CLIENT ALERT: July 30 2004

Mitigating The Effects Of The NJ "Fair" Plan Income Tax Rate Increase

Recently enacted NJ tax legislation creates a new 8.97% marginal individual income tax rate on taxable income in excess of $500,000. The new rate is retroactive to 1/1/04 and the only change to the rate structure is the imposition of the new top tax rate. The existing tax rates and brackets continue to apply to taxable income up to $500,000.

While tax rate increases are never happy news, the law does present some opportunities to mitigate the impact of the rate increase.

It is interesting to note that the new tax rate applies to taxable income in excess of $500,000, regardless of filing status. Thus, a married couple filing a joint return will be subject to the new rate on the portion of their combined taxable income that exceeds $500,000. However, if that same couple files separate NJ returns and neither spouse reports more than $500,000 of income on his or her separate return, no portion of this couple's income will be subjected to the new rate and the combined tax liability will generally be the same as under prior law. The existing lower brackets do not penalize taxpayers for separate returns to any material extent.

The accompanying examples presented at the end of this memorandum illustrate the effects of the new rates on joint and separate NJ returns.

In choosing a filing status, one must be mindful of the general requirement that married couples use the same filing status for NJ filing purposes as they choose for federal tax purposes. Thus, it will only make sense to file separate returns if the NJ tax savings outweighs any increase in the federal tax.

There are many factors that contribute to the determination of the optimal filing status for federal tax purposes. Thus, to know for sure, we need to prepare both joint and separate returns (or projections) and compare the results. However, as a guideline, if the taxable incomes of each spouse are relatively equal or if both spouses have separate ordinary taxable income greater than $160,000, separate returns generally are not likely to result in a materially higher federal tax as compared to a joint return and, in some cases the aggregate tax will be lower on separate returns. Alternative Minimum Tax sometimes interferes with the rules of thumb, so they should be used only as an indicator of a possible separate filing opportunity.

Taxpayers with significant investment assets owned primarily by one spouse (especially if the other spouse has little or no other income) may want to consider reallocating such assets to joint accounts or splitting the assets into separate accounts for each spouse. Separate returns frequently result in a higher federal tax liability if one of the spouses does not have sufficient income to use up the lower tax rate brackets. Please consult us or your estate and trust attorney before implementing any changes in ownership of assets as such changes may have an impact on your estate plan.

Even in cases where the overall tax liability is the same or slightly higher on separate returns, taxpayers may choose to file separately. Tax liabilities attributable to a joint tax return are a joint and several liability, which means that either spouse can be held responsible for any and all taxes arising from such joint return. There are some relief provisions, but they don't always apply. Filing separate returns ensures that one spouse will not have to pay a tax liability attributable to the other.

In the course of preparing your 2004 tax returns, we will identify separate return filing opportunities and prepare separate returns where they prove to be advantageous.

Please contact a member of our tax department if you have questions regarding the New Jersey tax increase or any other matters relating to your personal income taxes.

NJ "FAIR" Tax Plan
Joint vs. Separate Filing Status
Illustrative Examples

As the following examples illustrate, joint taxable income in excess of $500,000 is subjected to an incremental 2.6% tax. However, the increase can be avoided or mitigated by filing separate returns.

The above examples are presented for illustrative purposes only. Actual results will vary depending on the particular facts and circumstances