transfer of property after death

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TRANSFER OF PROPERTY

AFTER DEATH:

Guide to Estate Settlement

Prepared by:

John C. Becker and Anthony D. Kanagy

The Pennsylvania State UniversityUniversity Park, Pennsylvania 16802

March 2002


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TRANSFER OF PROPERTY AFTER DEATH:GUIDE TO ESTATE SETTLEMENT

Transfer of Property After Death ...............................................................................................1By Operation of Law..........................................................................................................2By the Intestate Law..........................................................................................................3

By a Last Will and Testament ...........................................................................................4By a Living Trust ............................................................................................................... 7Inheritance Tax Effects of the Transfer .............................................................................8Federal Estate Tax Effects of the Transfer .....................................................................10Federal Gift Tax Effects of the Transfer .......................................................................... 10

The Steps Involved in Estate Settlement ................................................................................14Initial Decisions ............................................................................................................... 14

Appointment of Personal Representative........................................................................16Beginning the Administration ..........................................................................................19Review of Income Tax Issues .........................................................................................19Valuing Property in General ............................................................................................21

Date of Valuation.............................................................................................................21Fair Market Value............................................................................................................21Value of Types of Property..............................................................................................22Notification of Heirs .........................................................................................................27Settlement of Small Estates on Petition ..........................................................................28Filing the Inventory..........................................................................................................28Initial Payment of Inheritance Tax...................................................................................29

Administration of Assets..................................................................................................29Preparation of the Pennsylvania Inheritance Tax Return................................................31Payment of Pennsylvania Inheritance Taxes ..................................................................33Preparation of Federal Estate Tax Returns.....................................................................33Payment of Federal Estate Taxes................................................................................... 37

Preparation of Account, Schedule of Distribution Audit ..................................................37Family Settlement Agreement.........................................................................................38Receipt and Release.......................................................................................................39The Final Steps ...............................................................................................................40

Summary....................................................................................................................................40

Levels of Property Distribution Under the Intestate Law of Pennsylvania ..................................40

Glossary.....................................................................................................................................43

Endnotes....................................................................................................................................44

Prepared by John C. Becker, professor of Agricultural Law and Economics, Director ofResearch for the Agricultural Law Center of the Dickinson School of Law of thePennsylvania State University and Anthony D. Kanagy, Research Assistant for the

Agricultural Law Center. Revised March, 2002.

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A death is a traumatic event for most families. Whether the death is sudden orexpected, most people need an adjustment period to cope with the reality of thedeath of a family member. While this period runs its course, surviving familymembers may be distracted and have difficulty dealing with business and personalproblems.

Nonetheless, during the adjustment period, distribution of property owned bythe deceased must be considered. In some families this is cause for anxietybecause the situation involves the legal system and the services of an attorney. Forsome people, death of a family member may bring them in contact with the legalsystem for the first time. Inexperience with the legal system and the emotionaladjustment to the death can combine to create even greater anxiety for a bereavedfamily.

This publication will address legal issues and procedures for the settlement ofan estate. The settlement process refers to the method of transferring property

owned by a person at the time of death. This discussion will cover a typical estatesituation and will refer to the steps needed to complete the process. The discussionis general and does not cover all possible contingencies. Some situations mayrequire additional steps to complete the process.

Anyone who has questions concerning a procedure used in a particular case shouldconsult someone familiar with the situation or his or her personal attorney. Thispublication does not provide legal or tax advice to the reader and is not intended tobe a substitute for such advice or service. The reader should seek such advice orservice on his or her own before making a decision or taking any action.

TRANSFER OF PROPERTY AFTER DEATH

Why should we be concerned with transferring property following a person'sdeath? A simple answer to this question is that all items of property are owned at alltimes by someone, or something such as a corporation. When a person dies owningproperty, some disposition of the property must be made to provide a new owner forthe property. When an artificial person such as a corporation that owns propertygoes out of business, dissolution of the business will address the question of transferof property. When property is abandoned by its owner, the original ownershipcontinues. But someone who finds the property and controls, uses, and protects itmay acquire an ownership interest, if the original owner fails to exercise control ofthe property. Each of these examples points to the need to identify the owner ofproperty at all times.

This publication discusses the transfer of property owned by people at their deathand the tax consequences of the transfer. This can generally take place in one offour ways: by operation of law, by the intestate law, by a last will and testament, orby a trust created during their lifetime that provides for this transfer.


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By Operation of Law

A transfer by operation of law takes place when a person makes a lifetimedecision to share ownership of property, and provides that at the death of one of the

joint owners the surviving joint owner(s) will become the owner(s) of the property. A

typical example of such a transfer is joint ownership with the right of survivorship.

In this case, ownership is shared with one or more people, and each personis treated as the owner of an equal share in the property. This property can beeither real or personal property, or tangible or intangible personal property. Duringthe lifetime of the joint owners, their rights to the use of the jointly-owned propertyare dependent on the intent of the property owners when the joint ownership interestwas created. In the case of a bank account, unless there is clear and convincingevidence of a different intent at the time of creation of the account, each joint ownerhas access to the account in an amount that equals their net contribution to theaccount.1 For example, if a property owner decides to add an additional owner to

an account, thereby creating a joint ownership interest, the question would bewhether the original owner intended to give the added owner a present gift of aone-half interest in the account, or did the owner simply intend that the new ownerreceive whatever balance remains at the original owner's death? If clear andconvincing evidence of an intent to create a present gift is established, then eachowner would have access to an equal share of the account. Each owner would betreated as having contributed an equal amount to the account. If such evidencecannot be established, then each owner would have access to the account inwhatever amount is equal to the proportion of their net contributions to the account.If the original owner contributed all of the funds and the added owner failed tocontribute any funds, then the original owner would have lifetime access to the full

account and the added owner would have no lifetime access to the account. At thedeath of one of the owners, the survivorship feature transfers the deceased owner'sshare to the surviving owner(s), who acquire an equal share of the portion previouslyowned by the deceased.2

For example, if three people were joint owners with the right of survivorship,at the death of one person, that person's share would be divided equally betweenthe surviving owners. Their ownership share would increase by one-sixth; their newownership share would be one-half (1/3 or 2/6 + 1/6 = 3/6 or 1/2). At the death ofone of the two owners, the surviving owner would become the sole owner of theproperty by receiving the deceased's one-half share and adding it to his or herone-half share. Transfer takes place automatically upon the death of a person whoowns property as a joint owner with the right of survivorship. Documents whichshow ownership must specifically state that it is owned as joint tenants with right ofsurvivorship.

