Recently, New Jersey repealed its estate tax for residents passing away after December 31, 2017 [New Jersey Statutes Annotated (N.J.S.A.) 54:38-1 (c)(4)]. However, the New Jersey inheritance tax remains in effect [see N.J.S.A. 54:34-1 (imposing the inheritance tax)].
In 2017, the New Jersey Tax Court decided an inheritance tax case—Estate of Mary Van Riper v. Director, Division of Taxation [Docket No.: 008198-2016 (N.J. Tax Court 2017)]. In 2018, the Appellate Division affirmed the Tax Court’s decision [Estate of Mary Van Riper v. Director, Division of Taxation, 193 A3d 878 (App. Div. 2018)]; all page references for both opinions are to the pages within the opinion]. In 2020, the New Jersey Supreme Court affirmed the lower court’s decision [Estate of Mary Van Riper v. Director, Division of Taxation, Op. ID. 51-18 (Feb. 5, 2020)]. The New Jersey Supreme Court’s decision changes property law in the state and calls into question the theory underlying New Jersey’s compromise tax (see N.J.S.A. 54:36-3). First, the author will briefly discuss the New Jersey inheritance tax, followed by the Van Riper opinions. The conclusion will discuss the change in property law and the question of the theory behind the compromise tax.
The Inheritance Tax
The New Jersey inheritance tax is imposed on the inheritors of New Jersey real or tangible property, by whomever owned, and on inheritors of all property—tangible or intangible—owned by a resident of New Jersey [N.J.S.A. 54:34-1(a), (d)].
Inheritors or beneficiaries are divided into classes, based on their relationship to the decedent. Class A beneficiaries include the decedent’s spouse and lineal ancestors and decedents. There are no longer Class B beneficiaries. Class C beneficiaries are close family relatives, chiefly siblings. Class E beneficiaries are charities and governments. All other beneficiaries are Class D beneficiaries [N.J.S.A. 54:34-2 and 54:34-4(a), (d)].
There is no tax on amounts inherited by Class A or E beneficiaries. There is a $25,000 exemption for amounts inherited by Class C beneficiaries. The tax rate is 11% on the first $1,075,000 inherited above the exemption amount, 13% on the next $300,000, 14% on the next $300,000, and 16% on the amount above $1,700,000. Class D beneficiaries can receive $500 tax free. Inheritances above $500 are taxed at 15% of the first $700,000 inherited (with no exemption) and 16% on the amount over $700,000 (N.J.S.A. 54:34-2).
This leads to an obvious question: What happens if an amount is placed in trust, with the income going to a beneficiary of one class (along with rights to principal, possibly) while the remainder goes to a beneficiary of a different class? If both beneficiaries are in Class A or Class E, there is no problem because there is no inheritance tax due. If at least one beneficiary is a member of Class C or Class D, however, there is a problem—some inheritance tax is due, but how much? This amount is unknown because it is not known how much each class member will receive.
There are two solutions: The first is to compute the tax on the interest inherited by the income beneficiary (if the income beneficiary is a member of Class C or Class D). If the interest is income-only, life expectancy tables can be used to determine the interest to be received; if the income beneficiary has principal rights, some estimation of the value of those rights needs to be made. If a tax is required, it will be imposed on that interest; when the income beneficiary passes away, then the value of the remainderman’s interest can be determined and the appropriate tax paid.
The New Jersey Supreme Court’s decision changes property law in the state and calls into question the theory underlying New Jersey’s compromise tax.
Although New Jersey law allows for this approach (N.J.S.A. 54:36-6), state officials have expressed disagreement with this solution because of the need to keep an estate open between the passing of the decedent and the passing of the income beneficiary; this could be a long period of time. New Jersey does require a bond to be posted. But it is the author’s understanding, as a matter of practice, that such bonds are difficult, if not impossible, to obtain.
As a second solution, New Jersey also allows for a compromise tax. The compromise tax is an agreement between the executor and the Director of the Division of Taxation as to the amount of tax that should be paid currently to account for the various interests created by the decedent [NJAC 18:26-2.14]. The New Jersey Division of Taxation has published a “Guide for Computation of the Compromise Tax” [see Appendix I in Beck and Sherman, NJ Inheritance and Estate Taxes, 2017 (Gann)].
