with favorably low valuation of the business or family partnership – either due to current market conditions or a temporary decrease in fair market value. In addition, when an installment sale is made pursuant to a transaction involving a grantor trust, capital gains tax on the interest sold can be avoided and if the trust is properly structured, the future appreciation in value occurs outside the transfer tax system.

Charitable planning opportunities exist

For individuals who are charitably inclined, a CLAT can also perform well in a low interest rate environment. Under the terms of a CLAT, a charity receives annuity payments for a stated term. At the end of the trust term, the property remaining in the CLAT passes to one or more non-charitable beneficiaries (typically the children of the donor). Note that there are Generation-Skipping Transfer Tax implications if the non-charitable beneficiaries of a CLAT include grandchildren of the donor.

The annuity amount is valued by assuming that the charity’s interest will earn a rate equal to the 7520 Rate for the month the donor establishes the CLAT. If the growth of the trust property outpaces the 7520 Rate, the growth inures to the benefit of the trust’s remainder beneficiaries outside of the donor’s taxable estate.

Donors can obtain significant tax benefits utilizing a CLAT, including an upfront income tax deduction if the CLAT is structured as a “grantor trust” and the gift and estate tax laws allow a deduction for the actuarial value of the annuity interest committed to charity.

Legislation Regarding Digital Assets Poses Planning Considerations

As technology and the use of social media become more prevalent, access to digital assets in the event of the account owner’s death has become an increasingly important estate planning consideration. Digital assets include a variety of media including social media pages, emails, and frequent flyer points.

There have been many reported instances when family members have faced tremendous obstacles gaining access to a deceased relative’s digital assets.  A number of states have introduced and/or enacted legislation on the topic. Connecticut laid the groundwork for digital asset planning with the approval of Public Act No. 05-136, “An Act Concerning Access to Decedents’ Electronic Mail Accounts,” which took effect October 1, 2005. Over the past several years, other states have acted to adopt laws that protect digital assets and grant the family of a decedent the right to access and manage those assets.  In 2014, the Uniform Law Commission approved the Uniform Fiduciary Access to Digital Assets Act, which is designed to allow executors, trustees, or the person appointed by the court complete access to a decedent’s digital assets.

In April 2016, the New Jersey legislature proposed bill A3598 which would authorize an executor or administrator to access digital assets of a deceased person. The law was referred to the Assembly Judiciary Committee. A link to the full text of the proposed New Jersey bill is http://www.njleg.state.nj.us/2016/Bills/A4000/3598_I1.HTM.  In May 2016, the New York legislature proposed bill S07604, which is similar to NJ A3598, but primarily focuses on providing a procedure for disclosure of digital assets. The bill was amended on third reading, now titled NY A09910, and is currently awaiting Senate approval. A link to the full text of the proposed bill is http://assembly.state.ny.us/leg/?default_fld=&bn=A09910&term=2015&Summary=Y&Actions=Y&Text=Y&Votes=Y#A09910.

In the absence of a controlling statute, there are a few basic actions that can help secure access to an account owner’s digital assets. At a minimum, it is recommended that a list of all user names and passwords of digital accounts be maintained. This list should be stored in a secure place, and the executor of the account owner’s estate should be notified how to retrieve this information. These digital assets include email addresses and airplane miles/vacation rewards, as well as bank account login codes. This list should be reviewed and updated periodically to reflect password updates.

In an instance where an account owner may feel uncomfortable authorizing access to social media accounts, or other programs that contain personal messages and information, several of the major social media platforms have recently introduced procedures for users to decide how they want their account to be managed after they pass away. For example, Facebook recently allowed its users to select a legacy contact. This contact will be granted limited access to the account. For example, the contact may be authorized to change a profile/cover photo or add relatives who were not previously connected. Limitations have been placed on the contact’s ability to log in to the account or see personal messages or images. Other platforms have similar procedures which can be accessed by the following links:

https://www.linkedin.com/help/linkedin/answer/2842?lang=en

https://support.twitter.com/articles/87894#

https://help.instagram.com/264154560391256/

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