Estates and inheritances are subject to several kinds of tax if you reside in Pennsylvaniaa. No one likes to pay tax! I know how to help my clients save taxes on estates, both through advance lifetime estate planning, and later while administering an estate left behind by a decedent.
Today we focus on taxes that are assessed at the time someone has died. There is not space here to describe these taxes in detail nor is this an exhaustive list. These suggestions are by necessity broad and general in nature.
The main taxes that apply are:
Pennsylvania Inheritance Tax
This tax applies to the value of almost everything that you leave behind, except life insurance on your life. The flat tax rates in a nutshell are 0% for a surviving spouse, charity or minor child, 4 ½% for descendants, 12% for siblings, and 15% for any other relative or friend. PA Inheritance tax also applies to almost all gifts made less than a year before dying.
There are a variety of Federal Income Taxes potentially due on an inheritance:
- Deferred Income Tax on a Retirement account (IRA, 401K etc). Under the Federal “Secure Act 2.0”, income tax may be owed on the entire amount in an “inherited IRA.”Under the Secure Act, a beneficiary has to take all the money out within 10 years and pay income tax on the proceeds withdrawn each year. There are exceptions for spouses, disabled or chronically ill people, minor children and others. These exceptions can allow them to stretch out the withdrawals and defer the tax ‘till later. An inherited Roth IRA is subject to this 10-year withdrawal requirement, but no more tax will be owed.
- Capital gain tax on the sale of appreciated inherited assets. The beneficiary’s basis (cost) of the inherited asset is often “stepped up” to the value of the asset on the date of death. Assets sold soon after i receipt, therefore, generally do not generate a capital gain. Assets sold later may generate a gain or loss.
- Dividends and Interest Income. Income tax also applies to certain taxable ordinary income in an estate on e.g. dividends and interest income.
- Federal Estate Tax only applies to multimillionaires. In 2024, you can leave behind about $13 million per person, or $27 million per couple before you owe any Federal estate tax (at rates from 18% to 40% on the taxable part). In 2026 that amount comes down by half and an individual can leave about $7 million, or $14 million per couple.
Tax Saving Strategies
Here are some strategies to save on some of these taxes, either in advance, or , after someone has died.
PA INHERITANCE TAX: One way to avoid this tax is to move your legal residence to a State without an Inheritance/Estate tax, like Florida.
Lifetime gifts either outright or through an irrevocable trust made more than a year before you later pass away can save PA inheritance tax. However, the tax will still apply if you retain the use and enjoyment of property, or keep the income even though you give up right to the principal.
One way to reduce (but not eliminate) PA inheritance tax is by joint ownership of property (again, if created more than one year before you die) such as on a joint deed to a house, or joint depositors with right of survivorship on a bank account. Note that mere Pay on Death beneficiary designations, short of actual joint ownership or title, leave the inherited assets still completely taxable.
For unmarried life partners, biting the bullet and tying the knot by marrying – even at the last minute – lowers the applicable tax rate from 15%, all way down to 0% for a spouse.
Yet another strategy is to use taxable resources to buy life insurance, instead, which is not subject to PA inheritance tax.
Federal Taxes
DEFERED INCOME TAX ON IRAS AND APPRECIATED ASSETS: tax planning for inherited retirement accounts is all about who you leave it to. To start, a roll over to a surviving spouse is most often the most effective strategy.
When you have flexibility to choose, sending taxable retirement account money to “qualified designated beneficiaries” who can stretch out and defer the tax payments, or to lower income recipients, can also be effective.
If you have charitable intentions, funneling retirement account money that would be taxable if received by an individual, to a tax exempt charity instead, means no income tax on that money.
For appreciated assets, always be careful to preserve the step up in basis whenever possible in any transition planning.
FEDERAL ESTATE TAX: If you are in this territory based on accumulated wealth, you may need advice and planning beyond the scope of this brief article.
Suffice it to say that if a couple has more than the applicable individual exclusion amount, e.g., more than about $13 million now, then on the death of the first spouse, it’s important to promptly file a Federal Estate Tax return on the death of the first spouse to die – even if no tax is actually yet due – to secure and preserve the exemption amount in the estate of the first spouse and not lose it, by “transporting” that protection amount forward, for use at the second death.
Also, there are steps that you can take between now and the end of next year to preserve the greater exemption amount, before it’s cut half at the end of 2025.
Finally, there’s a very common misconception about the annual gifting limit, currently $18,000 per person per year. Unless you are wealthy enough to owe Federal Estate Tax later, this limit has no practical effect or bottom-line impact on you, even if you make a gift exceeding that amount.
