Estate Planning Basics – Estate and Inheritance Taxes

Published On: July 18, 2024

Written by: Ben Atwater and Matt Malick

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

This essay will focus on the Pennsylvania Inheritance Tax because for most families the Federal Estate Tax is not an issue given its high exclusion amount, as it applies to only 1 in 1,000 estates, according to the Tax Foundation, a group that advocates against the estate tax. However, this essay is timely in that the estate tax environment, absent congressional action, could change dramatically come December 31, 2025.

In 2024, each U.S. citizen has an exemption of $13,610,000 against the Federal estate tax and the Federal gift tax. Planners refer to this as a “unified credit” because it is a single credit that taxpayers apply 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 and prior lifetime giving must exceed $27,220,000.

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 $7,000,000 per person at that time (or $14,000,000 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.  If your net worth approaches $14,000,000, now is the perfect time to begin evaluating some of these options given the coming estate tax sunset.

Clients often ask about annual gifting as many inherently know that limitations exist. Currently, an individual can give up to $18,000 per year per person to as many people as they would like under the annual gift tax exclusion before tapping into their $13,610,000 exemption.

Spouses can “split gifts” by making joint gifts, thereby giving spouses the ability to gift up to $36,000 per year per person. For any gifts to another person above $18,000, the donor must report the gift to the IRS on a gift tax return (Form 709).

Although you are filing the 709, you owe no taxes until you have cumulatively gifted above the lifetime gift tax exemption ($13,610,000 for an individual, $27,220,000 for a married couple). In other words, many could theoretically gift their entire estate during their lifetime and pay no federal gift taxes along the way. The idea of filing a tax return, but having no taxes due, is a difficult concept for people. Do not let the requirement to file a gift tax return keep you from prudent gifting, provided that the gifting is part of a comprehensive estate plan.

Now, let us turn to the Pennsylvania Inheritance Tax for residents of PA and those non-residents who hold Pennsylvania real estate. For our clients who reside in other states, please contact us with specific questions. According to the Tax Foundation, 38 states do not impose an inheritance or estate tax, including common retirement states like Delaware, Florida, Nevada, North Carolina, South Carolina, Texas, and Wyoming. Maryland is the only state with an estate tax and an inheritance tax, while New Jersey ties for the highest inheritance tax rate at 16% (with, of all places, Kentucky).

Pennsylvania imposes an inheritance tax on the transfer of wealth at death. The tax applies to all assets owned or controlled by a Pennsylvania resident decedent, and Pennsylvania levies this tax on the heirs of the decedent.

PA expresses the tax as a percentage of the value of a decedent’s estate as of the date of the decedent’s death. However, there are certain items that can reduce a decedent’s taxable estate and other items that are exempt from PA inheritance tax. With respect to reducing a decedent’s taxable estate, PA has a family exemption of $3,500 that applies under certain circumstances. Additionally, costs and fees associated with the administration of a decedent’s estate, funeral expenses, grave markers, and debts owed by a decedent as of the date of death all further reduce the taxable estate.

Pennsylvania exempts from inheritance tax jointly held taxable assets among spouses, life insurance proceeds, certain farmland and agricultural property, and certain family-owned businesses. For non-exempt assets (those which are subject to PA inheritance tax), which is typically 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, 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, planners often use life insurance as a mechanism to cover the Pennsylvania inheritance tax owed on other assets.

PA has no gift tax. However, PA inheritance tax law does have a one-year “lookback” for gifts – any property a decedent gives away within one year of death PA will include in the decedent’s taxable estate to the extent the value of the gift exceeds $3,000. The intent of this rule is to avoid deathbed giving. This rule should not be confused with Medicaid’s 5-year lookback for asset transfers and gifts for Medicaid eligibility purposes.

Inheritance tax payments and the inheritance tax return are due nine months after the decedent’s date of death. If there exists a will or other document that contains a “tax clause” stating that the estate shall pay “all taxes” (and if there are sufficient assets to do so), then the estate is responsible for paying the tax. Otherwise, the recipient of the assets will be responsible for paying the tax. If the taxpayer pays the inheritance tax within three months of the decedent’s death, PA provides for a 5 percent discount. PA typically takes 4 to 6 months to review inheritance tax returns before issuing their acceptance of the return 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 estate planning. If you wish to talk through any issues related to better planning for PA Inheritance or Federal Estate Taxes, please contact us. Where appropriate, we are also happy to refer you to a qualified estate planning attorney.