Property owned by a husband and wife is generally classified under a specialform of joint ownership called tenants by the entireties. At the death of the firstspouse, the surviving spouse becomes the owner of the property automatically.


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When two people are married and property is placed in the names of both of thepersons, a presumption arises that the property is held in a joint tenancy by theentirety relationship.3

One situation in which joint ownership can create a problem is the

simultaneous death of both owners under such circumstances that it cannot bedetermined which owner died first. Since surviving the death of the other owner isthe key requirement to transfer of ownership, time of death of the first party to diemust be established to make that determination.

To resolve the problem Pennsylvania law provides that, unless a will, livingtrust, deed, or insurance contract provides otherwise, when there is no sufficientevidence that joint tenants or tenants by the entirety died other than simultaneously,the property held in these forms will be distributed one-half as if one had survivedand one-half as if the other had survived.4 If there is a joint tenancy of more thantwo and all die under such circumstances, the property distributed under this rule will

be in the proportion that each owner bears to the whole number of joint owners, i.e.one of three or one-third; one of four or one-fourth, etc.5 As mentioned above, aperson can change this result by specifying in a will their own rule for determiningthe order of death in such situations. This decision is frequently made whenplanning to minimize federal estate taxes.

By the Intestate Law

If a person owns property in his or her name alone, the transfer of ownershipwill be made either under a will prepared during the person's lifetime or under theprovisions of the intestate law of the state where the owner resides.6 If a person

does not have a will, the intestate law creates a schedule for the distribution ofseparately owned property. Within the schedule, the statute specifies who is toreceive the property, how much they are to receive, and any special conditions thatapply to this transfer.7

For example, under Pennsylvania's intestate statute, the following distributionwould be made of the sum of $70,000 owned by a person at death when the personis survived by a spouse and two children who are children of the marriage.Following the payment of debts, administrative expenses, and an exemption, thespouse receives the first $30,000 plus one-half of the difference.8 The childrenshare equally the remaining one-half of the difference. If $70,000 remains after theobligations are paid, the spouse receives $50,000 from the $70,000 ($30,000 +one-half of $40,000). The children each receive $10,000 of the remaining $20,000.9

If one of the children is not a child of the marriage between the deceasedperson and the surviving spouse, but was born from a prior marriage or otherrelationship, then the shares of the spouse and children change. The spouse isentitled to one-half of the amount or $35,000 (1/2 of $70,000). Each childs shareincreases to $17,500 (1/2 of $35,000).10


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If the deceased person and spouse did not have any children from their

marriage or a prior relationship, but the deceased person is survived by parents,then the spouse receives the first $30,000 plus one-half of the difference. Thedeceased person's parents receive the remaining one-half of the difference. The

surviving spouse receives the entire estate only when the deceased spouse issurvived by the spouse but no surviving children, grandchildren, or parents.11

In addition to provisions for surviving spouses, children, grandchildren, andparents, the intestate law controls the distribution of property when none of thepreviously listed relatives survive the deceased. Additional provisions cover distribu-tion to brothers, sisters, and their children; grandparents; aunts, uncles and theirchildren; children of first cousins; and finally the Commonwealth of Pennsylvania. Ifa person dies but is not survived by a relative who is closer in relation thangrandchild of a first cousin, ownership of that person's property passes to theCommonwealth.12 Except when the Commonwealth would receive the property,

each listed heir must survive the deceased for at least five days in order to receivethe share designated by the schedule.13

The intestate statute can be revised by the legislature, and the distribution ofproperty described above can change. Since this plan of distribution applies tothose people who have not made their own decisions about the transfer of theirproperty, it can be said that we all have an estate plan-- either one that we haveprepared for ourselves or one that has been prepared for us by the legislature.

By a Last Will and Testament

Property owners who want to control distribution of their property after deathcan do so by preparing a will. Like the intestate law, a will only provides for thedistribution of separately owned property. Unlike the intestate law, which primarilybenefits family members, a will can bestow benefits and property on familymembers, strangers, corporations, charities, churches, and other beneficiaries.

A valid and enforceable will in Pennsylvania is one prepared by a personeighteen years of age or older and of sound mind and understanding.14 Thedocument must recognize an intent to distribute property after death and be signedat the end by the person making the will.15 A will can be formally prepared by anattorney trained in these matters or by the property owner.16

Pennsylvania, unlike other states, does not require that people witness thesignature of the person who prepared the will. Although witnesses are not requiredin order to have a valid will, most wills are witnessed by several people since thesignature of the person who prepared the will must be proven when the will is filedwith the Register of Wills after a person's death. At that time the witnesses will cometo the Register's office to sign a document that confirms their role as witness and thevalidity of the person's signature.17


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An alternative procedure is available that eliminates the need for the

witnesses to appear before the Register of Wills. This procedure is known as"self-proving." Under this procedure, when a will is executed, the person making thewill signs a separate acknowledgement before a notary public that he or she

executed the document as his or her last will and testament and that it was donevoluntarily.18 Witnesses then sign an affidavit stating that they were present andsaw the person sign the will; that it was signed voluntarily; that the witnesses signedthe will in the hearing and sight of the person who made the will; and that to the bestof their knowledge the person who made the will was eighteen years of age or olderat the time, of sound mind, and under no constraint or undue influence. Theacknowledgement and affidavits are notarized and attached to the will. When thewill is ultimately filed, the register of wills can accept the acknowledgement andaffidavits to support the statements made therein.19 This procedure eliminates theneed to locate witnesses to the will and helps the register of wills proceed quickly.

Within six months after a person's death or before the expiration of six monthsafter the date of probate, whichever is later, a surviving spouse has a right to electagainst what the will provides and take what Pennsylvania law has designated as asurviving spouse's share.20 This election requires the surviving spouse to give uphis or her claim to certain property in return for a statutory share of one-third ofcertain other specifically identified property.21 In deciding whether to elect against awill, a surviving spouse should calculate what the spouses share would be with anelection and without an election. Whichever choice provides the surviving spousewith the most beneficial treatment can be selected.

