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Pennsylvania eliminates tax on family inheritance of small business interests

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Pennsylvania imposes an inheritance death tax on assets inherited by children and other non-spouse family members. The inheritance tax rates range from 4.5% to 15%.

Last year, Pennsylvania eliminated the tax on the inheritance of agricultural real estate by family members, provided the property continues to be devoted to agriculture for a period of 7 years. See my earlier article: Pennsylvania eliminates tax on inheritance of family farms if law’s conditions are met.

This year, Pennsylvania is eliminating the inheritance tax for small businesses that remain in the family. Act 52 of 2013 (HB 465), signed into law by the Governor on July 9, contains the new exemption.

Act 52 adds Section 2111(t) to the Pennsylvania Tax Reform Code to exempt the following transfers at death from PA inheritance tax:

(1) A transfer of a qualified family-owned business interest to one or more qualified transferees is exempt from inheritance tax, if the qualified family-owned business interest:

(i) continues to be owned by a qualified transferee for a minimum of seven years after the decedent’s date of death; and

(ii) is reported on a timely filed inheritance tax return.

What is a Qualified Family-Owned Business Interest?

Act 52 defines a “Qualified family-owned business interest” as follows:

(i) an interest as a proprietor in a trade or business carried on as a proprietorship, if the proprietorship has fewer than fifty full-time equivalent employees as of the date of the decedent’s death, the proprietorship has a net book value of assets totaling less than five million dollars ($5,000,000) as of the date of the decedent’s death, and has been in existence for five years prior to the date the decedent’s death; or

(ii) an interest in an entity carrying on a trade or business, if:

(A) the entity has fewer than fifty full time equivalent employees as of the date of the decedent’s death;

(B) the entity has a net book value of assets totaling less than five million dollars ($5,000,000) as of the date of the decedent’s death;

(C) as of the date of decedent’s death, the entity is wholly owned by the decedent or by the decedent and members of the decedent’s family that meet the definition of a qualified transferee;

(D) the entity is engaged in a trade or business the principal purpose of which is not the management of investments or income-producing assets owned by the entity; and

(E) the entity has been in existence for five years prior to the decedent’s date of death. 

Who are Qualified Transferees?

Act 52 defines “qualified transferee” as a decedents:

(i) husband or wife; 

(ii) lineal descendants; 

(iii) siblings and the sibling’s lineal descendants; and 

(iv) ancestors and the ancestor’s siblings.

Act 52 does not define the terms “lineal descendants” and “siblings” but the terms are elsewhere defined in the inheritance tax law as follows:

 “Lineal descendants.” All children of the natural parents and their descendants, whether or not they have been adopted by others, adopted descendants and their descendants and stepdescendants.

“Sibling.” An individual who has at least one parent in common with the decedent, whether by blood or by adoption.  

72 P.S.§ 9102

Losing the Exemption

A qualified family-owned business interest that was exempted from inheritance tax will lose the exemption if it is no longer owned by a qualified transferee at any time within seven years after the decedent’s date of death . In that event, the inheritance tax plus interest is due.

Each year for seven years owners of a qualified family-owned business interest exempted from inheritance tax are required to file a certification that the qualified family-owned business interest continues to be owned by a qualified transferee. A form is to be prepared by the Department of Revenue for this purpose. Owners must notify the Department within thirty days of any transaction or occurrence causing the qualified family-owned business interest to fail to qualify for the exemption. A failure to comply with the certification or notification requirements results in the loss of the exemption.

Rationale

Proponents of the new exemption argued that the Pennsylvania inheritance tax inflicts “an especially disruptive and destructive burden on family-owned businesses. The transfer of productive business assets at death often results in the sudden need to liquidate essential business resources (or sometimes the entire business) to raise the cash necessary to pay the tax bill, all at a time when the business and its employees are most vulnerable, in the aftermath of the death of a principal owner.” (Memo by Representative Stephen Bloom in regard to similar legislation – The provisions of Act 52 are similar to, but do vary, from those that were contained in Rep. Bloom’s House Bill 48 of 2013, which he referred to as the “Mom and Pop Shop Death Tax Elimination” legislation].

The House Committee on Appropriations estimates that the new inheritance tax small business exclusion will cost Pennsylvania $3,800,000 in lost tax revenues in the 2013-2014 fiscal year.

It appears that the exemption takes effect immediately (July 9, 2013) and should apply to the estates of decedents dying on or after that date. (See Act 52 Section 44(6)).