New PA Inheritance Exemption for Small Businesses

Pennsylvania’s 2013-14 budget passed the legislature and was signed into law by the Governor on July 9, 2013. Tucked away in Section 34 on page 143 of the 165 page Act 52 is a new inheritance tax exemption for qualified family-owned businesses.

It states: “A transfer of a qualified family-owned business interest to one or more transferees is exempt from inheritance tax, if the qualified family-owned business interest . . . .continues to be owned by a qualified transferee for a minimum of seven years after the decedent’s date of death.”

The exemption will be available for decedent’s dying after July 9, 2013.

A “qualified family-owned business interest” is an ownership interest in either: (1) a proprietorship that has been in existence for five years prior to the date of death, has fewer than fifty full-time equivalent employees as of the date of death, and has a net book value of assets of less than $5,000,000 as of the date of death; or (2) an interest in an entity carrying on a trade or business that has been in existence for five years prior to the date of death, has fewer than fifty full-time equivalent employees as of the date of death, has a net book value of assets of less than $5,000,000 as of the date of death, and, in either case, is wholly owned by the decedent or by the decedent and members of the decedent’s family that meet the definition of a qualified transferee.

To qualify, the entity must be engaged in a trade or business the principal purpose of which is not the management of investments or income-producing assets owned by the entity. For example, if you put your stock portfolio in an LLC or partnership and call it a business – it’s not really a business and doesn’t qualify for this exemption.

A “qualified transferee” is a decedent’s husband or wife, lineal descendants, siblings and the sibling’s lineal descendants, and ancestors and the ancestor’s siblings.

“Lineal descendants” are all children of the natural parents and their descendants, whether or not they have been adopted by others, adopted descendants and their descendants and step-descendants.

“Sibling” is an individual who has at least one parent in common with the decedent, whether by blood or by adoption.

Additional requirements for the exemption include a requirement that the qualified family-owned business interest continue to be owned by a qualified transferee for a minimum of seven years after the decedent’s date of death. Otherwise the inheritance tax and interest thereon from the date of death will be assessed. Also, the exemption will not be allowed for any property transferred by the decedent into the qualified family-owned business within one year of the date of death, unless the property was transferred for a legitimate business purpose.

A qualified family-owned business interest that was exempted from inheritance tax will lose the exemption if it is no longer owned by a qualified transferee at any time within seven years after the decedent’s date of death. In that event, the inheritance tax plus interest is due. Each year for seven years, owners of a qualified family-owned business interest exempted from inheritance tax are required to file a certification that the qualified family-owned business interest continues to be owned by a qualified transferee. A form is to be prepared by the Department of Revenue for this purpose. Owners must notify the Department within thirty days of any transaction or occurrence causing the qualified family-owned business interest to fail to qualify for the exemption. A failure to comply with the certification or notification requirements results in the loss of the exemption.

Last year, the legislature added a new exemption from the inheritance tax for farms that pass to family members, provided the property continues to be devoted to agriculture for a period of seven years. This year’s new exemption for a business provision is very similar to the farm exemption. Also last year, there was a new inheritance tax exemption added for the transfer of an agricultural commodity, agricultural conservation easement, agricultural reserve, agricultural use property or a forest reserve to lineal descendants or siblings.

The persons who pushed for the new exemption for family-owned businesses claim that the Pennsylvania inheritance tax inflicts an especially disruptive and destructive burden on family-owned businesses. They say the transfer of productive business assets at death often results in the sudden need to liquidate essential business resources (or sometimes the entire business) to raise the cash necessary to pay the tax bill, all at a time when the business and its employees are most vulnerable, in the aftermath of the death of a principal owner.

I beg to differ. In 35 years of practice I have never seen a business or a farm required to be sold to pay the PA inheritance tax. Why are business owners and farmers singled out for special treatment?