A new tax-saving opportunity was created by a 2013 change in the Pennsylvania Inheritance Tax law. There is a new exemption for family-owned business interests that are passed on to certain other family members. The availability of the exemption depends upon a number of factors including the family relationship among the owners and the size of the business. With proper planning and implementation, this exemption can save substantial taxes. Pennsylvania Inheritance Tax is generally imposed at rates between 4.5% and 15%. The exemption reduces the tax on an exempt business interest to zero. An exempt business worth $500,000 could represent a tax saving between $22,500 and $75,000; an exempt business worth $3,000,000 could represent a tax saving between $135,000 and $450,000.
There are many planning opportunities for people with existing businesses. For example, owning income producing real estate might constitute a potentially exempt business. A business is potentially eligible for this exemption if its book value is less than $5,000,000. This is to be contrasted with traditional valuation methods for Pennsylvania Inheritance Tax based upon actual fair market value. The tax is imposed on the actual market value of the business but the business may qualify for this exemption based upon its book value. Thus a business with assets worth substantially more than $5,000,000 might still be eligible for the tax exemption. If the historical cost of the assets, less proper depreciation and less business debt is below that amount, it meets this requirement. Although book value must be below $5,000,000, the exemption places no limitation either on the actual market value of the exempt business or the size of the tax savings. For example, a real estate business with assets worth $10,000,000 - but with book value – cost less depreciation less debt - of $4,000,000 - could be fully exempt if properly structured – representing a tax saving between $450,000 and $1,500,000!
The law does not limit a person to a single family owned business. Therefore, a person who owns interests in multiple qualifying businesses may leave interests in a number of businesses to one or more qualified family members without having to pay Pennsylvania Inheritance Tax on the businesses. This provides another planning opportunity to greatly increase exempt assets. For example, a person might separate a business into a real estate owning entity and an operating entity – allowing each to be exempt even though the combined entity had a book value above the $5,000,000 limit. This separation will probably work if there is a legitimate business reason for the separate entities (beyond saving tax) but will probably not work for a sham separation. A classic example of a sham separation – in a wholly different context – was a taxi cab company that was really a single enterprise but that had each taxi incorporated as a separate entity to limit liability exposure.
The exemption may not be appropriate for every Pennsylvania small business owner. Where it is appropriate, this exemption can provide a substantial elimination or reduction of Pennsylvania Inheritance Tax if the business succession is properly planned and implemented. Many business owners might be able to take advantage of this exemption and save substantial taxes. However, they may have existing wills and estate plans or existing entity and ownership structures that would disqualify the tax exemption. In many cases, these problems could be easily cured now to make the tax exemption available later. The law contains certain minimum qualifying time periods so last minute or deathbed restructuring will not work. Like many aspects of estate planning, delay can destroy planning opportunities.
If you are a business owner in Pennsylvania, you should review your situation with a knowledgeable lawyer and see (i) whether you might take advantage of this new tax exemption and (ii) whether there are changes that might be made to your existing estate plan or existing business structure that would make you eligible for this tax exemption without negatively affecting your other tax, business or family planning. If you have not reviewed your overall estate plan for the last few years, this might be a good time to do that. At the same time, you might also want to see if the recent federal law changes have changed the way your will or trust operates. Because of the federal law changes, many people have wills (or trusts) that no longer provide the intended result or even create a horribly perverted result and they do not realize this problem. Even if you have reviewed your estate plan more recently, this new change in Pennsylvania law may warrant at least a brief review of the opportunities to take advantage of this new tax exemption.
If you have further interest in the family owned business interest exemption, please see a more detailed explanation of the new exemption and how to qualify to take advantage of the exemption.
See a separate article on this website about Pennsylvania Inheritance Tax generally.
This article is for information purposes only and is not intended to be legal advice. You should consult a lawyer about this exemption and how it affects you.
Copyright 2014 Marc H. Jaffe