Understanding and Managing Pennsylvania Inheritance Tax
Disclaimer: This content does not constitute legal advice. You should not act, or refrain from acting, based on the information provided without getting specific advice from your lawyer.
When a person dies as a resident of Pennsylvania, Pennsylvania Inheritance tax is owed on most categories of the assets they owned at their death (exceptions to this are below). This is true even if the assets are held in revocable or “lifetime” trusts or have beneficiary designations; even joint accounts are taxed in part. Unlike the federal estate tax and many other states’ death taxes, there is no exemption for the tax – the estate assets are taxed in their entirety from dollar one, although there are deductions available.
When Is Pennsylvania Inheritance Tax Due?
Pennsylvania Inheritance tax is due nine months after the decedent’s (the individual who died) date of death and begins accruing interest after that due date. Along with the payment of the tax, an Inheritance Tax Return (REV-1500) is filed describing the decedent’s assets, deductions taken, and applicable tax rates. A voluntary “prepayment” can be made on this tax (no separate form is required for this) within three months of death, leading to a 5% credit on the amount prepaid.
How is Pennsylvania Inheritance Tax Calculated?
The rate at which the Pennsylvania Inheritance Tax is assessed is based upon the beneficiary’s relationship to the decedent. If the beneficiary of a given asset is:
A spouse, a child of the decedent under the age of 21, or a charity, then the tax rate is 0%.
A child above the age of 21, a grandchild (great-grandchild, etc.), or parent of the decedent, then the tax rate is 4.5%.
A sibling of the decedent, then the tax rate is 12%.
Anyone else (a cousin, friend, non-married partner, etc.), then the tax rate is 15%.
Are there any exceptions to Pennsylvania Inheritance Tax?
There are a few categories of assets that are exceptions from the otherwise encompassing inheritance tax, including:
Life Insurance;
Real Estate and Tangible Personal Property located outside of Pennsylvania;
PSERS (Public School Employees’ Retirement System) accounts with named beneficiaries;
Assets gifted more than a year before death (but note that assets gifted within a year of death, beyond $3,000 for any one person, are includable in the estate for inheritance tax purposes);
50% of most joint assets, if the asset was made joint more than a year before death;
Retirement assets, if the decedent died before they were aged 59 ½;
Certain family-owned businesses, if they meet the requirements of a Qualified Family-Owned Business.
Recommendations
With this information in mind, here are several strategies we recommend that you consider utilizing to manage the Pennsylvania Inheritance tax that will be owed for your estate:
Utilize Untaxable Assets for High-Rate Beneficiaries. As explained above, beneficiaries are taxed at different tax rates. If you have select beneficiaries at higher tax rates (e.g. a friend or cousin to receive a gift) and have (for example) life insurance, which escapes Pennsylvania Inheritance tax, consider using the life insurance to fund the bequest. You would do this by updating the beneficiary designations on your life insurance account to name the high tax rate beneficiaries. Note that the gift will lapse if the policy does, so this would have to be kept in mind for the future, especially for term life insurance policies with known ending dates. But while the policies are in effect, this can lead to significant tax savings.
Gift During Your Life. Gifting during your life to the people important to you can be a good way to avoid some inheritance tax at your death – and to be able to see your money help the people you love. However, this strategy is only possible if you know you won’t need the funds in the future. Note that this will result in the loss of the step up in basis for those assets (if they would otherwise have been received by the beneficiary at your death), so it’s not always the best strategy for appreciated/appreciating property, like stocks or real estate. There can be other potential tax and loss-of-benefit implications for gifting that you should discuss with an advisor (see our separate blog post on gifting here). However, if there are assets you know you won’t need, and you don’t need the step up in basis, consider gifting them – and then survive the year!
Be Thoughtful About Out-of-State Property. Out-of-state real estate and tangible personal property are not includable assets for Pennsylvania Inheritance Tax, although they are then taxable in that state’s death tax structure. That is usually a positive outcome, as only 17 states have inheritance or estate tax, and in many states assets below an exemption amount do not lead to tax. However, if you own out-of-state property as a business (e.g. you hold real estate in an LLC), such ownership turns the property from “real estate” (not taxable in PA) to “a business” (taxable in PA). Therefore, think carefully before putting out-of-state real estate in an LLC or similar business structure.
Give to Charities. Charities are taxed at 0%, and if you are charitably inclined, giving to charity at your death is a great way to reduce Pennsylvania Inheritance tax. You can maximize tax savings even more by funding the charitable gifts through your retirement account (see our separate blog post on this topic here).
Carefully Manage Family Business Ownership. If you have a family business, you should be aware of the strict rules that would allow the business to qualify as an exempt family-owned business in Pennsylvania – and be careful to take steps to maintain that qualification before and after your death.
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