State’s inheritance tax: Who pays at what rates?

Pennsylvania's Inheritance Tax - First in a Series

Pennsylvania has an inheritance tax which is an excise tax on the receipt of inherited property by a beneficiary.

Rates depend on relationship

For property passing to spouses, zero percent. Prior to 1995, transfers passing to spouses were taxable at the six percent rate. This was a very controversial tax and was finally repealed so that no tax is due on property inherited by a widow or widower.

For property passing to lineal descendants, mother, father, grandmother, grandfather, wife or widow of a child, husband or widower of a child, the rate is 4.5 percent. Lineal descendants include children and more remote descendants. Children includes stepchildren and adopted children.

For property passing to siblings of the decedent, the rate is 12 percent.

Property passing to charity is not taxed.

For property passing to all others, the rate is 15 percent.

Exceptions

There is a $3,500 family exemption which may be claimed by a spouse of a decedent who died as a resident of Pennsylvania. If there is no spouse, or if the spouse has forfeited his/her rights, then any child of the decedent, who is a member of the same household as the decedent, may claim the exemption.

The inheritance tax does not apply to the proceeds of life insurance (in any amount) on the life of the decedent. The tax must be paid within nine months of the decedent's death. If the tax is paid within three months of the date of death, there is a 5 percent discount available for early payment. This is a 5 percent discount for paying six months early; on an annualized basis that is 10 percent.

Who pays?

The executor of the decedent's will is responsible for reporting assets and paying the tax on all assets in the estate and any other assets subject to inheritance tax that are known to him. If there is no executor or administrator, the recipient of property is responsible for filing an inheritance tax return and paying the tax. For example, if a child receives a bank account because it was in joint names with the decedent and the account was not reported by the executor, it is that child's responsibility to make sure the account is reported properly and the tax is paid.

What property is subject to tax?

First, all property passing under the will or by intestacy is taxable. This includes real estate, bank accounts, stocks and bonds, mutual funds, partnership interests, sole proprietorships, collectibles, jewelry, household furnishings. All items must be valued as of the date of death. This means appraisals for real estate, businesses, jewelry, furnishings and the like. Only real estate and physical objects located in Pennsylvania are subject to the tax. Real estate and physical objects located in other states cannot be taxed by Pennsylvania. (But be cautious, they may be taxed by the state in which they are located.)

Lifetime transfers

Consider this lifetime transfer subject to tax - a transfer with a retained life estate. Let's assume Mom transfers her home to her daughter by a deed in which she retained the right to use and occupy the home for her life. Even though she has transferred the remainder interest in the home to daughter, the whole value of the home is subject to inheritance tax at the 4.5 percent rate on Mom's death.

Some folks think they can avoid this result by transferring the home from Mom to daughter by deed with no reservation of a legal life estate or by selling the house for $1.00. If Mom continues to occupy the home, the value of the home is still subject to the inheritance tax if there is an "implied" agreement between mother and daughter that Mother can continue to live in the home. Such an agreement need not be in writing. Many people are unaware of this provision of the law and do not pay inheritance tax on such property.

Lifetime transfers made by the decedent which are revocable are also subject to inheritance tax. An "in trust for" bank account is an example of this. If Grandfather opens a bank account in his name "in trust for" grandson, on Grandfather's death, this account passes to grandson. However, during his life, Grandfather could have closed the account, changed the beneficiary, and was in full control of the money. The date-of-death balance of this account on grandfather's date of death is subject to inheritance tax at the 4.5 percent rate.

Similarly, if the decedent had transferred all of her assets to a revocable trust during her life, the full value of the trust assets on her date of death are subject to inheritance tax. These trust are sometimes called "living trusts." No inheritance taxes or estate taxes are saved by such trusts.

Part II of this column's series will continue with a summary of the Pennsylvania Inheritance Tax including the treatment of gifts, jointly-held property and retirement plans.