Mr. and Mrs. Van Riper established a trust in 2007 into which they placed their principal residence. The purpose of the trust was to provide a home for the transferors until the passing of both transferors [Van Riper (Tax Court), pp. 2-3]. The house could be sold, but the proceeds had to be used to provide shelter for the transferors. Upon the passing of the second of the transferors, the house went to their niece (pp. 2-3 n. 1). In 2007, shortly after the trust was established, Mr. Van Riper passed away; Mrs. Van Riper passed away in 2013 (pp. 2-3).
The question posed in this case, according to the court, was whether the conditions of a 1955 exemption from the inheritance tax were satisfied (p. 3). The statute provides as follows:
A transfer of property by deed, grant, bargain sale or gift wherein the transferor is entitled to some income, right, interest or power, either expressly or by operation of law, shall not be deemed a transfer intended to take effect at or after transferor’s death, if the transferor, more than 3 years prior to death, shall have executed an irrevocable and complete disposition of all reserved income, rights and powers in or over the property transferred (N.J.S.A. 54:34-1.1).
The estate argued that the Van Ripers gave up all power and control over the house more than three years before the end of the trust by transferring the house to a trust. The estate claimed that section 1.1 overrides the transfer in contemplation of death provision of N.J.S.A. 54:34-1(c) [Van Riper (Tax Court), p. 9].
That provision provides that gift transfers made within three years of the decedent’s death shall be treated as if made in contemplation of death and are therefore subject to inheritance tax. Proof to the contrary can be introduced and can override this presumption [N.J.S.A. 54:34-1(c)].
For the provisions of section 1.1 to apply, the court said, three elements must be satisfied. First, there must be a transfer of property. Second, the transferor must be entitled to some income, right, interest, or power in the property transferred. Third, the transferor must execute an irrevocable and complete disposition of all reserved income, right, interest, and power in the property three years prior to death [Van Riper (Tax Court), p. 10].
The court then examined those three elements in order to determine if each had been satisfied. The court first concluded that there was no dispute that property had been transferred (pp. 10–13).
Second, the court concluded that the Van Ripers’ retention of a life interest in the house gave them a right or power in the property. The court reviewed several court decisions and concluded that the Van Ripers’ life interest postponed their niece’s ability to enjoy the property until their passing; therefore, the second element had been satisfied (pp. 10–13).
The court then examined the third element. The Van Ripers had transferred their house to an irrevocable trust. The estate argued that the transfer was the disposition required under the third element. In other words, the estate urged the court to read “transfer” and “disposition” synonymously (p. 13). The court declined to do this, however, and concluded that the statutory language, the interpretation of section 1.1 by the Director of the Division of Taxation, and the legislative history of section 1.1 all required the court to come to the opposite conclusion—that the two words should not interpreted synonymously (p. 14).
The court first reexamined the statutory language. Courts generally interpret words in a statute according to their ordinary meaning. The court found that a disposition is a termination of an interest in property. A transfer is conveyance of title. The court concluded that a disposition is more than a transfer (pp. 14–15).
Courts can also consider the associated words in a statute and the spirit of the statute when interpreting a word in a statute. In this case, the court noted, the statute refers to a “complete disposition.” This, to the court, indicated that the Legislature had in mind something more than a transfer of title when it referred to a complete disposition (p. 15).
The court then examined the regulations promulgated by the Director of the Division of Taxation regarding section 1.1. Those regulations provide that the transferor “completely and irrevocably disposes all of his reserved income, rights, interests and powers in and over the transferred property” for the transfer to meet the statutory requirements (N.J.A.C. 18:26-5.10). The court found that this rule requires some action more than the mere transfer of title [Van Riper (Tax Court), p. 16].
The court then examined the statutory language. Prior to the enactment of section 1.1, any transfer occurring at or after death was subject to the inheritance tax, even if the transferor had relinquished all rights in the property. The test before the 1955 amendment was whether assets passed to someone after the decedent’s death (pp. 17–19).
In the early 1950s, a wealthy New Jersey family had five trusts. In four of those trusts, the grantors retained an interest in each trust; they subsequently transferred each interest in each trust. The fifth trust provided for income to one person until the death of the grantor. At that time, the remainder passed to another [p. 20 (citing In re: Estate of Lambert, 63 N.J. 448 at 456 (1972)].