A surviving spouses right to elect against a will can be forfeited for failure tofinancially support the deceased spouse, for desertion, and for participation in thewillful or unlawful killing of the deceased spouse.22 In addition, the right to elect canbe waived, as in the case of an agreement made by two parties before theymarry.23 This agreement, which is often called a premarital agreement, is subject toits own standards and rules for enforcement. Other family members do not have thisright to elect against what the will provides.

Although a will provides some assurance that a person's property will bedistributed according to its terms, a will can be challenged either before or after it ispresented to the register of wills after the person's death. Some of the people whocan challenge the will are beneficiaries who are named by the decedent in one willbut not in another, the intestate heirs of the decedent, and beneficiaries whose sharewould increase or decrease depending on which will is admitted to probate. Someof the common grounds for a challenge to a will are that the decedent was not ofsound mind when the will was prepared, that someone unduly influenced thedecedent to prepare his or her will with particular terms, fraud practiced on the de-cedent, that the decedent intended to give property away during lifetime rather thanat death, and that the decedent failed to properly execute the document.


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In addition to cases where a will is challenged, a will can also be modified asa result of certain events. For example, if a married person prepares a will thatprovides for his or her spouse, and the marriage is later ended by divorce, thetermination of the marriage voids all provisions in the will for the divorced spouse.24In a somewhat reverse situation, if a single person prepares a will and then marries

after the will is prepared, the surviving spouse will be entitled to an intestate share ofthe decedent's property if the person has not provided for the spouse in a will.25 If aperson prepares a will and a child is born to or adopted by that person's family afterthe will is prepared and before the person dies, the share of the after-born oradopted child could be either an intestate share comparable to that of all of thechildren, a share mentioned in the will, or nothing if the person clearly expressed anintention to leave nothing to after-born children.26 If a person participates in thewillful and unlawful killing of someone, the slayer will be prevented from receivingany benefit or acquiring any property from the estate of the person who was killed.27

If a person who is a resident of Pennsylvania at the time of death is divorced

from his or her spouse, but after having designated that spouse to be the beneficiaryof a life insurance contract, annuity, pension or profit-sharing plan or any othercontractual arrangement that provides benefits to the spouse, the designation of thedivorced spouse to receive the benefit will not be effective.28 An exception to thisresult applies where the document that designates the spouse to receive the benefit,or a court order, or written contract between the parties clearly expresses theintention that the designation is to survive the divorce.29

Transfers by a will have other advantages that are important to the estate andthe heirs. A person with a will can name a guardian for the children and therebysomewhat reduce the time and expense involved to obtain the necessary court ap-pointment. Guardians have legal authority to hold property for a minor child until thechild reaches eighteen years of age.30

At a person's death, a personal representative is appointed to deal with thedeceased's separately owned property. The personal representative has theauthority to deal with the estate assets and the obligation to administer the assetsaccording to the will or intestate law. This obligation includes filing all necessaryestate, inheritance, and income tax returns for the estate. The person who preparesa will can select the personal representative to perform these duties andresponsibilities. If the deceased did not have a will, the personal representative isappointed from a list of those eligible to petition the court for appointment to thisposition. Pennsylvania law determines who is eligible to petition the court.31

In the case of a business owned by one person, a will gives the owner theopportunity to name a personal representative to operate the business for the benefitof heirs or other beneficiaries. Without such authority the personal representativemust seek court approval to get the authority.32 This procedure may be timeconsuming and expensive.


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By a Living Trust

Transfer of property under terms of a living trust reflects the owners lifetimedecision to use the trust vehicle to own, control, and manage property, and todesignate those who have a beneficial interest in the property. To create a trust, a

property owner transfers real or personal property to a trustee who has ownership ofthe property subject to the interests of the beneficiary selected by the owner.Following the trust beneficiary's death, the living trust by its own terms can providefor the transfer of ownership to some other beneficiary. When the trust is created,the property owner and trustee negotiate an agreement that controls the trustee'sownership of the property, and its eventual distribution to a beneficiary. A trustcreated during an owner's lifetime is called a living trust in contrast to a testamentarytrust which is created in a will. Under a living trust arrangement, an owner mayreserve the right to receive some benefit from the trust property during his or herlifetime. If the owner becomes disabled, incapacitated, or simply does not want to beresponsible to manage the property, a living trust is a convenient alternative that

gives someone the needed authority to take effectve action regarding the property.This saves the expense of having a court appointed guardian named to accomplishthe same thing. The appointment of the trustee s a decision made by the personwho creates the trust. The decision to name a guardian is made by a court.At theowner's death, the trust agreement would direct the trustee to distribute the propertyto an eventual beneficiary. In this context, a living trust becomes an effective way totransfer the property to the designated beneficiary after the owner's death. Manyliving trusts also grant the property owner the right to terminate the trust andre-acquire the property. This gives the property owner flexibility to deal withchanging circumstances. Such trusts are commonly called revocable trusts. Truststhat cannot be changed after being created are called irrevocable trusts.

Comparing Distributions by Living Trust to Distributions by Will

In comparison to each other transfers by a will and transfer by a living trustboth require a property owner to take action during his or her lifetime.

If the trust is revocable, as many living trusts are, the value of the property inthe trust will be subject to inheritance and federal estate taxes if the value of theproperty is large enough for these taxes to apply.

The applicable exclusion amount under federal estate tax, which is discussedbelow, is available in both cases.

Distributions by will follow a process that allows creditors of the decedent topresent their claims to the personal representative of the estate. This is alsodescribed below. In living trust cases, these creditors present their claims to thetrustee on the basis of the decedents failure to fulfill the terms of a contract oragreement. This may allow the creditor a longer period of time in which to file theclaim and take the claim out of the procedure normally followed for estates.


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Under income tax law, income that is generated by an estate or trust and is subjectto tax at that level is taxed at a higher income tax rate than that for individuals.Estates are able to take a deduction for the amounts they distribute to heirs. Trustshave a similar opportunity. During the lifetime of the owner who created a revocableliving trust the owner generally reports the income of the trust as personal income.

