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New Pennsylvania Law Provides Death Tax Savings for Family Businesses

On July 9, 2013, Governor Tom Corbett signed into law an exemption from the Pennsylvania Inheritance Tax (the "PIT") for certain family businesses owned by decedents passing away on or after July 1, 2013.  With proper planning, this exemption can potentially save beneficiaries hundreds of thousands of dollars in tax and alleviate liquidity problems that arise when a family has to pay the PIT. 

PIT Generally
The PIT is a transfer tax imposed on the value of a decedent's assets transferred to a beneficiary by virtue of the decedent's death.  The PIT rate is based on the beneficiary's relationship with the decedent.  The PIT rates are currently zero percent to spouses, charities and governmental entities, 4.5 percent to children and lineal descendants, 12 percent to siblings, and 15 percent to all others.

The Exemption
The recently passed Family Business Exemption (the "Exemption") allows an individual to pass on a "family business" to certain qualified transferees free of PIT.  In order to qualify for the Exemption, the "family business" must meet the following criteria:  1) the business must be in a trade or business whose purpose it not the management of investments or income producing assets; 2) the business must have a net book value of less than $5 million at the time of the decedent's death; 3) the business must have less than 50 employees; 4) the business must be wholly owned by the decedent and/or the decedent's spouse, lineal descendant, sibling and the sibling's lineal descendants and ancestors and the ancestor's siblings (the "Qualified Transferees"); and 5) the business must continue to be owned by the qualified transferees for a period of seven years (the "Exemption Period") after the decedent's death.  The business can be set up as an entity (that is, LLC, partnership, or corporation) or as a sole proprietorship. 

The Qualified Transferees must certify to the Pennsylvania Department of Revenue each year of the Exemption Period that they continue to own the business.  Furthermore, the Exemption requires notification to the Pennsylvania Department of Revenue within 30 days from the date that the business no longer qualifies for the Exemption.  If the business is not retained by Qualified Transferees for the entire Exemption Period, the PIT will then become due, together with interest from the original due date. 

An Example
To illustrate the potential PIT tax savings created by this Exemption consider the following example:

Suppose that Bob owns 100 percent of a manufacturing business with a net book value (and fair market value on date of death) of $5 million.  Bob has a Will that passes his business to a child.  If the business fails to qualify for the Exemption, the PIT due by virtue of the transfer of the business would be $225,000 (4.5 percent PIT rate times $5 million).  If the business qualifies for the Exemption (and continues to qualify for the entire Exemption period) the total PIT due would be zero---a $225,000 tax savings.  The tax savings could be as high as $750,000 if Bob wanted to pass the business to a niece or nephew (15 percent PIT rate times $5 million).

Potential Pitfalls
While the Exemption can be very beneficial, the business owner (and Qualified Transferees) must be careful when claiming the Exemption.
  • The Exemption is not available for business interests held by Qualified Transferees in trusts.  Therefore, the business interests must be owned outright by all owners.
  • If the business is not owned solely by the Qualified Transferees fir the entire Exemption Period, then the PIT is due with any applicable interest.
  • The business owner cannot use the Exemption as a means to transfer other assets.  Assets transferred to the business within a year of death are not entitled to the Exemption unless such a transfer was done for a legitimate purpose.