New Inheritance Tax Exemption For Family Businesses In Pennsylvania

Pennsylvania Inheritance Tax Break For Family Businesses

Pennsylvania has just created a new tax break for transfers of businesses to certain family members.  This new inheritance tax law applies to estates of some one who dies on or after July 1, 2013.

Qualification For Inheritance Tax Exemption:

To qualify for this Qualified Family Owned Business exemption under new Section 9111(t), the following criteria must be met:

• Type of Organization that qualifies can be either:
  • A proprietorship or
  • Entity

  engaged in a trade or business;

• The entity or proprietorship had a Net Book Value of Less Than $5,000,000 at the date of death;
• The entity or proprietorship had been in existence for 5 years at the date of death;
• The entity or proprietorship had less than 50 employees at the date of death;
• The entity or proprietorship must be wholly owned by the decedent and other qualified family members (defined as qualified transferees as defined below).
• The transfer of ownership must be to qualified transferee in most cases individual family members under Section 9111(t)(5).  A “qualified transferee” is the decedent’s spouse, lineal descendent, sibling (and the sibling’s lineal descendants) and ancestors (and the ancestor’s siblings). The exemption is lost if the business does not continue to be owned by a “qualified transferee” for seven years after the death of the decedent;
• Where the transfer of an interest into an entity took place within one year prior to death, such transfer must have been the result of a legitimate business purpose;
• Family Ownership after death must continue for 7 years.  If this period of ownership is not met then inheritance taxes will have to be paid when ownership ceases. This is the so-called recapture tax and must be reported if this ownership period is not met.  Important Compliance Point: This requires annual certification to the Department of Revenue that the family-owned business interest qualifies for the exemption, as well as notification to the Department of Revenue within 30 days of any failure to qualify;
• Any expenses or debts related to or incurred in connection with this exemption are not allowed under new Section 9130 (5).

Entities Engaged In Investment Activities Do Not Qualify For This New Exemption:

This tax break is not available to entities with a principal purpose of “management of investments or income producing assets” held by such entity.  Section 9111(t)(5). The principal purpose of an entity cannot be simply managing its own investments.

Estate Planning Implications:

A cursory look at the new law appears to show that transfers to trusts would not be eligible for exemption.  Those attempting to do estate planning where they own an active business in Pennsylvania may have a very difficult choice to make.  They can either give the business outright to children to save inheritance taxes or they must give up this exemption if  family issues, financial reasons or federal estate tax considerations dictate the use of trusts.  For more insights into these estate planning implications please read Estate Planning 2013: Now What? A Must Read For Everyone.

Final Thoughts:

Since this law is so new and some of its terms may not be fully understood or defined, more guidance will probably be forthcoming from the Pennsylvania Department of Revenue.  Stay tuned.