The Impact of Settlements of Death Taxes

Mike and Hillary have been married for many years.  Although Hillary thought the marriage was wonderful, she found out that Mike’s feelings were not mutual when he died.  Two weeks after the funeral, she received a letter from an attorney representing the estate, Travis Tanner, enclosing a copy of the Will.  Mike’s will left nothing of his $7,500,000 estate for Hillary, but rather divided his estate between his nieces and nephews as well as his secretary, Floozy.

Emotionally and financially devastated, she went to a renowned litigator, Harvey Spector, to take care of her.  In the course of his representation, he went to the local probate court and successfully reached a settlement whereby Hillary would get $2,500,000 of the estate.  As part of the agreement, it was agreed that Harvey’s firm would prepare the amendments to the necessary death tax returns which had been previously been filed by taxes.

Harvey transferred the file to his partner, Louis Litt, to handle the tax issues.  Louis filed an amended federal estate tax return with the IRS.  Because the amount paid to Hillary was exempt due to the unlimited marital deduction, there was no tax due and refund of $1,035,000 was received.

Louis filed amended inheritance and estate tax returns with the State of New Jersey.  Because the State collects the higher of the two taxes, and because the tax rate for the nieces, nephews and Floozy ranged between 15-16%, no estate tax was due, as the rates for that tax were significantly lower.  At the initial filing, this tax was $1,155,000.  Because these individuals took a pro rata reduction to make the settlement work, and because a spouse is a Class A beneficiary, who owes no inheritance tax, Louis requested that the tax be reduced to $770,000 and that a refund of $385,000 be issued.

Louis’ request was denied and the amended return was rejected.  Louis filed an action in tax court.  Louis lost.

In essence, a federal estate tax return will acknowledge a settlement.  However, the Division of Taxation in New Jersey does not and they hold only to the terms of the original will.

This position was reaffirmed in De Rosa v. Director, Div. of Taxation, Tax Ct. (Bianco, J.T.C.).  It upholds the provisions of N.J.S.A. 54:34-1 which was initially upheld by the New Jersey Supreme Court in Pope v. Kingsley, 40 N.J. 168 (1963).

Moral of the story:  settlements can be good.  However, one needs to understand the tax impact or lack thereof on same.

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