Kyle Rolek, Retirement Planning Specialist
How to Minimize or Avoid Pennsylvania Inheritance Tax
Updated: Oct 27, 2021
How can you minimize or avoid Pennsylvania inheritance tax?
There are practical ways to minimize or avoid PA inheritance tax while maintaining PA residency.
You don’t necessarily need to move to a state without an estate tax or inheritance tax to effectively minimize Pennsylvania inheritance tax.
Who pays the inheritance tax in PA?
Pennsylvania inheritance tax is due when a PA resident who owns property dies, or when an out-of-state resident dies that had property located in PA. An inheritance tax return must be filed within 9 months of the date of death.
The person named as personal representative in the will or as the administrator of the estate is required to file the inheritance tax return. The inheritance tax return is generally filed with the Register of Wills in the county where the PA resident died or owned property.
Either the recipients of the property or the estate pay the PA inheritance tax depending on how instructions were written into the will.
How much is inheritance tax in PA?
The PA inheritance tax rate is 0% for property passed to a surviving spouse or a child under age 21
The PA inheritance tax rate is 4.5% for property passed to direct descendants and lineal heirs
The PA inheritance tax rate is 12% for property passed to siblings
The PA inheritance tax rate is 15% for property passed to other heirs (excluding charities and organizations that are exempt from PA inheritance tax)
Data Source: revenue.pa.gov
Pennsylvania inheritance tax example:
John and Jane are married.
John dies first. All property can pass to Jane without any PA inheritance tax.
Once Jane dies, property will be passed to their kids, grandkids, Jane’s sister, and a friend.
For property received by their kids when Jane dies, the PA inheritance tax rate is 4.5%. For every $100,000 in property received by the kids, the PA inheritance tax bill will be $4,500.
For property received by the grandkids when Jane dies, the PA inheritance tax rate is 4.5%. For every $100,000 in property received by the grandkids, the PA inheritance tax bill will be $4,500.
For property received by Jane’s sister, the PA inheritance tax rate is 12%. For every $100,000 in property received by Jane’s sister, the PA inheritance tax bill will be $12,000.
For property received by the friend when Jane dies, the PA inheritance tax rate is 15%. For every $100,000 in property received by the friend, the PA inheritance tax bill will be $15,000.
If the Pennsylvania inheritance tax payment is made within 3 months of the date of death, a 5% discount is applied.
Method #1 to minimize or avoid PA inheritance tax: Gifting
Assets gifted more than 12 months prior to death are excluded from PA inheritance tax.
There is no limit to the amount that can be gifted each year. Gifts can be taxable, but very few people ever have to pay a gift tax (described more below).
In 2020, there is currently a $15,000 “annual gift tax exclusion”, which means that $15,000 or less can be gifted from one person to another during a year without the gift reducing your “lifetime gift tax exemption”, which is about $11.5 million for 2020.
For example, if you gift $25k in 2020 to one person, which is $10k above the “annual gift tax exclusion” limit, your lifetime gift tax exemption is reduced by $10k from $11.5m to $11.49m.
Other than slightly reducing the lifetime gift tax exemption of the donor, there is no actual tax implication to either the donor or the recipient (the donor would have to file a gift tax form in this example).
Based on estate law as of 2020, the lifetime gift exclusion also serves as the federal estate tax exemption amount. As a result, reducing your lifetime gift exclusion by gifting over $15,000 per recipient in a year will also reduce your federal estate tax exemption. With the large amount of the current exemption, this appears not to matter in most cases, at least on the surface.
However, it’s very possible that the lifetime gift tax exclusion and federal estate tax exemption will be reduced in the future. For example, the estate tax exemption was only $675,000 as recently as 2001. Especially with real estate included, many people were above this limit in 2001. The exemption has increased very significantly into the tens of millions of dollars for married couples only relatively recently.
It’s often good planning to keep gifts below $15,000 per recipient per year, which doesn't reduce your lifetime gift or estate tax exemptions at all, in case the lifetime gift and estate tax exemptions get reduced significantly by a law change in the future.
When the majority of liquid assets are held within a Traditional IRA or other pre-tax retirement account, this can present some tax challenges for gifting. You'd have to take a taxable distribution from your IRA account to gift the money.
Paying income taxes on money you don’t need isn’t desirable. As a result, a gifting strategy to consider for those in a strong financial position is to gift the annual Required Minimum Distributions from IRA accounts. This money needed to come out of IRA accounts anyway, so there is no additional tax-cost to gifting these funds.
When the annual Required Minimum Distribution is gifted, the IRA owner isn't incurring any unnecessary income taxes, and they avoid PA inheritance tax for the dollars gifted during their life (assuming they live for at least 12 months after the gift is provided).
