By Michael Salad, Esq. and Brad Lomax
Charitable remainder trusts can be useful estate planning tools for individuals and families who want to support charitable causes while also providing income to noncharitable beneficiaries. However, a recent New Jersey Tax Court decision serves as an important reminder that a trust’s federal tax treatment does not necessarily determine its New Jersey tax treatment.
The Klein Decision
In The Jacob & Alice Klein Charitable Remainder Unitrust, Ilana Kahn, Trustee v. Director, Division of Taxation, the New Jersey Tax Court considered whether a charitable remainder unitrust (commonly known as a CRUT) qualified as a “charitable trust” exempt from New Jersey Gross Income Tax.
The trust was designed to make payments to a noncharitable beneficiary for twenty years, with the remaining assets then passing to a charitable foundation. Although CRUTs generally receive favorable income tax treatment under federal tax law, the New Jersey Tax Court held that this trust was not exempt from New Jersey Gross Income Tax.
Why the Trust Did Not Qualify for the Exemption
The court explained that under New Jersey law, a trust must be operated exclusively for charitable purposes to qualify for the charitable trust exemption.
In Klein, the court found that the trust benefited both:
- a noncharitable beneficiary, and
- an eventual charitable beneficiary.
Because the trust served both charitable and noncharitable interests, it did not meet New Jersey’s standard for exemption.
The court also emphasized that New Jersey has not incorporated Internal Revenue Code § 664 into the Gross Income Tax Act. As a result, the federal income tax treatment of CRUTs does not automatically apply for New Jersey Gross Income Tax purposes.
Key Planning Considerations for Donors, Trustees, and Advisors
The decision highlights several important considerations when establishing or administering a charitable remainder trust:
- A CRUT may be treated favorably for federal tax purposes but still be subject to New Jersey Gross Income Tax.
- The presence of a noncharitable beneficiary may prevent a trust from qualifying as a charitable trust under New Jersey law.
- State tax exposure should be reviewed before creating, funding or administering a charitable remainder trust.
- Planning strategies should account for federal and New Jersey tax implications.
The Bottom Line
Charitable remainder trusts remain valuable planning tools in certain circumstances. However, the Klein decision underscores the importance of carefully reviewing New Jersey income tax consequences in addition to federal tax rules.
Individuals and families considering charitable planning strategies should work with experienced legal and tax advisors to help ensure the plan achieves its intended goals while addressing potential New Jersey tax liability.
Michael Salad is an attorney in Cooper Levenson’s Business & Tax practice group. He concentrates his practice on estate and asset protection planning, probate and trust administration, special needs planning, business transactions, mergers and acquisitions and tax matters. Michael holds an LL.M. in Estate Planning and Elder Law. Michael is licensed to practice law in Florida, New Jersey, New York, Pennsylvania, Maryland, Connecticut, Georgia, Massachusetts, Alabama, Arizona, Virginia and the District of Columbia. Michael may be reached at (954) 889-1850 or via e-mail at msalad@cooperlevenson.com.
Brad Lomax is a Summer Associate at Cooper Levenson. He is a J.D. Candidate at Rutgers Law School, where he serves as a Senior Editor on the Rutgers University Law Review. Brad may be reached at blomax@cooperlevenson.com.
The content of this post should not be construed as legal advice. You should consult a lawyer concerning your particular situation and any specific legal question you may have.