Many of our clients have a real aversion to having their heirs pay inheritance taxes. The topic frequently comes up while we’re reviewing their estate plans. Mostly, they want to know what the tax is and how it is assessed.
Pennsylvania is one of a handful of states that has an inheritance tax. The tax is assessed to certain property owned by Pennsylvania residents that is passed to a beneficiary that is not that individual’s spouse or a charity. The inheritance tax applies to any non-resident of Pennsylvania that owns property in the state. The individuals that receive this inheritance are responsible for paying the tax, unless special instructions have been given to have the estate pay the tax.
Assets received are not subject to inheritance tax if you are the spouse of the decedent, or if you elect a charity as your beneficiary. The same is true for estates of children ages 21 or younger, of which, go to the child’s parent.
Assets that go to lineal heirs, or up and down the family line, would pay the Pennsylvania inheritance tax of 4.5 percent. Heirs in this category would include children, grandchildren, parents, grandparents, sons and daughters-in-laws.
The next group would include siblings at tax rate of 12 percent. This group would include half-brothers and sisters. And finally, all other beneficiaries – nieces, nephews and friends – would pay 15 percent Pennsylvania inheritance tax.
Generally, our clients look for opportunities to avoid having their heirs pay this tax. There are strategies to minimize or avoid this tax. Probably the most popular is gifting your assets to your beneficiaries while you are alive. Keep in mind that if you don’t live at least one year after making the gift, the recipient could be subjected to the state’s inheritance tax.
Also, be aware of federal gift tax implications. If you give too much of your estate away, as well as certain assets like low basis stocks, it may actually end up costing your heirs more in capital gains taxes than paying Pennsylvania’s inheritance tax. One asset that is not subject to inheritance tax is life insurance. You may look to leverage assets like traditional IRAs, which may not be the most tax efficient assets for beneficiaries, into life insurance.
Utilizing certain types of trusts that allow you to remove assets from your estate could assist in reducing your Pennsylvania inheritance tax. Essentially, the focus is reducing your estate, but this is actually a lot more complicated than one would think. That’s why it is critical that you work with a financial professional to get good advice regarding your estate plan. I would gladly assist you if you have these concerns.