In these tight budget times, the mention of taxes usually means a tax increase. Recently, however, when the Pennsylvania legislature talked of taxes, they made a significant change to the inheritance tax law that amounts to a huge tax-cut.
To understand the significance of this most recent change, it’s helpful to review the history of Pennsylvania’s inheritance tax law. Traditionally, the Pennsylvania inheritance tax had a very narrow exemption for transfers between the spouses. In basic terms, assets were exempt from tax only if the spouses owned them jointly. That is, in the past, the exemption didn’t apply if the property was owned solely by one of the spouses. For example, if a husband owned a bank account in his own name and left it to his wife under his will, the account was subject to a 6% inheritance tax even though it would pass to his wife. The tax was imposed because the account was owned solely by the husband and not jointly by the spouses. That was the case in Pennsylvania until last year when the legislature finally succumbed to the political pressure and got in line with the rest of the country by eliminating inheritance tax on transfers to a surviving spouse. That is, under the new law which was effective January 1, 1995, there is no longer any tax on assets that are left to a spouse.
In addition to eliminating the tax on transfers to a spouse, the new law made another change that creates new opportunities for Pennsylvania couples that have more sophisticated estate plans. This change has to do with trusts that are created for a surviving spouse. For example, a husband may leave property in trust for his wife for her lifetime, but direct that it pass to his children upon her later death. Under the new law, this type of trust will not be taxed upon the husband’s death, but rather, it will be taxed as part of the wife’s estate. Under the old law, tax would have been due when the husband died.
While expressly permitting such tax-free trusts for a spouse, the new law allows additional flexibility by allowing an election to be made when the first spouse dies. If the trust qualifies, the election permits you to choose between paying tax when the first spouse dies or deferring the tax until the second spouse dies. Making a wise choice in a particular case involves many considerations. But making the right choice will certainly reduce the overall taxes to be paid by the family.
The new law should be seen as a positive for all Pennsylvania residents and should cause many to review their estate plans. For example, couples who have always owned their assets jointly in order to avoid inheritance tax may now wish to consider retitling those assets to achieve other goals. Also, those who have plans that include trusts for a spouse should review those trusts to make sure they continue to be tax-wise under the new rules.