How NJ and Federal Estate Tax Changes May Wreak Havoc with Your Will

The NJ estate tax exemption increased from $675,000 to $2M in 2017 and the tax is repealed in 2018. President Trump has proposed a repeal of the federal estate tax. That means that there is no need to worry about taxes. Perhaps, but these changes could dramatically affect your will distributions in ways you may not realize. No tax may not mean no problem.

Example: Clients are married and live in New Jersey. A credit shelter funding provision provides as follows: “If the Grantor’s Spouse survives the Grantor, the Grantor gives a fractional share of the Trust Fund, as determined after payment of transfer taxes, expenses and other pre-residuary gifts but before payment of any Formula Gift hereunder, the numerator of which shall be equal to the Grantor’s Estate Tax Exemption and the denominator of which shall be equal to the value of the Trust Fund, as finally determined for Federal Estate Tax purposes, to the Trustee of the Credit Shelter Trust under this Trust Agreement, to be disposed of under the terms of that trust. This gift is intended to equal the smaller of the available Federal estate tax exemption or the state estate tax exemption under the laws of the Grantor’s domicile or, if there is no Federal estate tax in effect at the Grantor’s death, equal to the state estate tax exemption under the laws of the Grantor’s domicile.”

• ·         If one spouse dies in 2016 the New Jersey estate tax exemption is $675,000 and that would fund the credit shelter.
• ·         If the first spouse dies 2017 the New Jersey exemption rises to $2 million and that amount would fund the credit shelter trust.
• ·         If the first spouse dies in 2018 the New Jersey estate tax will be repealed and the credit shelter trust will be funded with $5,490,000 (based on the 2017 exemption amount).
• ·         If the first spouse dies in 2019 and the Trump administration has successfully repealed the estate tax the credit shelter trust presumably would not be funded since the “smaller of the available Federal and estate tax exemption and state estate tax exemption” is zero.

In the preceding example, 2018, $5,490,000 will be transferred to the credit shelter trust. Might assets in a credit shelter trust avoid being subject to any capital gains tax on of the death of the 2^nd spouse if Trump replaces the estate tax with a capital gains on death tax? In the preceding example, in 2019 the entirety of the estate would pass to the QTIP trust. Would any capital gains tax on death be deferred on the first death by a capital gains at death tax marital type deduction? Will a classic QTIP trust meet that spousal deferral requirement? May capital gains tax could be avoided if the assets pass to the surviving spouse. Will any trust qualify for the marital exemption from the capital gains tax at death? Will a QTIP type trust defer the capital tax? Will a less restrictive or different trust qualify? Will there be a requirement of a QDOT type trust if the spouse is not a US citizen?   Might some portion of the capital gains on the first and second deaths be avoided if instead a credit shelter trust were funded?

Conclusion

Tax law changes can undermine the distributions you intend to accomplish under your will. It is not only about taxes, but about meeting personal goals as well. Everyone must re-examine their wills and planning as tax law changes unfold.