It is tax season and, due to COVID-19 related extensions, will continue to be for some time. With this topic in mind, what are the taxes that need to be considered when someone dies? There are several categories of taxes.

Income tax.  Income tax must be filed for the last year of life of the individual. Also, you need to confirm that prior tax year income tax returns have been filed and accepted.

Inheritance tax. In Pennsylvania, there is an inheritance tax. Currently only six states still collect this tax. These states are: Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. Generally, the state law that applies is the state where the person had her primary residence at the time of death. Each of these states has its own inheritance tax rules.

The Pennsylvania inheritance tax rate is based on the relationship between the person who died (decedent) and the person who inherits (“beneficiary” or “heir”). If someone dies without a will he is said to die “intestate.” The intestacy law identifies the “intestate heir(s)” of this person’s estate.

Pennsylvania’s Inheritance Tax looks at who receives your assets – the recipient of your 401(k), annuity, IRA, joint bank account, or the recipient of your house or other personal property. The question is how is this person related to you? The tax rate is based on this relationship. Lineal descendants; those who are in your line of descendancy or ascendancy (i.e. parents, children, and grandchildren) pay tax at a rate of 4.5%. The next level of tax is 12% for collateral descendants, such as siblings. All other recipients of your estate are taxed at 15% (except that charitable organizations are exempt from inheritance tax). Good news! Did you notice that “spouse” is not mentioned? This is because there is a 0% tax rate for any property which passes to your spouse. (This 0% tax rate also applies to any distribution to a parent from a child under the age of 21).

Pennsylvania inheritance tax is paid on both probate and non-probate property. (Pennsylvania does not apply inheritance tax to insurance proceeds). What do these terms mean? Assets are divided into different categories: “probate” and “non probate.” The assets mentioned above may all be “non probate” assets, depending on how they are titled, or designated. For example, if a decedent’s house is jointly owned with right to survivorship, it passes, at death, to the surviving spouse (or joint owner). If the asset is a joint bank account, same result, the account passes at death, by the nature of how it is titled. If an asset has a beneficiary designation, then, at death, this named beneficiary inherits this asset. None of these assets will be controlled by a will or intestacy laws, so they are “non-probate” assets. (Unless the person to whom this asset is intended to go has predeceased the decedent, then, the asset will become a “probate” asset because it must pass through the decedent’s estate). The inheritance tax rate applied is based on the relationship of the decedent to the recipient.

Probate assets are the assets owned only in decedent’s name that are not designated to go to a beneficiary. This is where a person’s Will matters.  Your Will provides specific instructions as to how you want your probate estate to be distributed and administered. If you do not actively give these directions during your lifetime, the Commonwealth of Pennsylvania has intestacy laws in place that determine this process. (There are other laws and rules that control this as well, depending on where and how your assets and debts are held and titled).

The intestacy law is your “default” will. This law determines how your estate will be administered in the absence of any direction from you. Just to be clear, the state doesn’t get everything if you do not have a will, as I have heard from concerned clients when we first meet. The law directs that the persons who receive your property (after your just debts have been satisfied; including taxes) are the closest surviving relations to the decedent in a particular, sequential order.

Federal Estate Tax. Currently, the federal estate tax exclusion for an individual is $11,580,000 (for 2020). Unless your estate exceeds this dollar amount, you do not have to pay federal estate taxes. Please note that this exclusion amount may change annually, so it is important to keep current on what this amount is. As a result of ALTA (the American Taxpayer Relief Act, signed into law in 2013) if you are married you may choose to use DUSE (decedent spouse’s unused exemption). You must make the specific election during the required time period, and the amount of the exemption not used for the deceased spouse’s estate may be added to surviving spouse’s exemption. These elections should be made in consultation with an estate attorney or accountant.

These are only three areas of tax liability to consider with respect to death and taxes. Other taxes, such as corporate taxes, capital gains taxes, and real estate taxes, come into play with many estates. If you have questions about estate administration or taxes, either after a loved one passes or for planning purposes, please contact an experienced estate attorney.

If you have questions regarding estate planning and estate administration or any of our other practice areas, contact any of our convenient offices. Wolf, Baldwin & Associates, P.C. can be reached toll-free at 866-967-8935 or through our online contact form.