Courts can also consider the associated words in a statute and the spirit of the statute when interpreting a word in a statute.
This family intended to thereby avoid federal estate taxation of the trusts, but also wanted to avoid the New Jersey inheritance tax. The Director finally supported the amendment that became section 1.1 (p. 21); this amendment presumably helped the family avoid the inheritance tax.
The court determined that the legislature’s intent in adopting section 1.1 was to exempt from taxation transfers occurring at or after the decedent’s death when the decedent had given up all interest in the property transferred more than three years before death. The court rejected the idea that the legislature intended to exempt, at or after death, transfers of property in which the decedent had retained a life estate (pp. 21–22).
Based upon the language of the statue, the regulations issued by the director, and the legislative history, as outlined above, the court concluded that the transfer at issue in this case was taxable. Thus, it was not exempt under section 1.1 (p. 22).
The estate had also contended that only half of the interest in the house was taxable. The trust was created in 2007. At that time, the court contended, three interests were created: the life estate of the husband, the life estate of the wife, and the remainder interest of the niece. When the husband and wife each passed away, their respective life estates were extinguished. The niece did not receive her interest until the second of the spouses passed away (pp. 22–23).
The court concluded, therefore, that the transfer to the niece was fully taxable under N.J.S.A. 54:34-1 (c). That provision provides for the taxation of transfers made that are intended to take effect at or after the death of the grantor (p. 23).
The estate appealed, arguing that Mary Van Riper had only a one-half interest in the home when it was transferred to the trust and that the inheritance tax should have been imposed only on that half [Van Riper (App. Div.), pp. 3–5].
The court rejected this argument. It ruled that the Van Ripers, before they put the house in the trust, owned the house as tenants by the entirety. Each spouse, when owning property as tenants by the entirety, owns the entire property. Upon the death of one spouse, the surviving spouse continues to own the entire property (p. 6). Therefore, the court concluded the director of the Division of Taxation reasonably concluded that the entire house was subject to tax upon Mary Van Riper’s passing. Furthermore, when Walter Van Riper passed away, his estate reported the property and asserted that no tax was due because the property passed to a surviving spouse (pp. 6–8).
The court then asserted that it would be unfair to have taxed one-half of the property’s value at Walter Van Riper’s death.
The New Jersey Land Title Association (NJLTA) filed an amicus curiae brief in this case. In that brief, the NJLTA argued that the Division’s assessment was inconsistent with N.J.A.C. 18:26-8019(a), which provides for a compromise tax (as discussed above) when a life estate is created after the death of a decedent (p. 3, 10).
The NJLTA asserted that there were three transfers after the death of Walter Van Riper in 2007. The first was the transfer of Walter Van Riper’s life estate to his wife; this would not be subject to tax, because it is a transfer to a spouse. The second transfer, taking place at Walter Van Riper’s death, was of the remainder of Walter Van Riper’s interest to his niece. That transfer should have been subject to tax at Walter van Riper’s death. The third transfer was of Mary Van Riper’s one-half interest in the house to her niece at Mary Van Riper’s death. That transfer would also be taxable (p. 10).
The court rejected this argument because the Van Ripers owned the property as tenants by the entirety before the property was transferred to the trust. Mary Van Riper therefore owned the entire property and it was reasonable for the Director of the Division of Taxation to tax the entire interest (pp. 10–11).
Affirmation by the Supreme Court
The New Jersey Supreme Court affirmed on the estate’s appeal. The court began by pointing out that a common estate planning strategy is for each spouse to put their one-half interest in the marital home into a separate trust. Then, on each spouse’s death, that trust is assessed a compromise tax [Van Riper (Supreme Court), p. 2].
The court then contrasted that common technique with what the Van Ripers did. The Van Ripers transferred the ownership of their home to a single trust. The trust specifically provided that the house would be available to finance the care of either or both spouses (pp. 2–3).
After reviewing the facts and the lower courts’ decision, the New Jersey State Supreme Court examined the estate’s claim that only Mary Van Riper’s interest in the residence was subject to inheritance tax at her death. The estate argued that the Van Ripers’ tenancy by the entirety ownership was severed when the house was transferred to the trust. Therefore, the estate argued that upon the death of Walter Van Riper, his interest passed to their niece, with a life estate going to Mary Van Riper (pp. 13–14).
