Should you be worried about death taxes?
Many Pennsylvania seniors share similar financial and estate
planning concerns and 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. [The following information is based on the
tax laws as they exist in September 2020.]
Death taxes are imposed by two taxing authorities: state and
federal.
Federal Transfer Taxes
The federal government imposes a set of taxes (estate, gift,
and generation-skipping) on the transfer of wealth. Under current law few
families are affected.
Generally, there is no tax on what you leave to your spouse
or charity. And there is no tax on the first $11.58 million (in 2020) that passes
to your other heirs. This means that a married couple can protect 23.16 million
from the tax. These exclusions increase each year with inflation. There is the
potential that the exclusion amounts could be reduced in the future, but they
will still likely be more than most people require. If you are one of the few
people who do have an estate over the exclusion limits you need to plan to
avoid or limit federal transfer taxes. The tax rate is 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% federal death tax is severe, it doesn’t affect
many people. Fewer than 1% of all estates are subject to federal estate tax.
For most of us, it is not a worry. [Note, however, that the current
estate tax structure is set to expire after 2025. In addition, nothing prevents
future lawmakers from reducing the exemption amounts or increasing the tax
rate.]
Pennsylvania Inheritance Tax
The Pennsylvania inheritance tax applies to the things that
Pennsylvania residents leave to their children, grandchildren and other
non-spouse heirs. It will impact most Pennsylvania families.
Inheritance tax is imposed as a percentage of the value of a
decedent’s estate transferred to beneficiaries whether the assets pass through
probate or not. There is no bottom threshold – even small estates are subject
to PA inheritance tax. The tax also applies to transfers made by a decedent
within a year of death to the extent in excess of $3,000. The tax rate
varies depending on the relationship of the heir to the decedent.
With a few special exceptions the rates for Pennsylvania
inheritance tax are as follows:
- – 0
percent on transfers to a surviving spouse, to
a child age 21 or under from a parent, and to a parent from a child
aged 21 or younger;
- – 4.5
percent on other 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” include 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” include
grandfathers, grandmothers, fathers, mothers and their children. “Children”
include natural children (whether or not they have been adopted by others),
adopted children and step-children.
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. In addition,
real estate and physical objects located in another state are not subject to
Pennsylvania inheritance tax.
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.
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 net 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 in value.
If the $300,000 estate were left to a brother or sister the
toll would be much higher. The PA inheritance tax would be 12% of that, or
$36,000.
[This posting is an update of an article I
originally posted on April 8, 2018.]