People say that love conquers all, but a decision by the New Jersey Tax Court indicates that doesn’t always hold true.
In a ruling that’s sure to upset some cohabitating couples, the court earlier this year ruled that, for state tax purposes, the estate of a wealthy Alpine woman could not take a marital deduction for a multimillion-dollar payout to her longtime live-in companion—even though the deduction was permitted for federal purposes. The case presents a clear example of how state tax law does not always follow federal tax law, even though NJ tax positions are, for the most part, based on Federal ones.
Here’s the detail on the background
The decedent Lillian Garis Booth died testate on November 22, 2007 at age 92, leaving an estate worth some $200 million. Although fellow New Jersey resident Misha (Michael) Dabich and Booth cohabited together for approximately 51 years, he was not named as a beneficiary in her will. About two years later, however, the Estate reached a $9.9 million settlement with Dabich.
Trouble began brewing, however, when the Estate filed an amended NJ IT–Estate and a second amended IT–R in March 2010, seeking, among other changes, a net refund of previously paid taxes totaling $1.5 million. The amended items reflected, among other things, a deduction for the $9.9 million paid to Dabich, under the theory that their lengthy cohabitation period constituted a “common-law” marriage.
In April 2011, the NJ Dept. of Taxation issued a Notice of Assessment based on the amended IT–Estate. Among other adjustments, the Notice denied the $9.9 million marital deduction. The Court’s reasoning, according to the Notice, was that “[t]he common-law marriage claim of Dabich is not recognized by” New Jersey, thus, the estate’s claim for marital deduction was being “disallowed for NJ estate tax and inheritance tax” purposes.
The Court added that it was “not bound by the IRS determination to recognize Misha Dabich as a common-law spouse” pursuant to a September 2008 settlement with Dabich and a subsequent 2009 amendment.
In July 2011, the Estate filed a timely administrative protest, maintaining that NJ Dept. of Taxation could not use the Inheritance Tax laws to disallow estate expenses, since the NJ estate tax is the federal “State death tax credit amount;” therefore, expenses allowed by the IRS must be allowed by NJ.
But after another denial, the Estate filed a lawsuit challenging, among other issues, the disallowance of the marital deduction.
In its response, the Tax Court noted that “The burden is upon the executor of an estate to prove facts establishing that “[t]he decedent was survived by a spouse” and “[t]he property interest passed from the decedent to the spouse.” For federal purposes, it reported, the IRS recognized “common-law” marriages “for over 50 years, despite the refusal of some states to give full faith and credit to common-law marriages established in other states” since “uniform nationwide rules are essential for efficient and fair tax administration.”
But, pursuant to state amendments made in 2002, the New Jersey estate tax was decoupled from the federal estate tax, and “was imposed independently of the federal estate tax and of the federal credit for state death taxes.”
Additionally, according to the Tax Court, the NJ Legislature specifically rejected the concept of common-law marriage, and “Although it is the federal estate tax law which provides for a marital deduction, it is State law that determines whether an individual is a spouse for purposes of application and allowance of that marital deduction.”
The decision could reportedly cost the estate some $1.5 million in net NJ Estate & Inheritance Taxes.
Should you be concerned?
The ruling appears to break new ground. Although it only addresses an allowable estate deduction, it also illustrates the way that common misperceptions can result in a costly tax bill. That’s one more reason to speak with your tax, accounting or legal advisor before committing yourself to any kind of significant activity.