State laws vary, so be sure to check with an estate planning attorney if you are leaving assets to family members who are not children or parents.
Inheritance taxes in different states treat different family members differently, so you’ll want to plan this in advance to avoid saddling beloved nieces and nephews with burdensome estate taxes. A recent article from nj.com, “Dividing and conquering the inheritance tax,” provides some insight into strategies to consider.
New Jersey repealed its estate tax as of January 1, 2018, but it still has an inheritance tax.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.
Making a provision in the aunt or uncle’s will that all taxes, including inheritance taxes, are to be paid from the residue of the estate is one way to cover the cost for a niece or nephew. This means that the value of the estate will be reduced as a result, but all beneficiaries, daughters and nieces, will have their inheritance taxes taken care of. Make sure the estate has enough assets to do this. An experienced estate planning attorney will be able to help you evaluate your situation.
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