Pennsylvania has an Inheritance Tax that applies in general to transfers resulting from a person’s death. The tax rate depends on the relationship of the recipient to the decedent (i.e., 0% for a spouse or parent of child under age 21; 4.5% for a lineal descendant or ancestor, 12% for a sibling and 15% for other taxable recipients).
Some transfers are exempt from the tax, and as of July 9, 2013, a new exemption was added (Act 52) concerning specified transfers in a qualified family-owned business that are reported on a timely filed Inheritance Tax Return.
Qualified Family-Owned Business
A qualified family-owned business is defined as a proprietorship or entity that was in existence with respect to a trade or business for five years prior to the decedent’s death and at the time of the decedent’s death has (i) fewer than fifty full-time equivalent employees and (ii) assets with a net book value less than $5,000,000. Further, an entity qualifies only if it was wholly owned by the decedent or by the decedent and eligible family members (i.e., spouse, lineal descendants, siblings, sibling’s lineal descendants, ancestors and ancestor’s siblings). Plus the entity must have a trade or business with a principal purpose other than the management of the entity’s investments or income-producing assets.
To prevent people from making transfers in contemplation of death merely to avoid tax, the new law provides that if the decedent added property to the qualified family-owned business within one year of death, such property will not be exempt unless it was added for a legitimate business purpose.
Valuation matters and the classification of employees may come under added scrutiny with the new law.
The exemption applies only if the decedent’s interest in a qualified family-owned business is transferred to one or more eligible family members (i.e., spouse, lineal descendants, siblings, sibling’s lineal descendants, ancestors and ancestor’s siblings.) Thus, the class of eligible transferees is the same as the class of family members who can have an ownership in a qualified family-owned business entity at the time of the decedent’s death.
The language of the new law does not state that the exemption applies to a transfer in trust for the benefit of family members included in the class of eligible transferees. Accordingly, it may be that only outright transfers qualify, but further clarification is necessary.
Also, because transfers to a spouse are already taxed at a 0% rate, the new exemption provides no immediate advantage in the case where a decedent transfers his or her business interest entirely to his or her spouse.
The exemption applies so long as a qualified transferee continues to own the transferred interest for at least seven years after the decedent’s death. If the exemption is lost, the business interest will be subject to tax as though the exemption never applied, with interest accruing from the original due date that otherwise would have been in effect. The owner at the time of the disqualification will have the personal obligation to pay the resulting tax and interest. During the seven-year period, each owner must certify to the Department of Revenue on an annual basis that the interest continues to be owned by an eligible transferee. Any transaction or occurrence that causes the qualified family-owned business interest to fail to qualify for the exemption must be reported to the Department of Revenue wi