Estate Planning Basics – Estate and Inheritance Taxes

Published On: June 3, 2020

Written by: Ben Atwater and Matt Malick

This is the fifth and final installment of our Estate Planning Basics series.  We began discussing the core documents you need for an estate plan, examined the differences between probate and non-probate assets, addressed life insurance, explored trusts and now we finish with estate and inheritance taxes. 

This essay will focus mainly on the Pennsylvania Inheritance Tax because for most families the Federal Estate Tax is not an issue, as it applies to only 1 in 700 deaths given its high exclusion. In 2020, each U.S. citizen has an exemption of $11,580,000 against the Federal estate tax and the Federal gift tax. The credit is referred to as a “unified credit” because it is a single credit that can be applied towards gifts made during life or transfers of wealth at death. Therefore, for a married couple to have a federally taxable estate, their net worth must reach $23,160,000.  That said, this large exemption runs through 2025 when Congress will need to write new legislation, or the exemption will drop back to the pre-2018 level, as indexed for inflation. Current estimates are that the exemption may be approximately $6,000,000 per person at that time (or $12,000,000 for a married couple).  For most estates above the exemption, the Federal tax rate is effectively 40%. 

For Americans with this level of net worth, transferring appreciating assets out of their estates at reduced values, annual exclusion gifting, strategic titling of assets among spouses, use of by-pass trusts or estate tax portability, charitable planning, life insurance trusts, and many other tools are available to reduce and mitigate exposure to the Federal estate tax and to take advantage of today’s high exclusions.

Clients often ask about annual gifting as it seems many inherently know that limitations exist.  Currently, an individual can gift up to $15,000 per year per person to as many people as they would like under the annual gift tax exclusion before tapping into their $11,580,000 exemption. Spouses can “split gifts” by making joint gifts, thereby giving spouses the ability to gift up to $30,000 per year per person.  For any gifts to another person above $15,000, the donor must report the gift to the IRS on a gift tax return (Form 709).  Although you are filing the 709, no taxes are owed until the donor has cumulatively gifted above the lifetime gift tax exemption ($11,580,000 for an individual, $23,160,000 for a married couple).  In other words, almost everyone could theoretically gift their entire estate during their lifetime and pay no federal gift taxes along the way. 

Now, let us turn to the Pennsylvania Inheritance Tax for residents of PA.  For our clients who reside in other states, please do not hesitate to contact us with specific questions.  Thirty-two states do not have estate nor inheritance taxes, including common retirement states like Delaware, Florida, Nevada, North Carolina, South Carolina, Texas, and Wyoming. 

Pennsylvania imposes an inheritance tax on the transfer of wealth at death. The tax is applied to all assets owned or controlled by a Pennsylvania resident decedent. The tax is expressed as a percentage of the value of a decedent’s estate.  PA has a family exemption of $3,500 under certain circumstances.  Also, there is a PA inheritance tax exemption on jointly held taxable assets among spouses, on certain farmland and agricultural property, and on certain family-owned businesses.  For non-exempt assets, which is generally the bulk of a decedent’s estate, the tax rate varies depending on the relationship of the beneficiary to the decedent: 

• 0 percent on transfers to a surviving spouse or to a parent from a child aged 21 or younger.
• 4.5 percent on transfers to direct descendants and lineal heirs.  (Grandfather, grandmother, father, mother, and their children are lineal heirs.  Children include natural children, whether they have been adopted by others; adopted children; and stepchildren).
• 12 percent on transfers to siblings. 
• 15 percent on transfers to other heirs, except charitable organizations, exempt institutions and government entities exempt from tax (note: the 15% rate applies to nieces, nephews, aunts, uncles, and unmarried significant others).

PA taxes all real property located in Pennsylvania and all tangible personal property including but not limited to cash, houses, automobiles, furniture, antiques, jewelry, etc.  PA further taxes all intangible property of a resident decedent, including stocks, bonds, bank accounts, closely held business interests, loans receivable, Individual Retirement Accounts (if you are over 59.5 years old), etc.

In the case of a nonresident, PA taxes all real property and tangible personal property located in Pennsylvania at the time of the decedent’s death, while PA does not tax intangible personal property of a nonresident.  For example, if you are a Florida resident with a summer house in PA, you owe PA inheritance tax on the house, but if you have a brokerage account, then PA does not tax it. 

Further, PA assesses tax on jointly-owned property with rights of survivorship – except between husband and wife – to the extent of the decedent’s fractional interest in the joint property (calculated by dividing the value of the joint property by the number of joint owners at the time of the decedent’s death).

Interestingly, PA has no inheritance tax and no income tax on life insurance proceeds. Therefore, life insurance is often used as a mechanism to cover the Pennsylvania inheritance tax owed on other assets.

PA has no gift tax.  However, PA does have a one-year “lookback” for gifts – any property the decedent gives within one year of death is included in their PA estate to the extent the value of the gift exceeds $3,000. The intent of this rule is to avoid deathbed giving.  For Medicaid purposes, PA has a 5-year lookback for asset transfers and gifts. 

Inheritance tax payments and the inheritance tax return are due nine months after the individual’s death. If there exists a will or other document that contains a “tax clause” stating that “all taxes” are to be paid by the estate (and if there are sufficient assets to do so), then the estate is responsible for paying the tax.  Otherwise, the recipient of the non-probate assets will be responsible for paying the tax.  If inheritance tax is paid within three months of the decedent’s death, a 5 percent discount is allowed.  PA typically takes 4 to 6 months to review inheritance tax returns before issuing their acceptance or demanding changes. 

The PA inheritance tax rules can be tricky and certainly have some complexity to them.  We highly recommend using the services of an attorney who specializes in estates at the death of a loved one.  If you would like to talk through any issues related to better planning for PA Inheritance or Federal Estate Taxes, please do not hesitate to call on us.  We are also always more than happy to refer you to a qualified estate planning attorney. 

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