By Joe Marmorato, CPA
Tax laws often treat married couples and cohabitating couples differently. While there can be significant tax advantages to those who do tie the knot, there can be some tax drawbacks as well. The Pennsylvania inheritance tax is not one of those areas where there is a tax drawback to marriage. In fact, it is the unmarried who encounter a more difficult tax situation with inheritance.
Pennsylvania is one of the few states with an inheritance tax, which technically requires a beneficiary to pay tax on any assets they receive from a decedent. An inheritance tax should not be confused with an estate tax. While both are considered “death taxes,” the estate tax requires a person’s estate to pay the tax bill before any assets are distributed to beneficiaries. Pennsylvania currently has no estate or gift tax.
The state’s inheritance tax is based on the value of the decedent’s assets on the date of his or her death. Most real and tangible personal property located in Pennsylvania is subject to this tax. This property usually includes someone’s personal residence, automobiles, and various other collectibles. Intangible personal property owned by a resident of Pennsylvania is also subject to the tax. These assets generally include stocks, bonds, bank accounts, closely held business interests, and most retirement accounts (though it doesn’t apply to IRAs held by the decedent if they passed before the age of 59 ½). The inheritance tax even applies to certain nonresidents who own personal and real property in Pennsylvania.
The relationship between the beneficiary and decedent determines the amount of tax owed. The current Pennsylvania inheritance tax rates are as follows:
- 0% - Transfers to a surviving spouse, children 21 or younger, charitable organizations, and governmental entities
- 4.5% - Transfers to direct descendant heirs (child, stepchild, grandchild, or great-grandchild)
- 12% - Transfers to siblings
- 15% - Transfers to all other heirs
Married couples have a significant advantage over unmarried couples when it comes to the inheritance tax. The 0% tax rate applies to surviving spouses only; it does not apply to unmarried couples. In fact, nonmarried individuals will be subject to the highest tax rate of 15%. So, for example, an unmarried individual who inherits a $500,000 IRA from a life partner upon their passing would pay up to $75,000 in inheritance tax. A married couple would pay nothing.
Unmarried couples who jointly own property can’t escape this tax either. The inheritance tax will apply to the decedent’s fractional interest held in the jointly owned property. This is calculated by dividing the total value of the joint property by the number of joint owners at the time of the decedent’s death. So, for an unmarried couple that owns a home together, a tax of 15% would apply to half of the value of the house upon the death of the first partner, even if the couple had lived there together for decades.
There is, however, some relief that can help lessen the inheritance tax burden for unmarried couples. For instance, deduction for estate expenses and debts of the decedent are available to claim when arriving at the overall inheritance tax. Pennsylvania also does not impose its inheritance tax on some assets. Life insurance proceeds and certain qualified family-owned business interests are exempt. Residential real estate owned outside of Pennsylvania (even by a resident decedent) is also exempt. Pennsylvania even allows 5% discount on tax payments made within three months of the decedent’s death (excluding any amounts that may be subsequently refunded).
There are other important tax benefits to manage. As a matter of fact, the federal tax code includes numerous favorable provisions for married taxpayers, including the same unlimited marital deduction that Pennsylvania has for transfers to a spouse at death. One such benefit came out of the SECURE Act that was signed into law on Dec. 20, 2019. This act changed the way inherited IRAs are taxed for nonspousal beneficiaries. A spouse that inherits the partner’s IRA account has the ability to roll it into his or her own IRA and spread the required distributions over their lifetime, potentially allowing for years of tax-deferred growth. For an unmarried individual who inherits their partner’s IRA, he or she may be required to receive the balance of the account within 10 years, which could result in higher income taxes due over a shorter period of time.
Married or not married, having a comprehensive estate plan in place and an understanding of the particular tax obligations is essential to ensure assets pass to loved ones as planned and are subject to the lowest tax possible.
Joe Marmorato, CPA, is manager of tax planning with Domani Wealth in Lancaster, Pa. He can be reached at firstname.lastname@example.org.
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