The cost for preparing a revocable living trust and other documents for aperson who is subject to federal estate tax often reflects the time, effort andexpertise of the person providing the service. This cost is generally higher than thecost of preparing a will. This is a lifetime expense as the service is provided then.Other lifetime costs that can be associated with a revocable living trust involve feesto the trustee for the service the trustee provides. These fees are most commonwhen a financial institution is named as a trustee. The cost of settling an estate thatis subject to federal estate taxes will also reflect the time and effort involved as wellas the expertise of the person who is providing the service. This is a post deathexpense which is treated as an administrative expense of the estate which may be

paid before distributions to heirs

When a will is filed in the Registers office after the person dies, the willbecomes a public document. When a petition for Letter Testamentary is filed at thesame time as the will, a fee is paid to the Register of Wills. A revocable living trustgenerally is not filed on the public record if the trust does not own real estate. If thetrust is not recorded it does not pay a filing fee. In the case of revocable living trust,after an owners death the trustee files the inheritance tax return and distributes theproperty to those identified in the trust agreement This may give the property ownera greater degree of privacy than the decedent whose property is transferred under awill or the intestate law.

If a person owns property in several states, having the out of state propertyowned by a revocable trust can avoid the necessity to have a separate probateproceeding opened in each state where property is located. This is accomplished bythe fact that the trust owns the property. If a trustee is authorized to act, the trustcan transfer the property without having the personal representative be given thesame authority. This may save some expense and time in completing the transfer.

Inheritance Tax Effects of the Transfer

For Pennsylvania residents and nonresidents who own real or tangiblepersonal property located in the state, an inheritance tax is imposed on the transferof property following an owner's death. The tax is imposed at one of four rates.

Tax-free transfersinclude transfers to recognized charities; to federal, state,or local governments; transfers to a surviving spouse which occur on or afterJanuary 1, 1995; transfers from a child aged 21 or younger to his or her natural oradopted parent(s) or stepparent, transfers of life insurance proceeds and socialsecurity death benefits.33 No inheritance tax is imposed on these transfers.


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Transfers under a trust for the sole use of a surviving spouse are not necessarilytaxable in the estate of the first spouse who dies, but can be included in thesurviving spouses estate when that spouse dies.34 The exclusion of the asset fromthe estate of the first decedent may be bypassed if the estate elects to include thetrust in the first decedents estate. This election is made on a timely filed inheritance

tax return in the first decedent's estate.35 Retirement benefits and individualretirement accounts may also be exempt from inheritance tax if the decedent wasyounger than age fifty nine-and-one-half years at death, or otherwise did not havethe right to withdraw the retirement funds without penalty.36

Transfers taxed at 4.5 percentinclude transfers to decedent's grandparents,parents, lineal descendants, or to the wife or widow, husband or widower of achild.37 Lineal descendants, for inheritance tax purposes, include natural childrenand their descendants, adopted children and their descendants, and stepchildrenand their descendants. Adopted children are considered to be natural children oftheir adoptive and their natural parents for inheritance tax purposes.38

Transfers taxed at 12 percentinclude transfers on or after July 1, 2000 froma decedent to a sibling. A sibling is considered to be a person who has at least oneparent in common with the decedent, whether by blood or adoption.

Transfers taxed at 15 percentinclude transfers to any other person or entitythat does not fall into the tax-free, 4.5 percent, or 12-percent tax categories,including for example a decedent's aunt, uncle, nephew, niece, all other familymembers, and all nonfamily members.39

Property may be transferred before death. Transfers by gift may still be

subject to inheritance tax if the gift takes place within one year of the person's deathand the value of the property given away to a single person is more than $3,000.40In this context, the property transfer means to give away something of value yetreceive nothing in return, such as a gift. If something is given in return, the amountof the gift equals the difference between the value of the item given away and thevalue of the item received in return.

Other provisions of the inheritance tax law affect transfers that restrict theright of the person receiving the property to immediately use and enjoy it, thatreserve a right to use the property during the original owner's lifetime, or that reservethe right to alter, amend, or revoke a gift.41 In the case of jointly owned propertywith the right of survivorship, the transfer of the deceased owners interest to thesurviving owner or owners is subject to inheritance tax in an amount equal to thevalue of the deceased owners share.42 In cases in which the joint ownershipinterest is created within one year of the deceased owners death, the full value ofthe property above $3,000 may be subject to inheritance tax if the decedent was theperson who created the joint ownership by giving the interest to the surviving owner.


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Pennsylvania law also provides for an estate tax. This tax applies only insituations where federal estate tax is payable and the amount of the inheritance taxpaid to the Commonwealth and other states is less than the state death tax creditamount that is allowed under federal law.43 For a person who resides inPennsylvania at death, the amount of the Pennsylvania estate tax is equal to the dif-

ference between the amount of the state death tax credit allowed by federal law andthe total amount paid in inheritance taxes and state death taxes. For a resident ofPennsylvania who dies owning property in Pennsylvania, as well as other states, thePennsylvania estate tax is reduced by the greater of either the amount of deathtaxes actually paid to other states, or an amount computed by multiplying the statedeath tax credit by a fraction of the numerator of which is the value of propertylocated in other states and the denominator of which is the value of the decedent'sgross estate for federal estate tax.44

For a person who is not a resident of the Commonwealth at the time of death,the amount of the estate tax is calculated by determining the ratio of property subject

to Pennsylvania inheritance taxes compared with the decedent's gross estate forfederal estate tax purposes. This ratio is then applied to the allowed state death taxcredit under federal law. If the amount of Pennsylvania inheritance taxes paid doesnot exceed the amount determined by applying the ratio above, then a Pennsylvaniaestate tax in the amount of the difference is applied.45

For example, if assets subject to Pennsylvania inheritance tax comprise 50percent of the assets in the federal gross estate, 50 percent of the state death taxcredit is allowed against these assets. If the Pennsylvania inheritance tax paid isless than the death tax credit allowed, the difference in amount is imposed as thePennsylvania estate tax.

The amount of state death tax credit allowed under federal law is calculatedas a percentage of the taxable estate of the deceased and is limited to taxes actuallypaid. The first $60,000 of the taxable estate is not considered when calculating thecredit. Percentages used to calculate the credit range from 0.8% to16%.46Beginning in 2002, the state death tax credit will be reduced by 25% eachyear until the tax is repealed in its entirety for the estates of people dying after 2004.

