Saturday, May 31, 2014

PA Income Tax Reporting Changes for Trusts and Estates

Pennsylvania levies income tax at the current rate of 3.07% on taxable income earned by individuals, estates and trusts. Individuals file a PA Form 40 income tax return to report their taxable income. Executors and trustees file a PA Form 41 Fiduciary return.  
If an estate or trust is subject to PA income tax, the tax liability is allocated between the beneficiaries and the estate/trust based upon whether the income is distributed to the beneficiary or retained by the trust.  See, 61 Pa. Code §§ 105.2 - 105.4.
In 2013 Pennsylvania enacted Act 52 (HB 465) which made several important changes regarding the income of estates and trusts.   

  • Withholding tax. When an estate or trust receives income from PA sources which is allocable to a nonresident beneficiary, it must now pay a withholding tax.

  • Non-Resident Estates and Trusts. Every estate or trust having a PA resident beneficiary which has any income from PA sources is now required to file Pennsylvania income tax returns.

Note that the withholding tax applies only to estates and trusts that have "income from PA sources." This would generally be income derived from one of the following sources:

• Operation of a business or ownership in a partnership, S corporation or limited liability company that has operations wholly or partially within Pennsylvania;
• Ownership of rental property or a partnership, S corporation or limited liability company that owns rental property located in Pennsylvania;
• Sales of tangible property located in Pennsylvania;
• Gambling and lottery winnings from a wager placed in Pennsylvania; and/or
• Estate or trust income from another estate or trust that has income from any of the above sources.

Act 52 further requires that the tax returns set forth all items of income, loss and deduction, and such other pertinent information as the PA Department of Revenue may require. The changes are effective for tax years beginning after December 31, 2013.
In response to these new requirements, the Department of Revenue has issued some initial instructions.  In its April/May 2014 Tax Update the Department advises:
To enable taxpayers and tax professionals to file short-period returns for tax years beginning in 2014, the department has developed the 2014 forms earlier than in previous years. However, the 2014 PA-41 forms and instructions will only be available upon request until all 2014 personal income tax forms and instructions are made available in January 2015. To obtain the 2014 PA-41 forms and instructions, call the Bureau of Individual Taxes Director’s Office at 717-787-8346.  
The Tax Update also contains a summary of the changes to the 2014 PA-41 forms, instructions, and reporting requirements. The instructions include new definitions for the terms nonresident beneficiary, resident beneficiary, Pennsylvania-source income, nonresident estate and nonresident trust. 

The Department has not posted the new 2014 PA-41 online because it is still in the process of being revised. Where it is necessary to file a short year return for 2014, the Department will mail the Trustee the forms to use.  

It is my understanding that, unlike estimated tax payments, the withholding tax does not have to be paid in advance. While there will be no penalty for underpayment of the withholding tax during the year, that tax will be subject to late payment penalties if not paid when due.    
See, Pennsylvania Department of Revenue, Tax Update, April/May 2014: 2014 BRINGS MULTIPLE CHANGES TO FIDUCIARY RETURNS AND REPORTING REQUIREMENTS

Tuesday, May 13, 2014

A Threat to Family Farms: Medicaid Estate Recovery

There is a big threat out there to the survival of family farms. No, it’s not taxes. Not anymore. The threat is the potential loss of farms due to uninsured care costs incurred by aging farm owners. 
Like many areas of the country, Central and Northeastern Pennsylvania were largely built on the sweat and perseverance of the owner/operators of small family farms. These farmers epitomize the American values of hard work, running your own business, providing for your family through all kinds of adversity, loving the land, and passing all these virtues along to your children.  
Now, long-term care costs, combined with government’s Medicaid qualification rules and Estate Recovery program, are working to destroy the family farm as the heartbeat of our American economy and our culture.  

Farm Owners are Aging

According to the Federal Government there are 2.2 million farms in America. Most of those farms (87%) are owned and operated by individuals or families. These owners are an aging group.  Among principal farm operators 33% are age 65 and older. (See, USDA 2012 AgCensus).
If we value family farms, we need to do what we can to foster their transition to the next generation. But the aging of our farm owners/operators makes it increasingly unlikely that the small family farm will be allowed to stay in the family.  

