Inheritance Tax Exemption for Small Businesses
Pennsylvania recently passed 72 P.S. § 9111(t), specifically aimed at eliminating the Pennsylvania inheritance tax on small family-owned businesses. The Pennsylvania Inheritance Tax is imposed at a 0-percent rate for transfers to a spouse, a 4.5-percent rate for transfers to descendants, a 12-percent rate for transfers to siblings, and a 15-percent rate for transfers to other individuals.
This new statute exempts from inheritance tax the transfer of a "qualified family-owned business" to "qualified transferees." There are specific rules that must be met in order to obtain the exemption from inheritance tax. The business asset must pass to a qualified transferee, which is limited to a spouse, descendant, sibling, sibling’s descendant, ancestor and ancestor’s sibling. The business itself must have (i) fewer than 50 full-time employees, (ii) a net book value of less than $5 million, and (iii) been in existence for at least five years prior to the decedent’s death. The business must also be wholly owned by the decedent or the decedent and members of his or her family.
If the exemption is met, the business must continue to be owned by the family for a period of seven years following the decedent’s death. If during this seven-year period the business ceases to be owned by the family, or if the family fails to file the required annual certification, then the inheritance tax that would have otherwise been due must be paid, plus interest accruing from nine months after the decedent’s death.
This new law is aimed specifically at small family-owned businesses, but leaves numerous unanswered questions, including whether or not business entities owned by trusts can qualify. Despite these unanswered questions, under certain circumstances this new law could prove to be valuable for certain clients whose businesses have net book values under $5 million.
Taxation of Pennsylvania Resident Trusts
The Pennsylvania income tax is imposed on "resident trusts." A resident trust is defined as one that was created under the will of a decedent who was a Pennsylvania resident at the time of his or her death, or a lifetime trust established by a person who was a Pennsylvania resident at the time the trust was established. Under Pennsylvania law, the trust remains subject to Pennsylvania income tax whether or not the settlor, trustee, or beneficiaries continue to have any contact with Pennsylvania. The recent case of McNeil v. Commonwealth of Pennsylvania, Pennsylvania Commonwealth Court, No. 651 F.R. 2010 (May 24, 2013), casts doubt on the validity of Pennsylvania’s application of the law. In McNeil, two trusts were established by a Pennsylvania resident. The trustee was a Delaware company and all of the assets were located outside of Pennsylvania. The permissible beneficiaries of the trusts were all Pennsylvania residents. The Commonwealth imposed an income tax on the trust based on its position that "once a Pennsylvania trust, always a Pennsylvania trust." The matter was eventually heard before the Commonwealth Court, which found that the imposition of Pennsylvania income tax against the trusts violated the Commerce Clause of the Constitution, because there was not sufficient contact with Pennsylvania to justify the imposition of the tax.
The McNeil case casts doubt on the constitutionality of Pennsylvania’s continued position that income tax is imposed on a resident trust even if the trust has no further contact with Pennsylvania. To date, Pennsylvania has not announced any change in its position. Nevertheless, a trustee in this situation should consider filing a protective refund claim. We will continue to keep you updated.