Death and Taxes

 

Many people say that nothing is certain in life except death and taxes, and that is absolutely true in estate administration cases. There are several federal and state taxes (collectively referred to as “death taxes”) that must be prepared and filed following an individual’s death.

In Pennsylvania, the most important death tax is the Pennsylvania Inheritance Tax, which is a tax on the transfer of assets from the decedent to his or her heirs. This tax is paid to the Pennsylvania Department of Revenue, and is a separate and distinct tax from any federal taxes that may be assessed. If the decedent is a Pennsylvania resident at the time of death, this tax is assessed on all tangible property and any real property located within Pennsylvania owned by the decedent. If the decedent is not a resident of Pennsylvania but owned real property in Pennsylvania at the time of his or her death, the Pennsylvania Inheritance Tax is only taxed on the real property located in Pennsylvania.

The Pennsylvania Inheritance Tax has several different tax rates depending on the relationship between the decedent and the heir. Property that passes to the decedent’s surviving spouse is taxed at a zero percent rate, while property that passes to lineal descendants (children, grandchildren, stepchildren, etc.) is taxed at a rate of 4.5%. Assets that pass to siblings are taxed at a 12% rate, and property that passes to anyone else (aunts, uncles, friends, non-marital partners) is taxed at a rate of 15%. Any bequest to a charity is exempt from Pennsylvania Inheritance Tax.

In order to prepare the Pennsylvania Inheritance Tax Return, all assets of the decedent’s estate subject to the tax must be valued as of the decedent’s date of death. The estate’s personal representative must contact all of the decedent’s financial institutions and request the balance of any account as of the date of death. This step is very important, as many assets fluctuate in value following the decedent’s death. The value of any real property may be determined by an appraisal or by the sale price if the property is sold after the decedent’s death.

The Pennsylvania Inheritance Tax Return must be filed within nine (9) months of the decedent’s date of death. A 5% discount on the total amount of tax due may be obtained if a “prepayment” of any portion of the estimated tax due is made within three (3) months of the date of death. If the personal representative is not able to obtain all the asset information within the nine month deadline, the Pennsylvania Department of Revenue may grant one six (6) month extension of the filing deadline. During this extension the Department of Revenue will not assess penalties; however, the estate will be charged a daily interest rate.

In addition to the Pennsylvania Inheritance Tax, some estates may be subject to the Federal Estate Tax. This tax is based on the gross value of a decedent’s estate, and it is assessed by the Internal Revenue Service. The Federal Estate Tax is only applied to the amount of a decedent’s gross estate that is in excess of the Federal Estate Tax Exemption for the year of the decedent’s death. In 2015, the Federal Estate Tax Exemption is $5.43 million; as such, the IRS will only assess Federal Estate Tax if a decedent who died in 2015 had assets in excess of $5.43 million. The top tax rate for the Federal Estate Tax is 40%.

Just like the Pennsylvania Inheritance Tax, the Federal Estate Tax Return uses the values of the decedent’s assets as of the date of death; additionally, the Federal Estate Tax Return is also due within nine (9) months of the date of death. There is, however, no discount for making an early tax prepayment.

Unlike the Pennsylvania Inheritance Tax, however, there are several estate planning techniques that can be used to reduce or delay the payment of the Federal Estate Tax. One of these techniques is called “portability”; this concept allows a surviving spouse to include the deceased spouse’s unused Federal Estate Tax Exemption with the surviving spouse’s own Exemption at his or her death. For example, suppose that Husband dies in 2015 with a gross estate of $3 million. Since the Federal Estate Tax Exemption for 2015 is $5.43 million, Husband’s estate will not pay any Federal Estate Tax; additionally, Husband has $2.43 million of “unused” Exemption remaining. Under portability, Wife could add this $2.43 million of “unused” Exemption to her own Exemption at her death, which would shield additional assets from the Federal Estate Tax at Wife’s death. There are additional estate planning techniques, such as gifting or distributing assets to certain types of trusts, that may be useful tools for estates that may be subject to the Federal Estate Tax.

In addition to death taxes, the personal representative of a decedent’s estate must also understand the various income taxes that may be assessed. The decedent’s final lifetime Personal Income Tax Return must be filed at both the state and federal levels for all income the decedent earned prior to his or her death. In addition, any income earned by the estate following the decedent’s death is considered fiduciary income and may be subject to state and/or federal Fiduciary Income Tax.