Should you worry about Death Taxes?

Many Pennsylvania seniors share similar financial and estate planning goals. We want to be sure that we have enough resources to provide for our needs during our lifetime. And we want to pass a little something – as much as possible really - on to our families after our deaths.

For most of us, death taxes are a nuisance, but won’t prevent us from reaching these planning goals. Death taxes don’t affect our lifetime financial security because they only come into play when we die.  And with proper planning they won’t affect the financial security of our spouse because in most cases there is no tax on what we leave to our surviving husband or wife.

For most of us death taxes hit our families only when both spouses are gone and our home and savings pass to our children or other heirs.  At that point, they usually do take a bite.

Here is my simplified overview of how death taxes apply for Pennsylvania residents. Pennsylvania families face two forms of death tax, state and federal.  

Federal Transfer Taxes: The federal government imposes a set of taxes (estate, gift, and generation-skipping) on the transfer of wealth. Generally, there is no tax on what you leave to your spouse or charity.  And there is no tax on the first $5.25 million (in 2013) that passes to your other heirs. 

If you do have an estate of more than $5.25 million, you need to plan to avoid federal transfer taxes. The tax rates are high – the federal estate tax is 40% on the excess - but that tax can be greatly reduced or eliminated by good advance estate planning. 

While a 40% death tax is severe, it doesn’t affect many people.  Less than 1% of all estates are subject to federal estate tax. For most of us, it is not a worry. 

Pennsylvania Inheritance Tax: The Pennsylvania inheritance tax, does affect the things that most Pennsylvania residents leave to their children and grandchildren after their deaths.  It will impact most Pennsylvania families.  

Inheritance tax is imposed as a percentage of the value of a decedent's estate transferred to beneficiaries by will, heirs by intestacy (where there is no will) and transferees by operation of law (for example, by trust). There is no bottom threshold – even small estates are subject to PA inheritance tax. The tax rate varies depending on the relationship of the heir to the decedent.  

The rates for Pennsylvania inheritance tax are as follows: 

• -         0 percent on transfers to a surviving spouse or to a parent from a child aged 21 or younger;
• -         4.5 percent on transfers to direct descendants and lineal heirs (see below for definitions);
• -       12 percent on transfers to siblings; and
• -         15 percent on transfers to other heirs, except charitable organizations, exempt institutions and government entities exempt from tax.

Direct descendants (4.5% rate) include all natural children of parents and their descendants (whether or not they have been adopted by others), adopted descendants and their descendants and step-descendants. Lineal heirs (4.5% rate) include grandfathers, grandmothers, fathers, mothers and their children. Children include natural children (whether or not they have been adopted by others), adopted children and stepchildren.

There are some inheritance tax exemptions written into the law. The proceeds of life insurance policies on the decedent’s life are not taxed, and special rules may apply to IRAs and other retirement plans.

Certain farm land and other agricultural property may be exempt from Pennsylvania inheritance tax, provided the property is transferred to eligible recipients. For more information about these agricultural exemptions and related requirements, see my earlier post: Pennsylvania eliminates tax on inheritance of family farms if law's conditions are met.

Inheritance tax payments are due upon the death of the decedent and become delinquent nine months after the individual's death. If inheritance tax is paid within three months of the decedent's death, a 5 percent discount is allowed.

Planning Implications:

While the Pennsylvania inheritance tax can take a bite out of your estate, it is rarely devastating. Let’s say that when you die, your leave your home and investments to your children and that the value of the inheritance is $300,000.  The PA inheritance tax would be 4 ½% of that, or $13,500, and the children would receive $286,500. 

For many Pennsylvania seniors a much bigger risk to their goals of lifetime financial security and passing along an inheritance is the possibility that their life savings will be used up paying for their care before death. Most seniors require care during an extended period of time prior to their deaths. The cost of that care, whether it is received at home, in assisted living, or in a nursing home, can quickly deplete a modest estate.

For most seniors, it’s the cost of long term care rather than death taxes that should be the focus of advance planning. Expert long term care advance planning with the help of an elder law specialist can help ensure that seniors will be able to:

    * remain financially independent,

    * maintain control,

    * maintaining privacy,

    * involve family members without burdening them,

    * maximize available government programs, and

    * leave an inheritance.

Pennsylvania seniors and their families can get expert planning guidance at any one of the four offices (Williamsport, Wilkes-Barre, Scranton and Jersey Shore) of my law firm, Marshall, Parker and Weber. The initial consultation is free of charge. 

For More Information: 

“Permanent” Gift and Estate Tax Rules Set by New Fiscal Cliff Law

Myths and Realities About the Estate Tax

Don’t Confuse Medicaid Rules with Tax Rules

Inheritance taxation of natural gas rights in Pennsylvania clarified

Pennsylvania eliminates tax on inheritance of family farms if law's conditions are met