Pennsylvania’s Family Business Death Tax on Life Support
June 27, 2013
The Pennsylvania inheritance tax’s days may be numbered. In a remarkable demonstration of bipartisanship, the Pennsylvania House of Representatives unanimously passed legislation exempting family-owned businesses from the inheritance tax. If cleared by the Senate and signed by the governor, the reform would apply to any estate transferred June 30, 2013 or after. This date is also the state’s budget deadline, so lawmakers will have to move quickly.
Typically, an inheritance tax is levied on a decedent’s estate when it is transferred to a beneficiary (“decedent” is just a fancy word for the person who died and passed along their estate) and calculated as a percentage of the overall transferred amount (often subject to certain exemptions). Pennsylvania’s death tax ranges from 4.5 percent to 15 percent depending upon the heir’s relation to the decedent (a common practice in state inheritance taxation). The different rates in the Keystone State are as follows, based on transfer type:
- 0 percent on surviving spouses, parent-to-child transfers (if that child is 21 or under), property that is jointly-owned between husband and wife, charitable organizations, government institutions, and other “exempt institutions" (effectively exempting these from the tax);
- 4.5 percent on direct descendants and lineal heirs;
- 12 percent on siblings; and
- 15 percent on all other types of heirs.
All assets, including business equipment, are subject to the tax regardless of whether or not the business is earning profits. Small businesses are sometimes forced to sell off valuable assets, fire employees, or even shut down altogether to avoid significant losses which would be incurred by the tax. Simply complying with the tax can be incredibly costly because many small businesses are forced to hire accountants and lawyers to wade through the complex rules and regulations. For example, the instruction packet (PDF) alone for filing a Pennsylvania inheritance tax return is 27 pages.
Last year, a measure was enacted (PDF) that exempted “real estate used in the business of agriculture” from the tax, as long as that real estate is transferred to a family member, was involved in agricultural business at the decedent’s time of death and for the following seven years, and produces more than $2,000 in annual gross business income for a seven year period after death. Critics argued that other family businesses experience the same issues—why should only family farms be exempted?
Lawmakers seek to address that question this year by using last year’s law as a model. The new legislation provides relief to small businesses by exempting the transfer of a family-owned business to another family member from the inheritance tax. The Pennsylvania House Appropriations Committee estimates that this will save small businesses approximately $3.8 million over the next year.
What does this mean for the ultimate fate of Pennsylvania’s death tax? These recent changes indicate a transition away from inheritance taxes towards a more business-friendly tax code. Pennsylvania’s inheritance taxes only generated $830 million (PDF) in state general fund revenue in 2011-2012, which was just under three percent of total tax revenue for the year. While completely eliminating inheritance taxes would be ideal, chipping away at these revenues through exemptions is a step in the right direction. As the exemptions reduce the importance of the inheritance tax as a revenue-generating mechanism, it will become more feasible over time to eliminate the tax entirely.
Estate taxes function similarly to inheritance taxes but the rates do not change based upon the decedent’s relationship to the heir. Polls conducted by the Tax Foundation show that people view the estate tax as the least fair form of taxation, and 68 percent of people support repealing it. As we explain here in the Huffington Post, the estate tax imposes significant compliance costs, is a detriment to capital formation (a key ingredient for economic growth), may actually increase inequality, and isn’t paid for by large wealth dynasties at which many death tax advocates often target.
Pennsylvania’s move away from inheritance taxes is a big victory for family-owned small businesses and the state in general. Hopefully lawmakers will continue the trend—or put the final nail in the inheritance tax’s coffin by going for a full repeal.
More on Pennsylvania here.
More on estate taxes here.
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