Gifting is especially beneficial when the beneficiaries of property will be siblings (subject to a 12% PA inheritance tax rate) or those who fall in the “other” category (subject to a 15% PA inheritance tax rate).
In the example above, from a tax planning perspective it would probably make sense for Jane to gift to her friend first (15% inheritance tax rate), siblings second (12% inheritance tax rate), and lineal heirs last (4.5% inheritance tax rate).
For example, if she gifts property to her friend during her life at least 12 months prior to her death, 15% of the property will be saved from PA inheritance taxes!
Any property gifted to lineal heirs, on the other hand, saves only 4.5% in PA inheritance tax.
As Jane gifts, she can adjust her will to make sure each party ends up receiving the intended amount with both gifts during life and property received at death considered.
Another category related to gifting is trust planning. When assets are contributed to certain types of trusts, including irrevocable trusts, PA inheritance tax can potentially be avoided. However, this isn’t true in all cases. It’s important to work with an experienced Pennsylvania estate planning attorney to make sure trust planning is handled correctly and trust language is drafted appropriately.
As a fiduciary financial advisor, we work in coordination with experienced Pennsylvania estate planning attorneys who can design an estate plan in a way that coordinates well with our client's overall retirement planning.
Method #2 to minimize PA inheritance tax: Buy Real Property in a State Without Estate or Inheritance Tax
Real property and tangible personal property located in Pennsylvania at the time of a PA resident’s death is subject to PA inheritance tax. Real property (such as real estate) and tangible personal property located outside of Pennsylvania is not subject to PA inheritance tax.
For example, liquid assets such as cash sitting in a bank account is subject to PA inheritance tax. However, a house in Florida isn't subject to PA inheritance tax, even for PA residents. Therefore, if a PA resident used cash to buy a house in Florida, they would avoid PA inheritance tax on these dollars.
Clearly, avoiding PA inheritance tax isn't the only factor to consider when making a decision to buy real property in another state.
For example, when property is owned in multiple states, the estate can become subject to probate in multiple states, which can increase probate costs. Also, the other state may have it's own state-level estate or inheritance taxes that may be higher than PA rates.
An experienced fiduciary financial advisor with retirement planning specialization will work in coordination with an experienced estate planning attorney to design an overall estate plan with the big picture in mind.
Method #3 to minimize or avoid PA inheritance tax: Buy Farmland and Agricultural Property
Effective for those who die after June 30, 2012, agricultural property and farmland is excluded from PA inheritance tax in certain cases.
The qualifying property must be transferred to members of the same family, it must have operated in the agriculture business at the time of the owner’s death, it must remain in the agriculture business for at least 7 years following the owner’s death, and it must produce at least $2,000 of annual revenue from the business of agriculture.
While this technique won’t be relevant in the majority of situations, under conditions where a family was already involved in or intended to get involved in the agriculture business anyway, this technique can also be utilized to minimize or avoid Pennsylvania inheritance taxes.
Safety Tip Regarding Life Insurance
Life insurance is excluded from PA inheritance tax.
Some may receive advice at some point that buying a life insurance policy is a good idea to pass assets without either your beneficiaries or your estate needing to pay PA inheritance tax. However, proceed with caution. Buying life insurance for the primary purpose of avoiding PA inheritance tax may not be in your best interest.
If you are purchasing life insurance primarily for the purpose of saving money on PA inheritance taxes, you are essentially purchasing life insurance as an investment. Taxes, costs, rate of return, liquidity, and other factors need to be carefully considered and compared with all other alternatives, including other investments that aren't insurance products, before proceeding.
Technically, buying life insurance to minimize PA inheritance tax can work fine, but so can spending all of your money so there’s nothing left to be taxed.
Keep in mind that the real goal is probably something closer to protecting your own financial security and passing assets efficiently to heirs, not necessarily minimizing PA inheritance taxes at all costs.
A fiduciary financial advisor, one who does not get paid commissions to sell products or policies, can help you objectively assess the best course of action for your unique situation.
This article discusses how to use investor.gov to verify this for yourself: How to Find a Fiduciary
In summary, there are practical ways to minimize or avoid PA inheritance tax without necessarily needing to move to a state without estate tax or inheritance tax.
As a Pennsylvania fiduciary financial advisor who specializes in retirement planning, estate planning, including PA inheritance tax planning, fits well within our scope of work.
We work with experienced Pennsylvania estate planning attorneys to structure an estate plan that coordinates well with our client's overall retirement planning. Estate planning is an important component of long-term, comprehensive retirement planning.
Want a 1-on-1 retirement planning session? Fill out the form on the homepage of our website, call us at 267-427-5667, or email firstname.lastname@example.org