The New Jersey Appellate Division recently issued its opinion in Estate of Van Riper v. Dir., Div. of Taxation, No. A-3024-16T4 (N.J. Super. Ct. App. Div. Oct. 3, 2018), upholding the Tax Court’s finding that the full fair market value of a marital home transferred to a trust was subject to New Jersey Inheritance Tax.  The case highlights the importance of understanding the effect of transferring property into trusts for estate planning and tax purposes.

A husband and wife transferred their home into an irrevocable trust and retained the right to live in the home until the death of the survivor.  Any assets remaining after their deaths were to be distributed to their niece.  It appears that this trust was created in connection with Medicaid planning.  The NJ Tax Court held that, due to the fact that the couple retained a life interest in the property and delayed their niece’s enjoyment of it until both their deaths, the value of the home in the trust was subject to Inheritance Tax.  Estate of Van Riper v. Dir., Div. of Taxation, 30 N.J. Tax 1 (2017).  

On appeal, the Estate argued that each spouse held only one-half ownership interest in the property at the time they transferred it to the trust, so the Inheritance Tax should only apply to one-half of the value of the home.  The appellate court upheld the assessment of the full value of the home because the couple owned the property as “tenants by the entirety,” meaning they each “held an interest in the entire estate, not fifty-percent interests.”  Van Riper, slip op. at 8-9.  This reasoning was further supported by the fact that at the first spouse’s death no Inheritance Tax was paid on the property as it qualified as an exempt transfer from husband to wife under New Jersey law.  See N.J.S.A. 54:34-2(a)(1).

This cautionary tale warns New Jersey taxpayers of the complications that may arise from retaining interest in property during one’s lifetime, even if such property has been placed in an irrevocable trust.  It is strongly advised that taxpayers seek the assistance of an estate planning attorney to better understand the tax and other consequences of certain planning techniques.

An inheritance left to a person with special needs must be distributed to a special needs trust to avoid jeopardizing such person’s government benefits.  A special needs trust can be created during lifetime or through a person’s Will upon death.  If a special needs trust is not properly established, this creates a myriad of problems which could have easily been avoided.

If a third party who wishes to benefit a person with special needs does not establish a special needs trust and he or she leaves assets to an individual with special needs either through his or her Will (without the proper special needs language) or as a result of the intestacy laws, then the only alternative may be for the estate to commence an action with the court to try and fix the non-qualifying trust or to create a special needs trust where one did not exist.  If an estate cannot successfully convince the court to create or reform a trust into a proper special needs trust, the beneficiary of the inheritance will have to create a first party special needs trust or contribute his or her inheritance to a pooled trust in order to continue to qualify for government benefits.  Neither of these options is ideal for several reasons.  Most significantly, they both require reimbursement to the state at the beneficiary’s death.

However, creating a special needs trust through the court is costly and there is no guarantee that the court will agree to create such a trust.  In many instances when an estate plan needs to be corrected or modified in some way, an estate will argue that the court should reform the Will or Trust to reflect the decedent’s probable intent.   For example, In the Matter of the Trusts to be Established in the Matter of the Estate of Margaret A. Flood, Deceased, the estate attempted to apply the doctrine of probable intent to create testamentary special needs trusts for Ms. Flood’s two disabled children, who received government benefits.  Ms. Flood was concerned about leaving an inheritance directly to her disabled daughters and consulted with an attorney prior to her death about the possibility of creating a special needs trusts for them. However, before her estate plan was implemented, Ms. Flood died intestate, without ever establishing a Will or special needs trusts.

The trial court initially determined that Ms. Flood’s intent was to create special needs trusts for her children and agreed to create such trusts for them notwithstanding the fact that Ms. Flood never signed her Will and died without a Will.  After years of litigation, the appellate court held that the trial court had no authority to establish and fund special needs trusts for the daughters.  The court reasoned that “the doctrine of probable intent is a rule of construction or interpretation and, therefore, [w]here there is no will there can be no will construction.”  This case precludes the application of the doctrine of probable intent to create a testamentary disposition where none existed.

This case highlights the importance of establishing an estate plan today that provides for a person with special needs without jeopardizing his or her government benefits.  Having a flawed estate plan or no estate plan at all will ultimately result in an estate incurring unnecessary legal fees to try an accomplish something though the court system that the decedent could easily have accomplished before death.