Pennsylvania imposes an inheritance tax at death upon all Pennsylvania residents as well as non-residents owning Pennsylvania real property.
This tax is imposed on all assets with the exception of life insurance and out-of-state real property. Tax rates are dependent on who you give your assets to at death. The following are the current Pennsylvania Inheritance Tax rates based upon the beneficiary:
- Spouse, Charity and Children under age 21 – 0%
- Children over age 21 or Parents – 4.5%
- Siblings – 12%
- Anyone Else – 15%
Clients often consider gifting assets to their children or other beneficiaries during their lifetime to avoid the Pennsylvania Inheritance Tax at death.
There are a couple of issues to consider before doing this. First, any gifts made within one year of death are pulled back into the taxable estate for Pennsylvania Inheritance Tax purposes. Second, the person to whom you gift the asset will receive a carry-over tax basis for income tax purposes.
Tax basis rules are governed by federal law. In summary, the value at which you buy an asset is your tax basis. The asset will hopefully grow in value over time. When you sell the asset, the difference between the sale price and your tax basis is a capital gain subject to a 20% capital gains tax in most circumstances. Current federal law provides that most assets receive a stepped-up tax basis to fair market value at a taxpayer’s death. This means that if you die owning the asset and it passes to the beneficiary at death, the beneficiary receives a tax basis equal to fair market value. Had you instead gifted the asset to the beneficiary, the beneficiary would receive your much lower tax basis and be subject to higher capital gains up sale.
Consider this scenario:
Client is a Pennsylvania resident who wants to avoid the Pennsylvania Inheritance Tax. The client has an investment brokerage account with a value of $1,000,000. The client initially invested $100,000 years ago. The client has a tax basis of $100,000. The client gifts the account to his adult child and lives at least one year from the date of gift. The client will avoid the Pennsylvania Inheritance Tax of 4.5% at death saving his estate $45,000 in Pennsylvania Inheritance Tax. However, assuming the child liquidates the $1,000,000 account, the child will be assessed a capital gains tax of $200,000. Had the client instead died with the asset and been subject to the $45,000 Pennsylvania Inheritance Tax, the family would have saved $155,000 in tax ($200,000 less $45,000) since the child would have received a stepped-up tax basis and would avoid the capital gains tax.
Although the client successfully avoided the Pennsylvania Inheritance Tax, the avoidance produced a $200,000 capital gains tax with an overall increase in tax of $155,000 for the family. Clients should consider the implications of all taxes before gifting assets.
For assistance on the implications of all taxes when gifting assets or to learn more about estate and gift tax, please contact David J. DelFiandra at email@example.com or 412.261.1600 for an initial consultation. David is a Partner with Leech Tishman and Chair of the Estates & Trusts Practice Group, and is also a member of the Nonprofits & Tax-Exempt Organizations and Tax Groups.