Exploring Pennsylvania Inheritance Tax Exemptions for Qualified Family-Owned Business Interests and Agricultural Properties
March 1, 2023
Reprinted with permission from the February 23, 2023 edition of The Legal Intelligencer © 2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
Pennsylvania imposes an inheritance tax on the transfer of certain assets from a decedent’s estate to certain beneficiaries of the estate. The payment of the tax can present issues for estates where the majority of the estate’s “value” is attributed to illiquid assets such as agricultural property or equity interests in closely held family businesses, and such assets are to be distributed to estate beneficiaries (rather than being sold to third parties).
Between 2012 and 2013, the Commonwealth of Pennsylvania introduced three additional exemptions from inheritance tax that directly relate to agricultural properties and closely held family businesses: the Qualified Family-Owned Business Interest (“QFOBI”) Exemption, the Business of Agriculture Exemption, and the Farmland Other Exemption.
While these exemptions present opportunities for reducing inheritance taxes, the Business of Agriculture Exemption and QFOBI Exemption carry risk of repayment of inheritance tax (plus interest), for which the recipient beneficiaries may be held joint and severally liable.
A. QFOBI Exemption
The transfer of a QFOBI to one or more “permissible transferees” is exempt from inheritance tax, provided that certain date of death and post-death requirements are satisfied and the exemption is reported on a timely-filed inheritance tax return.
1. Date of Death Requirements
A QFOBI is an ownership interest in a business that meets the following criteria as of the decedent’s death:
- The business has fewer than fifty full-time equivalent employees.
- The business (and not just the share of the business owned by the decedent) has a net book value of assets totaling less than $5,000,000. The “net book value” of the business may be significantly different than the fair market value of the business.
- The business is wholly owned by the decedent, the decedent and members of the same family, a trust whose beneficiaries are comprised solely of members of the same family, or an entity owned solely by members of the same family (collectively, a “permissible QFOBI transferee”). The term “members of the same family” includes the decedent, the decedent’s brothers and sisters, the brothers and sisters of the decedent’s parents and grandparents, the ancestors and lineal descendants of any of the foregoing, a spouse of any of the foregoing, and the estate of any of the foregoing.
- The business is engaged in a trade or business with a principal purpose other than the management or investment of income-producing assets owned by the entity.
- The entity has been in existence for at least five years.
2. Post-Death Compliance Requirements
Assuming the date of death requirements are satisfied, the following requirements must be satisfied for a minimum of seven years following the decedent’s death:
- The QFOBI exempted from inheritance tax must continue to be owned solely by permitted transferees of the decedent.
- Each new owner of a QFOBI exempted from inheritance tax must certify to the Department of Revenue, at least annually, that the QFOBI continues to be owned by permitted transferees of the decedent
B. Business of Agriculture Exemption
The transfer of real estate devoted to the business of agriculture to a permitted transferee is exempt from inheritance tax, provided that certain date of death and post-death requirements are satisfied and the exemption is reported on a timely-filed inheritance tax return. Importantly, this exemption encompasses the underlying land and structures used in the business of agriculture.
1. Date of Death Requirements
As of the decedent’s death, the real estate must:
- Be devoted to the business of agriculture. Certain structures on the underlying land but not used in the business of agriculture can be excluded from the exemption. For example, if the real estate includes a rental home not used in the business of agriculture, the estate would list that rental home as being excluded from the Business of Agriculture exemption. Though inheritance tax would be payable on the value of the rental home, the remainder of the real estate could be exempted from inheritance tax.
- Be transferred to one or more permitted transferee(s) of the decedent.
- Derive annual gross income of at least $2,000 in the business of agriculture (i.e., the income derived from the rental home referenced above would not be included in the gross income calculation). Each parcel for which the exemption is claimed must satisfy the gross income requirement, even if the parcels are used for the same business purpose.
2. Post-Death Compliance Requirements
Assuming the real estate transfer satisfies the date of death requirements, the following requirements must be satisfied for a minimum of seven years following the decedent’s death:
- The real estate must continue to be owned solely by permitted transferees of the decedent.
- Each new owner of the real estate exempted from inheritance tax must certify to the Department of Revenue, at least annually, that the real estate continues to be owned by members of the same family.
- Each parcel of exempted real estate must derive a yearly gross income of at least $2,000.
3. Use of the Farmland Other Exemption
Under the Farmland Other Exemption, a transfer of an agricultural commodity, agricultural conservation easement, agricultural reserve, agricultural use property or a forest reserve (as those terms are defined in 72 P.S. § 2122(a), to or for the benefit of lineal descendants or siblings is exempt from inheritance tax, provided the foregoing property is reported on a timely filed inheritance tax return.
Unlike the Business of Agriculture Exemption, there are no post-death compliance requirements that the transferees must satisfy. Once the exemption is granted by the Department of Revenue, the transferee(s) can freely transfer the agricultural property or commodity to any person or entity without liability for repayment of inheritance tax. However, the Farmland Other Exemption does not include structures, so any such structures would be subject to inheritance tax, and the initial transferees are limited to the descendant’s lineal descendants or siblings.
C. Consequences for failure to satisfy post-death compliance requirements:
If a permissible transferee fails to comply with or satisfy the post-death compliance requirements for QFOBIs or real estate devoted to the business of agriculture, such permissible transferee will be responsible for paying the inheritance tax that would have otherwise been due at the decedent’s death (plus interest). Additionally:
- For a QFOBI, the tax imposed (plus interest) will be a lien in favor of the Commonwealth on the real and personal property of the transferee-owner(s) that failed to satisfy the post-death requirements.
- For real estate exempt for business of agriculture, the tax imposed (plus interest) will be a lien on the exempt real estate, as well as the personal obligation of the transferee owner(s) that failed to satisfy the post-death requirements.
If the exempt asset is owned by a trust, and the trust fails to satisfy the post-death compliance requirements, then “all beneficiaries” of the trust can be held personally liable for repayment of inheritance tax plus interest. The liability for such tax is joint and several.
The statute does not state whether the term “all beneficiaries” includes contingent beneficiaries or if it is limited to current beneficiaries. Regardless, Executors and Trustees should exercise caution when claiming either exemption with post-death compliance requirements, and trust beneficiaries (current and contingent) should be made aware of the ongoing compliance requirements and potential personal liability for noncompliance by the Trustee.
D. Weighing the Risks and Rewards
Ultimately, claiming the QFOBI exemption or the Business of Agriculture exemption should be made with careful consideration of the facts and circumstances specific to the estate, the estate beneficiaries, and the nature of the particular estate asset. Assuming a proposed transfer satisfies the date of death transfer requirements for a QFOBI or for real estate devoted to the business of agriculture, Executors and Trustees should consider and discuss the following when deciding whether to claim one or both exemptions:
- Do any of the recipient beneficiaries plan to transfer their interest in the exempt asset to a non-qualified transferee within the compliance period?
- Are the transferees willing to satisfy the post-death compliance requirements? Is the exemption worth the hassle?
- If the qualified transferee is a trust, and the trust will not terminate in the foreseeable future, are the trust beneficiaries aware of their potential personal liability if the trust fails to satisfy the post-death compliance requirements? Are they willing to assume that risk to avoid payment of inheritance tax?
- For real property satisfying the requirements for both the Business of Agriculture Exemption and the Farmland Other exemption, does the risk of post-death noncompliance outweigh the reward of claiming the structures as exempt from inheritance tax?