Estate Tax Apportionment – Surprise: Who’s Paying My Death Tax Bill?

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Estate Planning Attorney

With Estate Planners advocating assets passing outside of probate, more focus should be given to the allocation of estate death taxes. Who is responsible to pay death and/or inheritance taxes if due? Individuals want give as much of their estate to various family members as possible but fail to have a clear understanding of the tax allocation rules. This failure to plan can easily be defeated. Federal and state laws have tax allocation rules. However, these laws can be overridden by an individual’s will and other testamentary documents. Evaluating how taxes are allocated among all of the individual’s estate assets can help avoid unintended consequences that adversely impact the individual’s estate plan.

A defective tax apportionment clause, can increase estate or inheritance taxes and potentially trigger tax when one would not otherwise be due. The allocation of estate taxes (commonly called a “tax apportionment clause”) may be one of the most important but often overlooked considerations in a Last Will or Trust. Tax apportionment issues most often come up with individuals who have substantial non-probate assets (such as life insurance and retirement plans), illiquid assets (such as a family business or family home), or multiple marriages and children from a prior marriage.

To illustrate the importance of an estate tax apportionment clause, consider the following fact pattern:

Tom dies at the age of 76. At the time of his death, he was married to Jean who is age 55. They were married for 20 years and have one child, May, who is 16 years old. Tom has two other children from a prior marriage, Bill and Joan, ages 29 and 32.

At the time of his death, Tom’s estate was valued at $8 million dollars. His will contains the following dispositive provisions:

  • All of his tangible personal property, valued at $500,000, is to be distributed to Jean.
  • His mountain ranch (which John inherited from his father), valued at $2,500,000, is to be distributed to his brother, Joseph.
  • The rest of the estate ($5 million) is to be divided as follows: 50% to a marital trust for Jean with the remainder to May, and 50% divided into equal shares and held in trust for Bill and Joan. Tom also has an IRA valued at $500,000 which is to be distributed to Bill and Joan.

The estate tax allocation among the bequests will depend upon Federal and state law, along with any overriding provisions found in Tom’s will.

Default estate tax apportionment rules found in Federal and state laws will determine how the estate tax is apportioned (that is, which beneficiaries bear the estate tax burden).

Federal Reimbursement Laws

The Internal Revenue Code (“IRC”) provides that absent state law or a direction under the decedent’s will to the contrary, estate taxes are to be paid out of the “residue” of the decedent’s estate before it is distributed. Even though the IRC requires that the tax be paid from the estate residue, it does not address how the tax will be allocated among the residuary beneficiaries.

State Appointment Laws

State laws provide the primary basis for estate tax apportionment and will applying unless the individual directs otherwise in his or her will. While state laws vary widely, New Jersey’s default laws are fair and equitable. Each beneficiary of a probate and non-probate asset bears a pro rata share of the tax. This means that bequests that generate a deduction or credit (such as gifts that qualify for the marital or charitable deductions) are exempt from bearing a share of the estate tax burden.

Tax apportionment provisions should be included in all documents that are part of the estate plan – including revocable and irrevocable trusts (just in case the assets are pulled into the individual’s estate at death). A tax apportionment provision will designate those bequests that should and should not bear estate taxes.

To discuss your NJ Estate Planning matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing consultations if you are unable to come to our office.