After the tax credit is fully repealed, decedents will be allowed to deduction statedeath taxes when calculating federal estate tax. In 2011, the amending law willexpire and the law in place in 2001 will return and become effective

Federal Estate Tax Effects of the Transfer

In addition to state inheritance tax, a federal estate tax applies to the transferof property following an owner's death. In 2001, Congress amended the FederalEstate tax in very dramatic ways. Beginning in 2002 and continuing until 2009, thelaw will undergo a variety of important changes. In 2010, the law that creates the taxwill be repealed. However, for individuals who die after December 31, 2010, the lawthat is in existence in 2001 will return. This is due to a sunset provision that


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appears in the 2001 amendments. In other words, the 2001 amendmentsthemselves will expire after December 31, 2010 and the law will return to theprovisions in place in 2001.

Unlike the fixed rates of Pennsylvania inheritance tax, the federal estate tax

has a graduated tax rate that currently starts at 18% and goes to a maximum taxrate of 50%.47 Between 2003 and 2009 the maximum tax rate will fall to 45%. In2010, the Federal estate tax will be repealed. In 2011 the amending law will beexpire and the law in place in 2001 will return. Under federal estate tax rules, thegreater the property subject to tax, the greater the tax can be. But, for two reasons,not all estates are affected by the federal estate tax.

First, the federal tax law gives each person an applicable exclusion that canbe applied against either federal estate tax liability owed. The amount of thisapplicable exclusion for 2002 is $1,000,000..48 This means that an individual whosegross estate is less than $1,000,000 can use the applicable exclusion to avoid

federal estate tax.

Over the next several years the applicable exclusion amount will be rising. In2004, the exclusion amount will be $1,500,000; from 2006 through 2008 it will be$2,000,000; in 2009 it will be $3,500,000;. In 2010 the Federal Estate Tax law isrepealed. In 2011, the Federal Estate Tax law returns and the applicable exclusionwill fall to $1,000,000 for people who die in 2011 or later..49 Estates valued belowthese applicable exclusion amounts will not be subject to estate taxes.

The rules that determine whether an estate tax return must be filed reflect theamount of the applicable exclusion. If the estate value does not exceed the amountof the applicable exclusion, there is no need to file a federal estate tax return.50 Thisrule only applies to the amount of the applicable exclusion that is available to theperson's estate. To determine the amount of the exclusion that is available to theestate, the personal representative must carefully examine the decedent's records,including prior year gift tax returns. If some portion of the exclusion has been used,the applicable exclusion will be reduced.

A second factor in calculating the property amount that is finally subject tofederal tax is the list of available deductions. Current tax law provides that estateadministration fees, attorneys fees, casualty losses, debts, and a marital deductionare allowed in calculating the amount subject to tax.51 Of the deductions on this list,the marital deduction is the most significant; it allows one spouse to transferpractically an entire estate to the other spouse and have the full value of the transferdeducted when calculating the amount subject to federal estate tax.52 However,when the surviving spouse dies, that property will be part of the surviving spouse'sestate and the full value may be subject to tax at that time. Various types oftransfers to a surviving spouse can qualify for marital deduction treatment, includingtransfers to a surviving spouse as a tenant by the entirety or as beneficiary of lifeinsurance proceeds.53


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Another important federal estate tax concept is the gross value of a

decedent's estate gross estate. This is the amount that is calculated and comparedto the exclusion amount available to the estate. To calculate the gross estate,include all separately owned property, one-half of all property owned as tenants by

the entirety, and that portion of the current value which represents the portion ofamount paid or contributed by the decedent toward the cost of an item of jointlyowned property.54 If the decedent at the time of death had the right to control thepayment of insurance proceeds through a change in beneficiary, a right to cancel thepolicy, or a right to borrow against its cash value, then the insurance proceeds willbe included in the calculation of the gross estate.55 As in the case of thePennsylvania inheritance tax, if a person restricts the right of the person given theproperty to immediately use and enjoy it, or reserves a right to use the propertyduring the original owner's lifetime, or reserves the right to alter, amend, or revokethe gift, the value of property transferred under these conditions is included in thecalculation of the gross estate of the deceased person.56

This discussion has illustrated several differences in estate, gift andinheritance tax calculations. Many different kinds of property and special rules areincluded in determinations of the gross estate. Some different rules are used for thefederal estate tax system and the Pennsylvania inheritance tax system. Thetreatment afforded life insurance proceeds is a good example, since thePennsylvania system excludes these payments from the calculation of inheritancetax while the federal system includes the value of the proceeds if specific conditionsare met. Note that including the amount of the insurance proceeds in the calculationof a gross estate does not bring the proceeds back to the estate, but that the valueof the proceeds is part of a calculation to determine how much tax is due. Theproceeds of the life insurance policy will be paid to the beneficiary named in thepolicy.

Federal estate tax law also provides for a generation skipping transfer tax.This tax is designed to prevent the tax free transfer of property from one generationto a generation of beneficiaries who are more than one generation below thetransferor's generation (grandparent and grandchild or lower or a non-family memberwho is more than thirty-seven-and-one-half years younger than the transferor).57This tax is a separate tax that is involved in planning for the transfer of property tothese younger generations of beneficiaries. Transfers that are typically subject tothis tax include transfers that arise from a direct transfer by gift or inheritance,transfers at the termination of a trust or transfers in the form of distributions from theincome or principal of a trust. In each case, the transfer must be to a person whomeets the generational requirement for the tax to apply.

If this tax applies, it is calculated at the flat rate which is equal to themaximum federal estate tax rate in effect at the time of the transfer.58 Currently,that rate is 50 percent. Individuals have an important exemption of $1,100,000 fromthe generation skipping transfer tax.59 In addition, this tax does not apply to gifts


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that are eligible for the $11,000 per person, per year, federal gift tax annual exclu-sion, and the tuition and medical expense exclusions, which are discussed below.60

Individuals whose estate values are high enough to merit concern aboutfederal estate taxes or federal gift taxes, should also evaluate the impact of this tax

on the distribution of property during lifetime or after death.