Death Taxes on Family Farms have been largely eliminated

Death taxes are not the problem. In recent years, the potential for the imposition of significant federal and state transfer and inheritance taxes has been greatly reduced by changes in the law. The Federal estate tax exclusion amount is $5,340,000 in 2014 and most family farms are well below that threshold.   
And farm land and other agricultural property can be exemped from Pennsylvania’s state inheritance tax if the property stays in the family and a few conditions are met. [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.]

Long-Term Care Costs Loom Large for Aging Farmers

While death tax concerns have diminished, many of Pennsylvania’s aging small farm owners are threatened by the specter of uninsured care costs. As people live longer, their care needs tend to grow until they can overwhelm family caregivers. Even if a care-recipient is able to remain at home, supplemental paid care is often needed. And the likelihood grows that the farmer’s modest life savings will be used up paying for that care.
Unlike acute health care needs, the cost of long-term care, whether it is received at home, in assisted living, or in a nursing home, is typically not covered by Medicare or private insurance. It is expensive and can quickly deplete a small farm owners modest financial resources.
When the farm owner’s savings are gone, he or she may qualify for Medicaid help to pay for required care. Medicaid is the safety net program that can pay long-term care costs for needy seniors. But the Medicaid program has rules and limits that can prevent the small farmer from qualifying.

A Trap for Farm Families

If the aging farm owner attempts to transfer the farm to a child, the owner may become ineligible for Medicaid for a period as long as 5 years. In addition, the child (and all of the farmer's children) may become personally liable for his care costs under filial responsibility laws. [See my earlier post: Children can be liable for a parent’s long term care costs in Pennsylvania.]
But if the aging owner keeps the farm and draws on Medicaid benefits to pay for long-term care, the farm property will be subject to a government Medicaid Estate Recovery claim at death.
For example, take the hypothetical case of Bob, a widower age 75, who owns a small family farm in Lycoming County, Pennsylvania. His son, Sam, has sacrificed and helped his father run the farm for the past 30 years. Bob repeatedly promised Sam that the farm would someday be his. In fulfillment of this promise, In March of 2012, Bob deeded the farm to Sam. 
In 2014, Bob suffers a massive stroke and is confined to a nursing home. His limited Medicare coverage quickly runs out. Over the following two years, Bob pays all of his savings to the nursing home. Then he is out of money and needs to apply for Medicaid, the government program that assists nursing home residents who can no longer pay for their care.  
As a result of federal and state Medicaid regulations, Bob will be ineligible for Medicaid because he gave the farm to his son within the prior five years. 
Sam can give the farm back to his father to undo this penalty. This will allow Bob to qualify for Medicaid payment of his cost of care. But it also means that the farm will be subject to Medicaid Estate Recovery reimbursement when Bob dies.
The Medicaid rules effectively force the farm to be sold either during Bob's life or after his death. This means that the family farm will be gone and Sam will lose the fruits of his thirty years of hard work. 

Bottom Line: Plan Ahead for Long-Term Care

Our federal and state legislators have acted to protect family farms from death taxes. But they have enacted laws like the Medicaid transfer penalty and estate recovery that effectively impose a “long-term care tax” which can and do force family farms to be sold. This long-term care tax is not going away any time soon. Families need to plan for it.   
The bottom line: For aging farmers who want to keep their farms in their families it’s the cost of long term care rather than death taxes that usually needs be the focus of legal planning. 
Expert long-term care planning, especially when implemented more than 5 years before the need for care arises, can help ensure that the farm stays in the family. 
If you own a farm and are over age 55, the time to plan is now.  
Related Reading

Monday, May 5, 2014

Could a Yellow Dot Save your Life?

