“Strategies to avoid the inheritance tax when you leave your estate to nieces.”
If you want to include nieces and nephews in your estate equally, you may need to consider whether an inheritance tax can make it difficult and the types of strategies to use to make it even.
nj.com’s recent article, “Dividing and conquering the inheritance tax” explains that there are some strategies you can use to save these transfers from incurring taxes.
New Jersey repealed its estate tax as of January 1, 2018, but it still has an inheritance tax. The inheritance tax is imposed on transfers of assets to certain classes of beneficiaries who are beyond the immediate family. This includes nieces and nephews.
The inheritance tax rate on transfers to nieces and nephews is 15% in New Jersey. There is an exception, if the bequest is less than $500. In that case, there’s no tax. Therefore, if an aunt or uncle leaves a niece or nephew $500 or more, there will be a tax on the entire amount.
It's important to know that the tax is imposed on every transfer, regardless whether it’s probate or non-probate. A probate transfer is an asset that passes under a will, like a family home or an auto the decedent owns in his or her name alone. A non-probate transfer is something that passes outside of your will, like a joint checking account or a retirement account.
As a result, if an aunt or uncle wants to designate a niece or nephew as a beneficiary of an IRA or 401(k), there’ll a 15% tax due on the amount they get. This is also true even when they withdraw money from the IRA. In most cases, they’ll also have to pay income tax on the withdrawal.
Like any rule, there are exceptions. There are some transfers that are exempt from the tax. One is life insurance paid to a named beneficiary. In the scenario with the generous aunt or uncle, if they name their nieces as beneficiaries of their life insurance, they won't have to pay any inheritance tax on the proceeds of that insurance policy.
Typically, the person receiving the asset is liable for the tax. This can be a troublesome issue for them when the asset they’re receiving isn’t liquid—like real estate. In that case, the beneficiary might have to sell (or liquidate) the property to raise the money to pay the tax. As an example, if an aunt or uncle leaves a house worth $300,000 to a niece or nephew, they’d be on the hook for inheritance tax of $45,000. That tax is due just eight months after the date of death.
One easy solution to the issue of the inheritance tax is make a provision in the aunt or uncle’s will that all taxes are to be paid from the residue of their estate. This is pretty common. It means that all of the inheritance tax would be paid before any assets are distributed to the beneficiaries. A daughter might receive less than what she might otherwise inherit, but this would have the effect of treating all three beneficiaries the same. The aunt or uncle will need to be certain they have enough assets flowing through their estate to pay the tax. That may require some planning, so speak with a qualified estate planning attorney.
Reference: nj.com (January 19, 2018) “Dividing and conquering the inheritance tax”