Federal Gift Tax Effects of the Transfer

Giving property away during a person's lifetime is sometimes a means toavoid inheritance taxes. A federal gift tax applies to transfers of real or personalproperty for less than the value of the property given away.61 For many years thistax was part of a unified Federal Estate and Gift Tax structure that taxed thesetransfers at the same rates as the federal estate tax.62 In addition the unified creditthat was available to federal estates was also available to individuals who facedfederal gift taxes. Beginning in 2002 these taxes will start a process by which they

will no longer be unified. From 2002 through 2009, a taxable gift will be subject to taxat the same rates as the federal estate tax. After 2009, when the federal estate taxis repealed, the federal gift tax will continue and have its own tax rate that will start at18% and reach a maximum rate of 35% for taxable gifts of $500,000 or more. In2011 these amendments expire and the law in place in 2001 will return.

The current federal gift tax has an annual exclusion that permits a person togive up to $11,000 to any one person or any number of people, in a calendar year,free of federal gift tax liability.63 (This $11,000 limit will be adjusted for inflation inupcoming years. It is important to check the statute in order to be sure of the currentexclusion amount.) For example, a person who has $110,000 to give away can give

$11,000 to each of ten grandchildren in any year without any gift tax liability or lossof the credit. No federal gift tax is due on the transfer and, therefore, no portion ofthe applicable exclusion is needed to offset this tax liability.

The federal gift tax also has an applicable exclusion amount. In 2002 thisamount is increased to $1,000,000 and does not increase later.

Federal law allows special treatment for joint gifts by married individuals.Each spouse can contribute his or her $11,000 exclusion to any gift made by theother spouse.64 This raises the amount excluded in such gifts to $22,000 perperson per year. This is called splitting a gift. Similarly, a married couple can writeone $22,000 check from their joint checking account to make a combined gift.

Gifting during a person's lifetime may avoid some taxes. Gifting allows asubstantial amount to be transferred out of one's federal gross estate. If the annualexclusion limits can be followed, then such transfers will also be free of federal gifttaxes. One problem in this situation, however, is that the Pennsylvania inheritancetax applies to gifts in excess of $3,000 if they are made within one year of a person'sdeath.65 The federal gift tax annual exclusion amounts may eliminate federal gift


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The first question requires a review of the property's ownership. If the property wasowned as a joint tenant with the right of survivorship or as a tenant by the entirety,nothing need be done to transfer ownership to the surviving joint owner or tenant bythe entirety. This transfer takes place automatically at the moment of death, asdescribed above, and the estate settlement process does not apply. The surviving

joint owner generally will face the need to establish the death of the joint owner, butthe survivor controls the situation.

Other types of property may pass from a deceased owner without using theformal estate settlement process. These include:

living trusts created during a persons lifetime for the purpose of accomplishingthis transfer after a persons death;

tentative trusts created during a persons lifetime where the trustees deathtransfers control of the trust property to the beneficiary, such as an accountopened by a parent in trust for a child;

social security and veteran's death benefits; employee benefits; and individual retirement accounts being transferred to the

designated beneficiary;

automobiles; savings bonds paid to or registered to someone sharing in the decedent's estate;

and

the family exemption which is explained later.

Four other transfers of property can be made without using the formal estatesettlement process in limited circumstances. First, if a person is entitled to wages,salary, or employee benefits at the time of death, the employer may pay up to

$5,000 of such benefits to the deceased's spouse, children, father, mother, or anysister or brother, in the order stated. This payment can be made by the employerwithout regard to whether a personal representative of the estate has beenappointed.69

Second, a transfer of up to $3,500 can be made from the decedent's bank orsavings account. This amount can be transferred to the spouse, child, father,mother, sister or brother of the deceased in the order stated. The person receivingthe funds must present a paid funeral bill or an affidavit showing that arrangementshave been made for the payment of funeral services.70

Third, insurance proceeds of $11,000 or less held by an insurance company(under a policy of life, accident, or endowment insurance or annuity contract) andowed to the estate of an individual who resided in the Commonwealth may be paidto the spouse, child, father, mother, sister, or brother of the deceased in the orderstated. A requirement to receive these funds is that at the time of payment thepersonal representative has not made a claim for the funds.71


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Fourth, upon the death of a person who is a patient in a county-affiliatednursing home, up to $3,500 from the patient's care account can be paid to a funeraldirector for burial expenses. The facility may pay these funds to the funeral directorand pay an additional amount to the spouse, child, father, mother, sister, or brotherof the deceased patient in that order. The total of all payments made by the facility

may not exceed $4,000.72 In each of these cases, if it is later determined thatpayment to the person was improper, and payment should have been made tosomeone else, the person who received the improper payment may have to returnthe funds.

If the decedent owned other property in his or her own name, it may benecessary to use the estate settlement process to transfer the property and toappoint a personal representative to accomplish the transfer by a person who hasthe authority to do so. If the decedent had a will, that document will determine whois entitled to ultimately receive the property. If the decedent did not have a will, theintestate distribution schedule will determine ultimate entitlement to the property.

Appointment of Personal Representative

To begin the process, a representative is appointed for the estate. Except as listedabove, no one has the right to deal with separately owned property until a personalrepresentative is appointed. If a person prepared a will, the executor or executrixnamed in the will is the personal representative. (Executor signifies a man, executrixsignifies a woman.) If a person did not prepare a will, the personal representative ofthe estate is an administrator if a man, or an administratrix if a woman. A personalrepresentative can be a person or a corporation that has authority to act in that ca-pacity, such as a bank or trust company that has a trust department. In preparing a

will, a person can name one personal representative or several representatives whoshare the position and authority.

To achieve official status, a petition is presented to the register of wills of thecounty where the decedent has his or her last family or principal residence.73 If thedecedent did not have a domicile in Pennsylvania, but had property located inPennsylvania, the petition can be filed with the register of wills of the county wherethe property is located.74 If an executor or executrix files this petition, it is called apetition for letters testamentary. If an administrator or administratrix files the petition,it is called a petition for letters of administration.

The petition must provide the following information:

Personal information about the deceased and the place and date of death. If the deceased died without a will, the names and addresses of the deceaseds

surviving spouse and heirs.

If the deceased died with a will, whether the will was modified by divorce,marriage, or birth of a child after the will was prepared.


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If the deceased was domiciled in Pennsylvania at death, the estimated value ofall personal property and the estimated value and location of real property withinthe state.

If the deceased was not domiciled in Pennsylvania at death, the estimated valueof personal property located in the state, the estimated value of personal property

located in the county where the petition is filed, and the location of real propertyin the state.

