New Pennsylvania Inheritance Tax Changes
“Death Taxes” are generally made up of two separate taxes for Pennsylvanians: federal and state taxes. Since the the federal estate tax exemption of $5 Million per person was made permanent early in 2013, most people are not affected by federal estate tax. However, Pennsylvania has an inheritance tax, which is structured a bit differently, and affects most Pennsylvanians in one way or another. Major changes have occurred in our inheritance tax over the past year, and it's important for Pennsylvanians to understand how the changes affect them.
There are three changes to Pennsylvania's inheritance tax that affect many Crawford County residents. First, there is the Family Business Exception that was signed into law last week. Second, there is the Family Farm Exception that was signed into law last July. Finally, there is the natural gas valuation standard that was established by the PA Department of Revenue last July.
How Does Pennsylvania's Inheritance Tax Work?
To start, Pennsylvania's inheritance tax is calculated by determining the person to whom property passes upon the death of the property owner: spouses and children under 21 are taxed at 0%, children and grandchildren at 4.5%, siblings at 12%, and all others (except charities) at 15%. Unlike the federal estate tax, there is no fixed exemption amount: the entirety of a person's assets (with a few exceptions) are taxed. Also, any transfers by the deceased within one year of death are taxed.
How the Family Business Exception Works:
Exempt Transferees: The Family Business Exception was modeled after the Family Farm Exception, in that exception applies to the following transferees of family-owned business interests: spouses, children, grandchildren, siblings, siblings' children and grandchildren, and parents. Thus, if a person's Last Will and Testament leaves his or her business interest to any of these related persons, it will be exempt from Pennsylvania inheritance tax, as long as it meets the following requirements:
Type of Business Interest: The business can be an entire proprietorship, or an interest of a business that has fewer than 50 employees, a net book value of less than $5 Million, has been in existence for more than 5 years prior to death, and is wholly owned by the deceased person or in conjunction with family members described above. In addition, the principal business of the business cannot be the management of assets owned by the business. (If it weren't for this last provision, estate planners would be currently advising many clients to fund their own asset-management companies to manage solely their own assets, to take advantage of the exception.)
Ownership After Death: The qualified transferee(s), which are one or more family members, must own the business for seven years after the date of death, and file a certification with the PA Department of Revenue for each of the seven years after the date of death. Also, the business must be reported on the deceased person's inheritance tax return (though no tax will be paid on it). If the business (or a portion of it) is sold in any of those proceeding seven years, then Pennsylvania inheritance tax and interest will be due on the taxable business interest.
How the Family Farm Exception Works:
Exempt Transferees: The category of persons eligible for the Family Farm Exception are broader than for the Family Business Exception. To qualify for the Family Farm Exception, the transferee may be any of the persons listed for the Family Business Exception, and also includes first- and second-cousins, so long as they are lineal descendents of a deceased person's grandparent. For both Family Business and Family Farm exceptions, persons of half- or whole-blood relation are included, and also adopted persons.
Type of Farm Interest: “Agricultural Interest”, for exception purposes, is defined broadly as the production of an agricultural commodity or the leasing to a corporation or person that produces an agricultural commodity; however it does not include recreational activities, breeding of game animals or domestic animals, fur farming, slaughterhouses, or manufacturing/processing operations of any kind. In addition, the interest can be in land that produces an agricultural commodity (plant or animal) or a conservation easement, but in those cases, the exception applies only to lineal descendants and siblings.
Ownership After death: The qualified transferee(s) must use the land for agricultural purposes that generate in excess of $2,000.00 (gross) for each of the seven years following the year of death. Also, each transferee must certify those facts to the PA Department of Revenue each year for the seven years after death. Failure to meet the law's criteria will result in payment of Pennsylvania inheritance taxes or a lien on the land in that amount in favor of the Commonwealth.
How Gas-Lease Valuation Works (for PA Inheritance Tax Purposes):
Under Inheritance Tax Bulletin 2012-01, which was issued in July 2012, natural gas interests are valued depending on the circumstances of the interest.
If the interest is sold by the Estate, or appraised, then its sale price or appraised value may be used for inheritance tax purposes. For leased and producing natural gas rights, the taxable value is the amount of income received from actual production in the 12 months preceding death and multiplied by two. For leased (but non-producing) natural gas rights, the taxable value is $0.00, unless there is a contractual agreement requiring fixed future payments, which would be totaled and reduced to present value. This would occur in the case of a person who signed a lease resulting in a “bonus” payment, but that payment had not been made at the time of the person's death. For non-leased non-producing natural gas rights, the taxable value is $0.00. Thus, owners of natural gas rights have some clarity as to how these assets will be valued, for inheritance tax purposes.
What These Exceptions Mean to You:
Knowing that these exceptions and standards exist is one thing, but understanding whether they apply to you is another matter entirely. It is a mistake to assume that you or your family will not face inheritance tax issues simply because you own and run a family farm or family business. Planning to take advantage of these exceptions requires an attorney knowledgeable in estate taxation, since these laws are more complex than they seem. The Family Farm Exception, especially, was loosely written and has both widespread applicability and numerous exceptions and requirements. The Family Business Exception was drafted more narrowly, but requires business owners to carefully review their formation documents and estate plan to ensure they will qualify for the exception. In short, if you think these exceptions apply to you, go see a lawyer.
Pennsylvania legislators are working hard to lessen the tax burdens on farmers and business owners, but drafting and passing the laws are only part of the equation: Pennsylvanians are responsible for ensuring their affairs are arranged in such a way as to take advantage of these generous opportunities.