Imagine that you are critically injured in an auto accident and you are shaken and confused and unable to communicate clearly. Emergency personnel arrive on the scene. They don’t know what pre-existing medical conditions and special needs you have. They don’t know what medications you are taking or if you are allergic to something. 
If they had this kind of information it would likely improve the care they are able to give. It might even save your life.
Now you can help ensure that your emergency responders have the information they need. You can participate in the Yellow Dot program. This free program is open to anyone. And it seems particularly valuable for seniors since we are more likely to have chronic medical conditions and to be on more medications.
Yellow Dot participants place a yellow decal on the driver’s side rear window of their car. Relevant emergency medical information goes on a sheet which is placed inside a yellow envelope stored in the glove compartment. 
The information allows the first responders to immediately access the information they need to treat you most quickly and effectively. It allows hospital emergency department staff to positively identify you, call your family, and personalize your care.
The Yellow Dot information includes your picture along with relevant medical conditions, medications, allergies, emergency contacts, and physicians.
The information sheet and photo goes into a Yellow Dot folder which you keep in your vehicle’s glove box. If there are multiple people riding in the same vehicle who want to participate, you just put multiple medical information sheets and photos in the Yellow Dot folder.
You can order your Yellow Dot materials online at or by phone by calling 717-787-6746. For more information on Pennsylvania's Yellow Dot Program visit
The Yellow Dot program is spreading nationally, so it may benefit you even if you are traveling outside of Pennsylvania.
The Yellow Dot is similar to the Vial of L.I.F.E. (“Lifesaving Information for Emergencies”) program which is intended to provide first responders with medical information when providing care to an injured or ill person at home. With the Vial of L.I.F.E. the medical information form is placed in a vial on the top shelf of the door of the participant’s refrigerator and stickers are placed on the refrigerator door and the participant’s front door or window to notify emergency responders.

Sunday, May 4, 2014

Don't Miss the Step Up in Tax Basis wnen your Spouse Dies

Most married seniors own at least some of their investments jointly with right of survivorship. That means that when one spouse dies, the ownership of the entire investment passes to the survivor.
This set up makes a lot of sense for married couples with modest estates who want everything they own to pass to the surviving spouse. In most cases, assets pass to the survivor with no state or federal death taxes, and no need for probate or other estate complications. 
But, I’ve found that the simplicity of this set up can cause the survivor to overlook a significant income tax consequence that takes place. The survivor’s tax basis in the formerly co-owned investment may have changed. If the investment increased in value during between the time of the couple purchased it and the death of the first spouse, the survivor should receive a “stepped up” basis that will reduce the income taxes due when the investment is eventually sold. But this change in tax basis is often missed.  
The step-up in basis rule applies to the assets you own (like stocks and bonds, real estate, and valuable collectibles) that are subject to capital gains taxes when sold.
The rule says that when you receive a capital gain asset from a decedent your tax basis in that property is not what the deceased paid for it. Instead it is normally “the fair market value of the property at the date of the decedent’s death.” Internal Revenue Code Section 1014a
This section of the tax law means that the appreciation in value of the asset that occurred during the lifetime of the decedent on the portion he or she owned will never be subject to capital gains taxes. When you later sell the asset capital gains taxes will be due only on that portion of the sales price that is in excess of the stepped-up basis you received. This can save you a lot in taxes.

Here is an example of how this works.

Let’s say that a few years ago my wife and I bought a vacation cabin for $50,000. We titled it in both of our names with right of survivorship. That $50,000 purchase price was our initial tax basis in the property ($25,000 for my wife and $25,000 for me.) 
Then my wife died. At the time of her death, the cabin was worth $90,000. If I sell the cabin for $90,000 I am going to have to report the sale and pay taxes on the difference between what I receive from the sale and my tax basis in the property.
But what is my tax basis? Many widows/widowers will report what was paid for the property (i.e. $50,000) as their tax basis. In the example above, this would mean they would pay capital gains tax on $40,000 - the difference between the sale price ($90,000) and the purchase price ($50,000). But that is wrong and will result in the overpayment of income taxes.
My tax basis in the vacation cabin is actually $70,000 rather than $50,000. And I should be paying tax on only $20,000 of gain, not $40,000. Here is why:
The tax basis on the ½ of the property that I inherited from my wife was stepped up from $25,000 to $45,000 (1/2 of $90,000) due to her death. My tax basis in the property is the total of what I paid for the ½ interest I purchased ($25,000) plus the date of death value of the ½ interest I inherited from my wife ($45,000). $25,000 plus $45,000 gave me a new tax basis of $70,000 in the property.        
The step up in basis rule is found in the tax law at Title 26, US Code, section 1014. (Note that the step-up in basis rules are different and can be even more advantageous to the surviving spouse in the 9 states that follow community property rules – check with your tax advisor. But Pennsylvania is not one of those states).
Don’t overpay your taxes. Be sure to get a “date of death” value and update the tax basis on any capital gain assets you receive as the result of someone’s death.
This is one of a number of articles I have written about legal and financial planning mistakes made by retirees. Here are links to some others that might be of interest to you:

Claiming Social Security too Early can be a Big Mistake