Estate and Inheritance Taxes

An Inheritance is not “income”, like your paycheck. Like a gift, an inheritance is not subject to income tax. After you receive and invest your inheritance, any future income created such as interest or dividends is income subject to federal and state income taxes.

The Pennsylvania Inheritance Tax Rates depend on who is inheriting the asset. The tax rate for transfers to parents or descendants (such as children and grandchildren) is 4.5%, 12% for siblings and 15% for others. Transfers to spouses and charities are not taxed. For more information, see Understanding the Pennsylvania Inheritance Tax.

The New Jersey Inheritance Tax rate starts at 11% and rises to 16% depending on the amount inherited. For more detail, see Understanding the New Jersey Inheritance Tax.

The New York Estate tax is a tax on the estate’s gross value, so smaller estates pay no tax. Starting on April 1, 2017 only estates over $5.25M are subject to the tax. In 2019, the rate matches the Federal Estate Tax Exemption. The tax rate varies from 5% to a top 16% rate, depending on the estate’s size.

The taxes due at your death will depend on many factors, such as residence. If you are a Florida resident, there is no state inheritance or estate tax, but if you are a Pennsylvania Resident there is a Pennsylvania Inheritance Tax. The location of your assets will also matter. For example, even though you might die a Florida resident, your Pennsylvania real estate is still subject to the Pennsylvania Inheritance Tax. Other taxes apply, such as capital gains taxes and your final state and federal income taxes. A good estate plan requires reasoned analysis of your assets and the potential taxes. Each estate is different, so only an examination of your assets can answer your question. Once analyzed, an Estate Plan can help reduce or even avoid taxes.

While some states like Florida have no inheritance tax, others, such as Pennsylvania have the Pennsylvania Inheritance Tax and New York, have the New York Estate Tax. If you live in a state with an Inheritance or Estate Tax, there are techniques to avoid the tax. Depending on your situation, an Irrevocable Trust can be an excellent tax reducing tool, such as a SLAT or an ILIT. These trusts all come at a cost. For example, you might avoid the Inheritance Tax but lose your step-up in basis. The only way to determine what, if any, tax reduction Estate Planning tools will work for you is to analyze your estate. This way you can identify the pros and cons and decide if tax avoidance is best for you.

The Pennsylvania Inheritance Tax includes all assets you gifted within one year of your death. For more detail, see Understanding the Pennsylvania Inheritance Tax. So, if you give away your house and live one year you can avoid the Pennsylvania Inheritance Tax, but there are many negative aspects to this plan. Firstly, your children own the house, and you are a renter. Your home might be taken away if they divorce, die or get sued. Second, at your death, the house does not get a “step-up in basis,” so your children may pay much more in capital gains taxes than they would have paid in Inheritance Taxes. Third, you lose your ability to shelter the house in Dynasty Trusts. Fourth, you will lose any real estate tax deductions or reductions you may have as the owner. There are many other negatives, depending on your particular circumstances. Before making a gift of your house, I suggest we brainstorm the options. There are many ways to reduce Inheritance Tax without having your house end up owned by your son-in-law!

Most states do not have a Gift Tax. If you are not worried about the Federal Gift Tax, then giving relatives gifts has no tax effect. For example, if you live in Philadelphia and give each uncle $100,000 in 2017 creates no Pennsylvania Inheritance Tax. But, if you die within one year of making the gift, your death triggers the tax. For more, read Understanding the Pennsylvania Inheritance Tax.