Name and address of the person who is requesting that letters be granted.75

In this context, domicile refers to the place where a person lives and intendsto stay and call his or her home. A domicile is not just a place where a personresides for a period of time.

Under the Probate, Estates, and Fiduciaries Code of Pennsylvania, theregister of wills of the county where the petition is filed may grant letters ofadministration to one or more people in the following order:

Those entitled to the residuary estate under a will. The surviving spouse. Those who are entitled to the estate under the intestate law and who are

determined to be best able to administer the estate.

The principal creditors of the estate. Other fit persons.76

If any of the above parties renounce their right to be appointed and nominatesomeone to act in their place, the register of wills may, at his or her discretion,accept the nominee of the person who renounces the appointment.77

Certain persons cannot act as a personal representative. Such personsinclude minors, corporations not authorized to act as fiduciaries in theCommonwealth, people found by the register to be unfit to be entrusted with theadministration of the estate, and, in certain cases, the nominee of a beneficiary whois a citizen of a foreign country (if it appears doubtful to the register that thedistribution of the estate will actually be received by the beneficiary).78 If anonresident of Pennsylvania petitions for letters of administration, the register canrefuse to grant the petition.79

In addition to the petition, the original signed copy of the deceased's last will

and testament is filed with the petition. In most cases the deceased's deathcertificate is also filed with the petition. The petition can be filed anytime after thedeceased's death.80

A personal representative is responsible for the true and faithful performanceof his or her duties. In some cases, this security is provided by a bond for twice theestimated value of personal property in the estate.81 The bond is purchased from acompany authorized to do business in Pennsylvania. In many situations, however, a


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bond is not needed. This could be a case where the appointed personalrepresentative is a bank and trust company incorporated in Pennsylvania, or anational bank with a principal office in Pennsylvania.82 In addition, the personalrepresentative may be excused from this requirement by the deceased when theexecutor is a Pennsylvania resident. Many wills make that provision to eliminate the

need for a bond. If the executor is not a Pennsylvania resident, but will serve as co-executor with a resident excused from the bond requirement, the nonresident mayalso be excused from the bond requirement if the nonresident acknowledges that allassets will remain in the custody and control of the resident co-executor. A bond isnot needed by a resident who is granted letters of administration and is the sole heirto the residuary estate or by a resident who is the next of kin. If the court orders thepersonal representative to be bonded, the requirement must be fulfilled.83

When presented with a petition for letters testamentary and the original copyof the decedent's will, the register will determine whether to accept the will as thelast will of the deceased and require proof that the will was signed by the deceased.

This proof may come from witnesses present when the will was signed and whosigned the will themselves, or from persons familiar with the deceased'shandwriting.84 If the self-proving procedure was used, the register of wills canaccept the acknowledgment and affidavits to support the statements madetherein.85 This procedure eliminates the need to locate witnesses to the will andhelps the register of wills proceed quickly. The process followed by the register ofwills is called probate or probating the will. Probate means that the register of willsis determining the validity of the will.

After the petition for letters is granted, the register of wills issues a certificateof authority, which is formal proof of the personal representative's authority to act onbehalf of the estate.86 The register issues short-form certificates that the personalrepresentative uses to close bank accounts or otherwise deal with the deceased'sproperty. These certificates are commonly called "shorts" or "short certificates."

After letters of administration or letters testamentary are granted, the personalrepresentative arranges to publish a notice of the grant of the letters and the openingof the estate administration. This notice runs once a week for three successiveweeks in one newspaper of general circulation published where the deceasedresided. If the deceased did not live in Pennsylvania, a newspaper in the countywhere the letters are granted is selected to publish the notice. In addition to thisnotice, an advertisement will also appear in a legal periodical once a week for threesuccessive weeks.87 This is a publication designated by the local court as a placewhere legal notices are published. In many counties, this is a law journal publishedby the local bar association and distributed to lawyers, other professionals, andlibraries.

The notice specifies the name of the deceased, the name and address of thepersonal representative, and requests all people having claims against the estate tomake the claims known to the personal representative or the attorney to the estate


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without delay. Giving this notice is important because it affects the rights of theestate and its unpaid creditors as they deal with debts and expenses of the estateand the decedent.

Beginning the Administration

After being appointed to represent the estate, the personal representativecollects as much information as possible about the assets of the estate and the heirswho are to receive them. If the person originally in charge prepared lists of property,these lists will form a portion of the personal representative's inventory. Thepersonal representative should attempt to find all assets and heirs.

Review of Income Tax Issues

Following an individuals death, important state and federal income tax issuesarise. For example, if the individual died before filing a tax return for the prior tax

year, the need to file that return must be addressed. Likewise, from the beginning ofthe current tax year to the date of the decedent's death, a short tax year is createdand an income tax return would be filed for that period as well. In addition, thecreation of an estate for the transfer of property creates a new tax entity that isobligated to file an income tax return in a timely fashion. Each of these three in-stances provide significant opportunities for the surviving spouse, personalrepresentative, and heirs to plan a tax strategy that accomplishes specific goals andmay minimize the tax burden that arises. Important decisions must be made andshould not be overlooked.

The first important decision is filing of state and federal income tax returns for

a prior tax year when the decedent had not done so. These returns are generallydue by April 15 of the following year. For example, if the individual died on January15, 1999, the deceased's income tax return for the calendar year of 1998 would bedue on April 15, 1999. The individual's death in the 1999 tax year generally willrequire a final income tax return to be filed by April 15, 2000, to report incomereceived from January 1 to January 15, 1999. A surviving spouse can elect to join inthese returns and file joint returns for the prior and final tax years, if the spouse hasnot remarried during the current tax year.88 In deciding to elect to file joint returnsfor the prior and final tax years, the surviving spouse has important factors to weighin reaching the decision. Close coordination with an income tax advisor is importantbecause, depending upon the circumstances, the surviving spouse may or may notbe entitled to the refund, if any.89

The estate of a decedent also faces income tax liability. Income earned bythe estate (from investments, sales, or exchanges) or income earned by thedecedent but received by the estate, can be subject to income tax.90 Income in thehands of the beneficiary can be subject to tax if distributed by the estate during thetax year. In effect, income is subject to tax only once.


