I ended last week’s blog post with a hypothetical estate left by John Doe. John died with an estate totaling $2,500,000. Because he had no spouse or children, he left his estate to nieces, nephews and friend, all Class D heirs. What they receive is subject to New Jersey inheritance tax at a rate of 15% to 16% after allowable deductions.
The problem is that some of the estate assets are payable directly to heirs by way of direct beneficiaries, such as retirement accounts and the non-retirement brokerage account. These assets go directly to those heirs and do not pass thru the probate estate. Other assets are passed by way of specific bequest, such as the home that John left to his friend.
Of the total $2.5 million, only $300,000 passes under the residuary clause of the will. But, inheritance tax is paid on the entire estate that passes by way of the will and outside of the will. More specifically, the will directs the executor to pay the taxes out of the residuary but the tax is in excess of $375,000. What is the executor supposed to do?
The first place to take funds to pay the tax should come from the residuary estate. As stated above, however, that still leaves the estate short about $75,000. The will says the home shall be specifically devised to John’s friend. This means that the executor is directed not to sell it but instead to deed it to the friend. However, the heir must provide the executor with funds to cover the tax before the executor can be compelled to transfer title to the property.
By law, the State has a lien on all New Jersey property and accounts in financial institutions which helps insure the tax will be paid. This lien automatically freezes 1/2 of the value of the assets. The lien is only released when the State issues a document called a tax waiver after the tax is paid. This acts as an incentive for each heir to contribute a share of the tax, which will then give the executor the funds to pay the tax and obtain the tax waivers. The waivers are then given to the heirs to turn over to the financial institutions so the rest of the assets can be released to them.
In John Doe’s case, the executor must coordinate the collection of funds from several different people, not an easy task. What could John have done to make the executor’s job easier and make the estate administration process smoother? His will should have been more carefully drafted, paying attention to insure the executor has enough liquid assets in the estate to cover taxes and other debts without the need to “negotiate” with heirs. That includes avoiding payable on death designations for non-retirement accounts such as the $800,000 brokerage account. Had John eliminated that POD designation, the executor would have had more than enough money to cover the taxes and other debts of the estate.