What is Inheritance Tax and When Does it Apply?

A key component of the Pennsylvania estate administration is the filing and payment of the Pennsylvania inheritance tax return. While estate tax is a tax assessed on and paid out of a decedent’s estate, an inheritance tax is a tax on a beneficiary’s right to receive property from a decedent and therefore imposed on transfers to certain beneficiaries. To avoid additional costs resulting from incorrect calculations of the tax, experienced counsel is needed in order to determine which assets are subject to taxation, the valuation of such assets, and to prepare and timely file the required return.

When Does Inheritance Tax Apply?

Pennsylvania inheritance tax applies to both residents and non-residents who died owning real and personal property located within the state. Intangible property of a non-resident is generally excluded from taxation, however, exceptions may apply to specific assets, i.e. a liquor license issued by the Commonwealth of Pennsylvania. Property owned jointly with someone other than the decedent’s spouse is subject to taxation as to the decedent’s ownership share[1]. Further, property that was solely owned by a decedent within one year of their death and became jointly owned or gifted to a beneficiary, will be subject to inheritance tax as well.[2]

Tax Rates

The rates of inheritance tax are statutorily set in accordance with the beneficiary’s relationship to the decedent and are currently as follows:

0% for transfers to:

• the decedent’s surviving spouse,
• the decedent’s surviving parent or stepparent if the decedent is age 21 or younger; and
• for decedents dying after December 31, 2019, the decedent’s surviving children and stepchildren age 21 or younger.

4.5 % for transfers to:

• the decedent’s children over age 21;
• the decedent’s children’s descendants;
• the decedent’s child’s spouse or a widow; and
• the decedent’s parents and grandparents, if the decedent is over age 21.

12% for transfers to the decedent’s siblings; and

15% for transfers to all other beneficiaries.[3]

Assets Excluded From Tax

Certain types of assets are excluded from inheritance tax such as qualified family-owned business interests.[4] In order for a “family business” to qualify for the exclusion, it must have fewer than fifty full-time employees, have a net book value of less than $5 million, be in existence for five years prior to the decedent’s death, wholly owned by the decedent or the decedent and members of his family, and must be engaged in a business or trade the purpose of which is not the management of investments. Additionally, the business must continue to be wholly owned by the decedent’s family members for a period of seven years after the date of death or the inheritance tax will become due upon transfer of the interest. Transfer of certain farmland, forest reserves or other agricultural use property to certain family members is also exempt from inheritance tax.

Further exempt assets include, but are not limited to, life insurance proceeds, charitable gifts, payments to federal or state governments, and death payments received from Social Security Administration or Veterans Administration. Individual retirement accounts, 401K’s, and other retirement assets are generally subject to taxation. Narrow exceptions allow for the exclusion of retirement assets depending on the type of account the decedent possessed and their age. Further consultation with counsel may be needed to determine whether retirement assets are subject to inheritance tax.

How to Value Assets

Once the taxable assets are properly identified they must be correctly valued as of the decedent’s date of death. Personal Representatives of an estate have a fiduciary duty to report the accurate values of a decedent’s assets, even if no inheritance tax is due. If no Personal Representative is appointed, the beneficiary of property received from a decedent is required to file a return. Appraisals may be needed and a review of the books may be necessary to determine the value of business interests. Proof of all valuations must accompany the inheritance tax return as well.

For real estate assets, several valuation methods are accepted when determining the date of death value. The gross sale price of the property may be used when the property is sold within 15 months of the decedent’s date of death. If no sale of the property is concluded within 15 months of the death, a retroactive appraisal may be sought. Alternatively, a method known as the “common level ratio”, set by the Pennsylvania Department of Revenue, may be used by multiplying the assessed value of the property by the common level ratio of the appropriate county.

Conclusion

Failure to file and pay the inheritance tax within 9 months of the decedent’s death, may result in interest and penalties.  Experienced legal counsel can provide assistance in the valuation of assets, preparation of the return, and saving unnecessary costs associated with incorrectly filed inheritance tax returns. Further, skilled attorneys may advise of strategies to help reduce a client’s potential inheritance tax liability by advising as to the titling of retirement accounts, how to designate beneficiaries with higher tax rates to receive tax-exempt assets and how to provide for charitable gifts[5].

[1] 72 P.S. §9107.

[2] 72 P.S. §9107 (c)(3).

[3] 72 P.S. §9116.

[4] 72 P.S. §9111 (t).

[5] Pennsylvania Inheritance Tax, Practical Law Practice Note w-000-3717

Kathy Bacenet serves on the firm’s Estates team, helping individuals and business owners navigate simple and complex estate planning and administration matters.