The court rejected this argument. First, there is no law in New Jersey that suggests conveyance of real property owned by tenants by the entirety to a joint trust destroys that tenancy by the entirety. Second, the court found that New Jersey law allows the creation of a tenancy by the entirety when a written instrument designates both of their names as husband and wife. Therefore, the court concluded that the Van Ripers held the real property as tenants by the entirety when it was held by their trust (p. 14).
Then the court asserted that no interest in the Van Ripers’ house passed to their niece until both spouses passed away. The court pointed out that the trustee could have sold the house and applied the proceeds to Mary Van Riper’s care, thereby depleting the trust without the knowledge or permission of the niece (pp. 14–15).
The court then asserted that it would be unfair to have taxed one-half of the property’s value at Walter Van Riper’s death, as the estate asserted should have happened, because it was not clear at that time that the niece would have inherited anything. The estate, and the Division of Taxation, would have had to make predictions about Mary Van Riper’s life expectancy, the cost of her medical care, real estate values, and other unknowable factors (pp. 15–16).
Finally, the court asserted that there are practical reasons for not assessing a tax at Walter Van Riper’s passing. The tax laws’ goals, such as simplicity, clarity, and ease of implementation, would be thwarted by requiring the speculation described above. The court asserted that the more common method of creating two trusts enables an easier computation of tax at each spouse’s passing. The court ended its analysis by disagreeing with the estate’s reliance on several different cases—one from New Jersey and two federal cases. The court concluded by affirming the decision of the appellate division (pp. 16–19).
There are two broad categories of difficulties with the New Jersey Supreme Court’s decision. The first is the idea that property held in a trust can be held as tenants by the entirety. The second is the court’s characterization of the compromise tax.
The property was held by the Van Ripers as tenants by the entirety (p. 4). Once the Van Ripers put the property into the trust, however, the trustee owned the property [N.J. Rev. Stat. 3b:31-19(d)]. Therefore, there can be no tenancy by the entireties in the property itself. There could, perhaps, be a tenancy by the entities in the life estate in the property, but the court specifically dealt with an interest in the entire property. The decision noted “the estate argues Mary did not simply continue to own the entire interest in the Trust upon Walter’s death” (pp. 13–14) and then rejecting that, quoting N.J.S.A. 46:3-17.2(a): “A tenancy by the entirety will be created when a husband and wife together take title to an interest in real property under a written instrument designating both of their names as husband and wife” (p. 14). This leaves open the possibilities of a life estate as being the interest referred to by the decision.
Through the decision, the court appears to be creating a new type of property interest—tenants by the entirety for property held in a trust established by a husband and wife. This seems to be unfounded, because of the change of owners when property is placed in a trust. Fortunately, because of the unusual circumstances of this case, this innovation may have little effect.
Through the decision, the court appears to be creating a new type of property interest—tenants by the entirety for property held in a trust.
The court attempted to differentiate between what the court described as the common estate planning method of creating two trusts and the method used by the Van Ripers of creating one trust (pp. 2, 16). In fact, the two situations are not that different.
Typically, when a husband and wife each create and trust and put each half of their marital home into a separate trust, the first income beneficiary of each trust is the surviving spouse if there is one. It is only upon the death of the second spouse that the property passes to a nonspouse beneficiary. This is, as the court points out, what happened in Van Riper (pp. 14–15).
As discussed above, if at least one of the remainder beneficiaries is a member of Class C or Class D, there will be a compromise tax. As the Division of Taxation states in its manual on the compromise tax, the compromise tax involves estimates of many factors, including longevity and the extent to which the corpus of the trust may be depleted during the term of the trust (“New Jersey Transfer Inheritance Tax Guide for Computation of Compromise Tax,” 2012 edition, https://bit.ly/3wZRwwW). Therefore, the court’s contention that the calculation of the compromise tax is not speculative [Van Riper (Supreme Court), p. 16] is simply not the case. This result appears to call into question the rationale for the compromise tax. Thus, in the author’s opinion, the court’s analysis and conclusions are incomplete. Fortunately, the unusual facts of this case will limit the impact.