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Pennsylvania Enacts New Inheritance Tax Exemption for Family Owned Business Interests

April 9, 2014

The Pennsylvania Legislature passed House Bill 465 which was signed into law by Governor Corbett on July 9, 2013.  House Bill 465 modified 72 Pa. Stat. § 9111 titled “Transfers not subject to tax,” to include subsection (t), a new exemption from the Pennsylvania Inheritance Tax for a “qualified family owned businesses interest” (“QFOBI”) provided such interest passes to a qualifying transferee (“QT”).   Prior to the QFOBI exemption, all family owned business interests were subject to tax and were exposed to different tax rates depending upon to whom the interest was transferred.  House Bill 465 dramatically changes the inheritance tax landscape.   

The Inheritance Tax rate is as follows: 0% tax for transfers to spouses and charitable organizations; 4.5% to children, grandchildren, or parents; 12% to siblings; and 15% for transfers to any other persons.  This structure resulted in significant potential tax liability for family owned businesses. For instance, if a child receives from his parent a family business valued at $1,000,000, the child would incur a $45,000 tax on the transfer.  The estate or transferee may not have the liquidity to pay the tax, which could force families to sell the business or certain business assets to raise funds to pay the Inheritance Tax.  This problem prompted the Pennsylvania Legislature to pass the QFOBI exemption.

To qualify for the QFOBI, a business must satisfy certain criteria.  A QFOBI must be a sole proprietorship or an interest in an entity carrying on a trade or business; that has less than 50 full-time employees; a net book value less than $5,000,000 (the whole business, not merely the decedent’s interest in it); has been in existence for five years up to the decedent’s death; is wholly owned by the decedent or the decedent and other QTs; and is engaged in trade or business other than the management of investments or income producing assets.  One of the most important features of the new exemption is the use of book value calculation to determine the value of a QFOBI.  Book value is an accounting concept and is determined by subtracting the company’s liabilities from assets.  Therefore, goodwill will generally not be taken into account in determining whether the book value threshold is exceeded.

Provided a business interest meets the statutory requirements as a QFOBI, the interest must be transferred to a QT.  A QT is one of the following classes of persons: a spouse; lineal descendants (children, grandchildren, or great grandchildren, but not their spouses); siblings and siblings of lineal descendants (brothers, sisters, nephews and nieces); and ancestors and ancestor siblings (parents, grandparents, uncles, aunts, grand uncles and grant aunts).  If a QFOBI passes to one or more of these classes of persons, the receiving QT must then own the QFOBI for seven years after the transfer and must report the QFOBI on their inheritance tax return.  Additionally, the QT must file an annual certification with the Pennsylvania Department of Revenue certifying they still own the QFOBI.  Failing to certify ownership annually, or failing to maintain ownership of the QFOBI for seven years, will result in the QT owing the inheritance tax rate above based upon the fair market value of the business interest.

This new exemption provides planning opportunities.  One of the more beneficial planning items is the net book value requirement of $5,000,000.  While the requirement is based upon the value of the entire business, the new exemption does not limit the decedent to one QFOBI.  With proper planning, a decedent can have multiple businesses qualify as a QFOBI.

It is particularly important for family owned businesses to satisfy the QFOBI book value requirement of less than $5,000,000 because if they fail to do so the inheritance tax will be based upon the fair market value of the business, which could be much higher. For example, a business with a book value of $6,000,000 might have a fair market value of $10,000,000.  If this business is transferred to the decedent’s child, an inheritance tax of $450,000, based on the $10,000,000 fair market value, would be levied.

One hurdle in the exemption is that a QFOBI must be wholly owned by the decedent or owned jointly with a member of the decedent’s family who must meet the definition of a QT.  Consequently, when a family owned business has a non-family member as a partner/shareholder, the business doesn’t qualify as a QFOBI.  In PA, a same sex spouse is not deemed to be a spouse qualifying as a QT.  The spouses of lineal descendants (sons and daughter in-laws), ancestors (mothers and fathers in-laws) and siblings (brothers and sister in-laws) are similarly not QTs.  Cousins also do not qualify as QTs.  Moreover, trusts for a person who would otherwise qualify as a QT do not qualify as a QT.  As a result, when a family owner dies with children under the age of 18 or when the only QT capable of receiving the interest is disabled, often a QFOBI would be transferred to a non-QT (in the form of a trust, or other non-qualifying individual) resulting in a loss of the exemption.

While not perfect, the new QFOBI exemption provides many new opportunities for family owned businesses to reap a significant tax benefit through proper planning.

For more information regarding the new Inheritance Tax or an estate planning matter in general, contact Gary A. Zlotnick at gazlotnick@zarwin.com, Chairman of Zarwin Baum’s Estate Planning Practice Group, or call Gary at 215-569-2800.


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