New PA Laws Provide Opportunities for Inheritance Tax Savings on Family-Owned Business Assets
Recent changes in Pennsylvania’s tax laws have created a valuable opportunity for family business owners to avoid inheritance taxes on your business assets. Within the last eighteen months, our legislature has made changes to the inheritance tax law which will lessen or avoid altogether the inheritance tax on certain family-owned business assets. These changes are complex and will not affect all businesses or all business assets; however, with careful planning, family owned businesses and farm businesses can dramatically lessen their inheritance tax burden.
In 2012, our Legislature approved Act 85 of 2012, which created exemptions from inheritance tax for farm assets - including farm ground, buildings, herds, crops, and equipment – passing to family members who will continue to operate the family farm business. On July 19, 2013, the Governor signed Act 52 of 2013, which encodes similar exemptions from inheritance tax for the assets of family-owned businesses which are of a limited size, and which will continue to be owned and operated by family members.
Our legislature approved these changes motivated by their stated desire to help family-owned businesses survive and thrive into the second and third generations of ownership. Currently only 30% of such family-owned businesses continue to operate in the second generation, and only 10% make it to the third generation. The legislature viewed heavy death taxes as one of the principal handicaps for the survival of such businesses. Second and third generation owners, saddled with the obligation to pay tax on the assets they inherit from their parents, must sometimes sell assets or the entire business to pay taxes.
If the legislature’s intent was to stimulate the growth and continuation of family-owned business, then the legislature certainly hit the nail on the head. Never has there been such an impetus for creation and continuation of family-owned businesses.
Under the new laws, qualifying business assets of a small family-owned business can be passed free of inheritance tax to lineal descendants who continue to own and operate the family business. Inheriting owners must meet specific requirements in order to make the transfers exempt – for example, all stock of the business must be owned by qualifying family members – and the new owners must also keep the business in family ownership for seven years, or be required to repay the forgiven tax.
The saving opportunities for family farm businesses are even more beneficial. In addition to providing tax exemption for farm businesses which stay in family ownership for seven years, the new law exempts certain farm assets and commodities outright from inheritance tax, with no requirement to hold the assets for seven years. And the list of family members who qualify for the savings are broader than in other businesses, including cousins, nieces/nephews, and even certain in-laws.
Obviously, such tax exemption can provide dramatic benefits for business owners. With inheritance tax rates on assets passing to family members ranging from 4.5 to 12 percent, the potential tax savings can easily run into the thousands of dollars and beyond. The law provides that a business with book value of up to $5 million can be exempt – for such a business passing to a son or daughter, the potential saving could be over two hundred thousand dollars. And the law does not limit the exemption to a single business – as many family-owned businesses as qualify could be exempted from state death tax.
The savings potential is obviously far-reaching. If the legislature’s intent was to stimulate the growth and continuation of family-owned business, then the legislature certainly hit the nail on the head. Never has there been such an impetus for creation and continuation of family owned businesses.
Of course, nothing comes without a catch. It is important to recognize that the exemptions provided by the new law are narrow, and careful planning must be utilized to qualify for the exemption. For instance, if even a single share of business stock is owned by a non-qualifying member, the entire transaction is taxable. The Department of Revenue has already issued a Tax Update clarifying the agricultural exemptions, and undoubtedly more such updates will be forthcoming as the law is put into practice. Careful planning is essential to qualify for these savings, and business owners should consult with professional counsel to help you plan for these opportunities.
While these recent changes in Pennsylvania’s tax code provide an opportunity for family-owned businesses and in particular family farm businesses to their death tax burden. With proper planning, family owned businesses can dramatically lessen or avoid such taxes entirely, and family business owners and farm owners can look forward to a brighter future for their business and for their children.