Inheritance Tax Treatment of Gifts
Transfers made by a decedent within one year of death are brought back into the estate for the purposes of the Pennsylvania Inheritance Tax. You can't avoid the inheritance tax by giving away everything you own right before you die.
There is an exemption of $3,000 per donee per calendar year. Suppose Dad gives each of three children $5,000 in March of 2012, and again in September of 2012, and again in March of 2013, and dies in June of 2013.
The March 2012 gifts are not taxable because they were made more than a year before his death. The September gifts each get a $3,000 exemption leaving three $2,000 taxable gifts. The March 2013 gifts, being made in a different calendar year as the September 2012 gifts, also get a $3,000 deduction leaving three more $2,000 taxable gifts. The taxable gifts to each child total $4,000. If there are three children, then the tax is .045 times $4,000 times 3 which equals $540.
Jointly Owned Property
The Pennsylvania inheritance tax applies to property the decedent owned with another. If Mom puts a $100,000 CD in the joint names of herself and Son, when she dies, there is an inheritance tax due on half the value of the CD at four and a half percent, that is $2,250. If Mom dies within a year of putting the CD in joint names, then it is taxed 100%, as if she were the sole owner and the tax is then $4,500. There is a trap for the unwary here. If Son dies before Mom and son is over 21, then Mom has to pay $2,250 in PA inheritance tax ($100,000 × ½ × 4.5%) to get her own money back.
For PA inheritance tax, the rule is that when a joint owner dies, a fraction of the joint account is subject to the inheritance tax. The fraction is one over the number of joint owners. In our example with Mom and Son above, there were two joint owners, so on the death of either, half of the account was subject to inheritance tax unless Son was 21 or under and died first. If there were three (3) joint owners, then one-third of the account would be subject to inheritance tax on the death of one of the three joint owners.
Assets in a retirement plan, whether it be a qualified pension, profit-sharing, 401(k) plan, IRA or other deferred compensation arrangement are subject to the inheritance tax only if they are "available" to the participant before death. Available means "the right to possess (including proprietary rights on the termination of employment) enjoy, assign, or anticipate the payment of the benefit. The right to name a beneficiary of unconsumed benefits is not enough to make the benefit subject to inheritance tax. The right to receive a stream of monthly payments is also not enough to make the benefit taxable. If, however, the decedent could have withdrawn the balance in the plan with a less than 10 percent penalty, then it is taxable.
The regulations provide that if the decedent possessed the right to withdraw benefits but that right to withdraw is subject to a penalty of 10 percent or more, then the benefits are not considered available to the decedent before death and are therefore not taxable. Usually these plan assets are not available to anyone under the age of 59 1/2 without payment of the 10 percent penalty, so if death occurs before age 59 1/2, the benefits are not subject to inheritance tax. After that time, when there is no penalty, the plans are subject to inheritance tax unless there is no option for a lump sum withdrawal. Any benefits that are exempt from the federal estate tax (and, yes, there are still some of those around) are also exempt from the Pennsylvania inheritance tax.
If a surviving spouse is the named beneficiary, the benefits, while technically taxable, are taxed at the zero rate. So no tax is due. If the beneficiaries are children, the rate is 4.5 percent. Of course, all distributions to the beneficiaries are also subject to income tax and may be subject to federal estate tax also. All of these taxes applied to a retirement plan can reduce the value to a small fraction of its date-of-death value.