Pennsylvania Estate Tax

Pennsylvania Estate Tax

Note: Act 46 of 2003 - signed in late December 2003 - changed the Pennsylvania Estate Tax for a second time in recent years. This Article has been revised to reflect those changes.

Pennsylvania's temporary experiment in preserving and perhaps enhancing revenue by changing the Pennsylvania Estate Tax was ended by Act 46 of 2003. A bit of historical background might be helpful to those unfamiliar with the situation. Pennsylvania has, for many years, imposed two different "death" taxes - the commonly known Pennsylvania Inheritance Tax and the less familiar Pennsylvania Estate Tax. Pennsylvania Estate Tax has been what is sometimes referred to as a "gap" tax. If the Pennsylvania Inheritance Tax in a particular estate was not as large as the credit given to the estate under the Federal Estate Tax law, then that "gap" was closed by imposing a second Pennsylvania tax - the Pennsylvania Estate Tax. In this way, the Commonwealth of Pennsylvania - not the estate - received the full benefit of the credit under the federal law. The estate received no benefit whatsoever from that particular credit. The old (and temporarily, the new) Pennsylvania Estate Tax generally became relevant for a particular estate where there was a large taxable estate for Federal Estate Tax purposes when contrasted with the size of the taxable estate for Pennsylvania Inheritance Tax purposes. For example, life insurance is not subject to Pennsylvania Inheritance Tax but is subject to Federal Estate Tax in many cases. Thus, an estate with large life insurance proceeds (that were not sheltered from Federal Estate Tax by an Irrevocable Life Insurance Trust or another arrangement) might have a large taxable estate for Federal Estate Tax purposes. The size of the state death tax credit was linked to the size of the taxable estate. Therefore, such an estate might generate a large state death tax credit under the federal law. However, because the life insurance was not taxable for Pennsylvania Inheritance Tax purposes, it might not generate much of a Pennsylvania Inheritance Tax. This could create a "gap" that would subject the estate to Pennsylvania Estate Tax.

Recent changes in the Federal Estate Tax law provide for a phase out of the state death tax credit. In 2004, it is reduced by seventy-five percent and that phase-out will eventually eliminate the credit and replace it with a deduction in 2005. These changes mean that Pennsylvania's revenue from the Pennsylvania Estate Tax is being phased out as well. Responding to this potential loss of revenue, the Pennsylvania legislature changed the law, removing the link between the current Federal Estate Tax and the Pennsylvania Estate Tax. The Pennsylvania law temporarily provided that the Pennsylvania Estate Tax was based upon what the federal credit would have been under the old federal law - how an estate would have been taxed under the law that existed on June 1, 2001. Under that law, estates in excess of $700,000 of persons who died in 2002 or 2003 were potentially subject to Federal Estate Tax. Thus, any estate that was worth more than $700,000, had the potential to generate a Pennsylvania Estate Tax.

In order to determine whether there would be any Pennsylvania Estate Tax for a particular estate, a three-step procedure had to be performed. First, the Pennsylvania Inheritance Tax was calculated under the current Pennsylvania law. Second, the computation for Federal Estate Tax was performed under the June 1, 2001 federal law to determine if any state death credit would have been employed against the Federal Estate Tax. Third, if any state death credit would have been employed against the Federal Estate Tax under the step two computation, then that figure was compared to the step one Pennsylvania Inheritance Tax calculation. If the Pennsylvania Inheritance Tax was equal to or greater than the "old" federal credit, then there was no Pennsylvania Estate Tax. However, if Pennsylvania Inheritance Tax was less than the "old" federal credit, then there was a Pennsylvania Estate Tax equal to the "gap" between those two figures. Wisely, the Pennsylvania legislature retroactively repealed these changes and restored the "old" Pennsylvania Estate Tax. In 2004, it again taxes the gap, if any between the current Federal State Death Tax Credit (now reduced to twenty-five percent of its former amount under federal law) and the Pennsylvania Inheritance Tax. The reduction in the federal credit means that it is now less likely that the tax will be applicable.

Warning: This Article is for informational purposes only and does not constitute legal advice. The summary of the law ignores many variables . The particular circumstances may affect a person's tax obligations. You should consult an attorney in the state where you reside to determine how the taxes should be calculated in your particular situation and what tax savings might be available and you should not act on any information contained here.

Notice Pursuant to Final Regulations Under Circular 230, effective June 20, 2005

The opinions contained in any communication on the web site are not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code.

Fromhold Jaffe & Adams
Attorneys at Law
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Villanova, Pennsylvania 19085
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www.fromholdjaffe.com

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