The Pennsylvania Inheritance Tax is the official name for the tax many people know as the ‘death tax’. If you die as a Pennsylvania resident, the state will apply a tax to most of the property you pass to your beneficiaries. There are exceptions to the Pennsylvania inheritance tax, but your beneficiaries can expect to pay the Pennsylvania Department of Revenue a percentage of the assets they’ve inherited.
Reasonable people may question why the state taxes the decedent’s property. After all, wasn’t the property already taxed during the decedent’s lifetime? While this is a valid question, the answer is beyond the scope of our article. What we can say with certainty, however, is that the Pennsylvania Department of Revenue considers the act of receiving property from a decedent to be a privilege.
The purpose of this article is to explain the basics of Pennsylvania’s inheritance tax. We will discuss who is and isn’t taxed, how much a beneficiary has to pay, and what property is and isn’t taxed.
Who must pay the Pennsylvania Inheritance Tax?
We need to make a technical distinction. If your mother or father died with a will or a trust, they likely appointed an executor or a trustee to administer their estate. Pennsylvania now refers to the executor or trustee as the personal representative.
The personal representative is responsible for filing the tax return. If the decedent died intestate or with no will substitute, then the Register of Wills appoints an administrator who is responsible for filing the tax. Finally, if no personal representative and no administrator exist, than the person inheriting the property must file the tax.
The personal representative may not be a beneficiary. But this person, technically, still pays the tax since they are responsible for filing the return with the state. In practice, the personal representative may pay the tax from the decedent’s estate. This means the tax is being paid from bank accounts, brokerage accounts, bonds, and other assets. These assets were earmarked by the decedent for his or her beneficiaries.
While the personal representative is responsible for filing the return and including a check for the inheritance tax, the beneficiaries of the decedent are ultimately paying the Pennsylvania inheritance tax.
If your mother or father died and left you everything they worked for, you will pay the inheritance tax regardless of whether you are the executor or trustee. Remember, the state of Pennsylvania considers your right to inherit from mom and dad a privilege.
Who doesn’t have to pay the inheritance tax?
The surviving spouse doesn’t have to pay the inheritance tax on property owned by husband and wife with right of survivorship. This means any property passing to the decedent’s spouse is exempt from inheritance tax. The surviving spouse is taxed at a rate of 0 percent.
If a person 21 years or younger dies, a transfer from their estate to parents, step-parents, or adopted parents is taxed at a 0 percent rate.
Charities and other organizations that are normally exempt from income tax also do not have to pay Pennsylvania inheritance tax.
The above three classes of beneficiaries are not subject to Pennsylvania’s inheritance tax. However, other classes of beneficiaries inheriting certain types of property may also be exempt from inheritance tax. But that exemption is based on the property and not the class of beneficiary. We will now discuss these other exemptions.
What property is subject to Pennsylvania inheritance tax?
To answer this question it is easier to state what property is not subject to the inheritance tax.
Life insurance on the life of the decedent is exempt from the inheritance tax. This is true whether a spouse, child, nephew, cousin, or friend is the beneficiary of the life insurance policy. Proceeds from the life insurance policy are also not subject to state income tax. These two features make life insurance policies an attractive way to reduce taxes.
Charities that are named as beneficiaries do not have to pay the inheritance tax.
Surviving spouses are exempt from paying inheritance tax.
If the decedent owned as IRA and died before age 59.5, the beneficiary of the IRA does not have to pay inheritance tax. This rule also applies to a 401k plan unless the decedent could have closed the plan while living.
If mom or dad owned real or tangible property (e.g. a vacation or rental property) in another state, that property does not fall under the jurisdiction of Pennsylvania’s inheritance tax. You will not have to pay Pennsylvania tax on a house located in another state.
Finally, property under a general or specific power of appointment is not subject to inheritance tax. A discussion of power of appointment is beyond the scope of this article but will be analyzed in the future.
Those are the exceptions to the Pennsylvania inheritance tax.
All other testamentary transfers by a Pennsylvania resident through a will or the intestacy laws are subject to inheritance tax. These are called probate assets. Beneficiaries of non-probate assets must also pay inheritance tax.
Non-probate assets include jointly owned bank accounts, payable and transferable on death accounts, and retirement accounts with a named beneficiary. Beneficiaries of assets held by a Revocable Living Trust must still pay inheritance tax on that property. Additionally, most other trusts do not avoid the inheritance tax.
What is the rate of tax?
The rate of tax on Pennsylvania’s inheritance tax is broken down into four classes.
1) Zero percent: surviving spouses, parents of a child 21 or younger, and charities pay tax at a zero percent rate. In other words, these beneficiaries are exempt and do not have to pay inheritance tax. If a child inherits a bank account valued at $100,000, they will owe $4,500 assuming no deductions are claimed.
2) 4.5 percent: direct descendants and lineal heirs of the decedent pay tax at a rate of four and a half percent. Direct descendants include children (step and adopted), grandchildren, and all children of parents and their descendents. Lineal heirs include fathers, mothers, and grandparents.
3) 12 percent: siblings of the decedent must pay the Department of Revenue 12 percent.
4) 15 percent: anyone else that inherits from a decedent is taxed at a rate of 15 percent. This includes cousins, nephews, aunts, and friends.
While those are the rate of tax for the Pennsylvania inheritance tax, the dollar value of the tax actually paid will depend on three factors: 1) the dollar value of the estate on the date of death, 2) the dollar amount inherited, and 3) the dollar value of the deductions claimed.
What deductions can I claim on the tax return?
The following unsatisfied liabilities and expenses can be deducted from the value of the taxable estate:
— A five percent deduction for pre-paying the inheritance tax within three calendar months.
— The funeral expenses of the decedent are deductible against the gross estate.
— Unpaid bills that won’t be reimbursed (including medical bills) and debts of the decedent are deductible against the taxable estate.
— Other administration costs of settling the estate including attorney fees and reasonable fiduciary fees are a deduction.
— A family exemption of up to $3,500 is given to the spouse of the decedent who dies a Pennsylvania resident or, if no spouse, any child that lived with the decedent. This exemption can be applied to offset probate assets of the decedent.
— Repairs and maintenance of the decedent’s home that is being sold are deductions. Closing costs from the sale of the home are also a deduction. These exemptions apply if the house was not specifically given to an individual in the will. If a beneficiary is living in the home, than the upkeep and repairs are not deductions.
— Other deductions related to agriculture property also exist.
The Pennsylvania Inheritance Tax can be a complicated and long process. Many people are not comfortable or used to completing the paperwork necessary to finalize the tax and receive a final approval from the Department of Revenue.
Hiring an attorney experienced in estate administration can save the personal representative time and money. An attorney will understand and recognize the various deductions that can be claimed to reduce the size of the taxable estate. These deductions will result in more money for the beneficiary.
An attorney can also complete an accounting. An accounting is a valuable asset for the personal representative and beneficiaries. The accounting will ensure the rights of the beneficiaries and reduce potential fighting and litigation between beneficiaries and beneficiaries and the personal representative.
To speak with an attorney about estate administration, contact VA Legal Team today for a free consultation.