By David S. Markle, CPA, PFS, CFP, CGMA

Few Pennsylvania residents need to worry about paying the federal estate tax, but this does not absolve anybody from the need for estate planning. When I do any kind of financial planning with clients, I recommend that everyone’s estate plan include the following:

• A will
• Durable power of attorney
• Durable health care power of attorney
• Letter of instruction

A letter of instruction is to the executor to help divide the decedent’s personal assets that are not mentioned in the will, such as jewelry or the family grandfather clock.

The biggest estate planning issue for Pennsylvania residents is the state inheritance tax. Every estate that files a death certificate with the county register of wills should file a Pennsylvania inheritance tax return, even if the balance due is zero. The estate has nine months from the date of death decree to file a return; any inheritance tax liabilities paid within three months receive a discount. A good planning technique is to estimate the inheritance tax liability and prepay within the first three months to receive the discount. The return can be filed up to the due date when the final asset values are known.

You may not know the true value of the estate within three months because most include real estate. If the beneficiaries want to sell a house or land, the appraised value may differ from the actual sales price. The actual amount received is the taxable value that goes on the inheritance return if sold before the return due date, not the appraised value.

Here are some of the common pitfalls that can happen regarding the state inheritance tax that you may be able to plan around.

• Gifts made within one year of the death of the transferor are subject to inheritance tax less a $3,000 exclusion. So, if a parent gives the federal gift tax exclusion amount of $15,000 to a child, but dies within a year’s time, $12,000 ($15,000 - $3,000) is included on the inheritance tax return.
• A parent puts the checking or savings accounts in joint ownership with a child. It may be a good intent so that the child can help her parent pay bills, but there are two big pitfalls with this strategy. First, if the child predeceases the parent, then the parent will have to pay inheritance tax on half the value of the account. Second, once the account is listed as joint ownership, it is no longer controlled by the decedent’s will. The joint owner has no legal requirement to share the funds with siblings or use the funds for the parent’s intended purpose.
• A transfer of assets to a child or irrevocable trust with expressly or impliedly retain use, enjoyment, possession, or right to income is included in the decedent’s estate for inheritance tax purposes. An example would be a parent transferring the deed to their home to the child’s name, but continues to reside in the home and dies while living at the home.
• Another pitfall regarding the gifting of assets to children prior to death is that there is no step up in basis for the beneficiary. For example, if parents transfer the deed to their house to a child, the parents’ basis in the house becomes the child’s basis. Assume the parents’ basis is $30,000 and at the time of death the house is worth $200,000. The child sells the house after his parents’ death and has a taxable gain of $170,000 ($200,000 - $30,000). At capital gains rates, the child’s tax would be $34,000. Alternatively, if the property was included on the Pennsylvania inheritance tax return and instead inherited by a child, the tax would be $9,000. The potential savings is about $25,000 by including the property on the inheritance return.

There are a few final items to keep in mind regarding Pennsylvania inheritance tax. There are agriculture and small-business exemptions available for inheritance tax. The tax rates are as follows:

• Spousal = 0%
• Child under age 22 to parents = 0%
• Decedent to lineal descendants = 4.5%
• Decedent to sibling = 12%
• All other transfers = 15%

Estate planning in general, and Pennsylvania inheritance tax in particular, is a complex area. You should consult with an experienced team of professionals, which may include an attorney, CPA, and financial adviser specializing in estate planning, to help you develop your individual estate plan.

David S. Markle, CPA, PFS, CFP, CGMA, is financial adviser and owner of Markle Wealth Management in Danielsville, Pa. He is chair of PICPA’s Lehigh Valley Chapter CPE & Personal Financial Planning Committee, and a member of PICPA’s state-level Personal Financial Planning Committee.

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