Unscramble Those Taxes
With the number and kinds of taxes in effect today, it is not surprising that average citizens become confused regarding what taxes apply to them and whether and when those taxes must be paid. Here is a summary of some of the most commonly held misconceptions regarding taxes on inheritances and estates that readers might want to keep for future reference.
Inheritance Taxes. Inheritance tax and estate taxes both affect estates but they are different. Most often a person referring to estate tax is discussing the federal Unified Estate and Gift Tax of which there is more below.
Pennsylvania is one of a minority of States that has an inheritance tax. The Pennsylvania Inheritance Tax affects all property of a deceased Pennsylvania resident and also some property, namely real estate located in Pennsylvania, of deceased non-residents. A Pennsylvania beneficiary does not have to pay Pennsylvania inheritance taxes when he inherits from out of state but whoever is settling the estate does have to check for taxes in that state.
The tax rate for Pennsylvania Inheritance Tax depends on the relationship of the person who inherits. Since husbands and wives have a 0% rate as to each other, they do not pay the tax although they might need to probate a Will to handle titling or other issues. Children and other lineal descendants such as grandchildren and great grandchildren currently pay at the rate of 4.5%. Brothers and sisters of the decedent pay at the rate of 12% and others including nieces, nephews, more distant relatives and friends pay at the rate of 15%.
Often the Pennsylvania Inheritance Tax is paid from the estate before the beneficiaries get the bequest especially if the Will is written this way so that
beneficiaries get the property after tax. Sometimes beneficiaries get confused and are concerned that they will owe income tax on their inheritance. They do not.
Another point of confusion is that heirs believe that probating a Will is what makes the property subject to Inheritance Tax. This is wrong. A Will can be
probated with no Inheritance Tax due as when the only person inheriting from the decedent is his spouse. On the other hand, even though no Will is offered for probate, if the decedent owned property that was titled as tenants in common or joint tenants with right of survivorship with another person not his spouse, Inheritance tax would still be due on the decedent’s proportionate share. The surviving joint tenant should pay the tax.
One major asset that is not subject to Pennsylvania Inheritance Tax, no matter who receives it, is life insurance.
Estate Taxes. The federal Unified Estate and Gift Tax is very complicated but here are some considerations.
First, Federal Estate Tax, unlike Pennsylvania Inheritance Tax, has an amount, referred to as the Unified Credit which is a threshold under which the tax does not apply. Currently, estates of less than $2 million do not pay the tax and next year, the unified credit is scheduled to rise to $3.5 million before the tax “abates” or goes away for one year in 2010. While the figure is high, it includes real estate including the family home, standard life insurance, retirement accounts, business interests, and other property. The tax rate is 45% for assets over the Unified Credit.
Spouses have an unlimited marital deduction so the problem presents itself, if at all, when both spouses have died and the children inherit. To prevent harsh tax results for their children, married persons may provide either by Wills or by Living Trusts for “By Pass” or “Credit Shelter” Trusts that continue during the lifetime of the surviving spouse and then can be passed on estate tax free to heirs on the death of the second spouse.
Gifting during lifetime to reduce the value of the estate using the “annual exclusionary amount,” currently $12,000 per person per year, is another possibility that may work with persons with assets in the Estate Tax range.
Two problems may arise. One is that couples with large estates may not plan and their heirs may be subject to the tax. Another is that persons with modest estates well under $2 million may innocently give $12,000 per year not realizing that, since passage of the Deficit Reduction Act effective February 8, 2006, gifts in such amounts can seriously affect the ability to receive Medicaid benefits if long term care is needed. Before distributing sizeable gifts, professional advice should be sought.
About the Author Janet Colliton
Esquire, Colliton Law Associates, P.C. Janet Colliton has practiced law for over 38 years, 37 of them in Chester County, Pennsylvania, a suburb of Philadelphia. Her practice, Colliton Law Associates, PC, is limited to elder law, Medicaid, including advice, applications and appeals, and other benefits planning including Veterans benefits, life care and special needs planning, guardianships, retirement, and estate planning and administration.