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Property that has appreciated in value and that passes through an estate alsoenjoys other tax advantages that do not apply to gifts of property made duringlifetime. For example, when appreciated property is given away during the ownerslifetime, the owner also gives the recipient the owner's basis in the property.91 If therecipient sells the property, the owner's basis is used to calculate gain from the sale

of the property. There may be a substantial difference between basis and fairmarket value which will be subject to income tax as gain from the sale.

When appreciated property passes to an estate, however, the tax basis of theproperty is increased from its value in the hands of the decedent to the value of theproperty as reported by the estate.92 This reported value can be either its fairmarket value as of the date of the decedent's death or the special use value whichhas been elected by the estate.93 Both of these concepts of valuing property areexplained below. When the personal representative sells property for an amountthat is close to the date of death value, little or no gain from the sale may berecognized for income tax purposes. When property is passed directly to heirs, the

heirs' basis in the property is the value of the property as reported by the estate.Personal representatives should be certain that heirs have the relevant informationabout property they receive.

As part of the 2001 amendments to the Federal income tax law, this step upin basis rule will be changed for individuals who die after 2009. In such cases, theheir who received inherited property will take as the basis in the property the lower ofthe decedents basis in the property or the propertys fair market value. Executors ofestates will be able to allocate up to $1.3 million of basis increase to any propertypassing under the decedents estate. If property passes to a decedents spouse,this basis increase allocation opportunity is an up to an additional $3,000,000. In2011, the law that amended the Federal Income Tax law will expire and the law inplace in 2001 will return and become effective.

For state and federal income tax purposes, an estate becomes a separateand independent taxpayer at the time of the individual's death.94 In the year ofdeath, the estate has an opportunity to select as its federal income tax year-- eithera calendar year or an acceptable fiscal year (which ends any time on or before thelast day of the month before the month in which the decedent died).95 The separateincome tax status of an estate continues until final settlement of the estate. Thisperiod cannot be unduly prolonged, but the time required to settle an estate variessignificantly with the complexity of the estate and the nature of the assets.

In selecting the tax year of an estate, the personal representative has animportant opportunity to tax plan for the receipt of income, distribution of the incometo the beneficiaries, and final termination of the estate. In the final tax year of anestate, certain unused income tax deductions, commonly called excess deductions,can be passed out to the beneficiaries for use on their personal tax returns. Timingthe receipt of income, distributions to the beneficiaries, and payment of deductible


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expenses is an important part of the estate settlement process. Close coordinationwith an income tax advisor is likewise important.

For state personal income tax purposes, similar issues arise in the filing ofstate income tax returns for the decedent's final year or years. The state income taxstatus of a decedent's estate will follow the tax year selected for the federal fiduciary

income tax return.96

Valuing Property in General

Property in the estate must be valued and protected. Certain types of propertyare in general easily valued; others may require appraisal by someone with specialknowledge and experience about assets such as jewelry, antiques, and land. Thepersonal representative should be certain that the property is adequately insuredagainst damage or loss. Value of the assets should guide the decision about theamount of insurance needed. The actual policy should be reviewed for importantterms and conditions of coverage.

In calculating value, a number of points must be known before applyingvaluation rules. First, the property to be valued must be clearly identified. Adescription such as the "family farm" or "family antiques" may not be sufficient toidentify all items or pieces of property. Ambiguous descriptions may result inincomplete calculations when assets are finally totaled. Second, the owner of theproperty and fractional ownership must be accurately identified to ensure a propercalculation. In trying to decide who owns property, all documents or receipts that lista buyer or owner are reviewed for relevant information. These documents mayinclude cattle registration certificates, purchase receipts, checking accounts,installment sales contracts, tax returns, certificates of title to registered vehicles, and

other documents of that kind. Third, any and all records should be obtained to helpestablish ownership and acquisition costs.

Date of Valuation

The next consideration is the date of valuation. The value of some items varies overtime. For most purposes, including Pennsylvania inheritance tax, the value ofproperty as of the date of death is used.97 In some situations, a tax statute mayallow for an alternative valuation. The personal representative should calculatethese values and then select the value that is most beneficial to the estate.

Fair Market Value

The general rule for determining property value is to consider its fair marketvalue on the valuation date. Fair market value is the price that a willing and ableseller of property would accept from a willing and able buyer, assuming that neitherparty is forced into the transaction and that both parties are similarly knowledgeableabout the property. If the item is generally sold on a public market, the current


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market price is included in the calculation.98 All types of forced sales, such assheriff's sales, are excluded from the concept of fair market value.

Fair market value also can be based on a recent sale or purchase of theproperty by the deceased. If there has not been a recent sale, then a review of the

sale of comparable property would help to estimate fair market value. However, thedifferences between these properties must be borne in mind.

Another method of valuing property is to have it appraised. The usefulness ofthe appraisal value depends on the qualifications and experience of the personsdoing the appraisal. A statement that the property value is a certain amount withoutan explanation of the methods and factors used in determining that amount mightnot be acceptable.

Value of Types of Property

There are many different kinds of property and value is often difficult todetermine. The following paragraphs describe common items of property and thevaluation rules that apply.

Real property. Comparable sales and appraisals are frequently used invaluing real estate. Some characteristics of land that affect its value are size andshape, natural resources, location, accessibility to roads and utilities, deedrestrictions on use or transfer, and current lease arrangements. Zoning and propertypotential are also factors. Property is valued at its highest and best use, and zoningmay determine what uses are possible within the communitys comprehensivedevelopment plan.

If property has been held for rental income, capitalization of such income mayprovide a value figure. However, capitalization may not be useful if the tenant is arelated party who obtained a favorable lease.

Offers to purchase property on the market may serve as an opinion of itscurrent value. If an offer is rejected (i.e., the seller is unwilling to accept the offer), itis reasonable to view the value of that property as higher than the rejected offer.

Current development of natural resource deposits on the property, such ascoal, oil, or gas also affects its value.

Special-use valuation of farm and business real property. Underspecial-use valuation provisions, anyone facing federal estate or Pennsylvaniainheritance taxes and qualifying for the provision may elect to value agricultural orother business real estate at its value in its particular use rather than at its fairmarket value. This valuation, known as a 2032A valuation, can substantially reducethe value of real estate assets from their fair market value to their value as used inagriculture or another business. But the election is subject to a maximum reduction,


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currently $820,000 in the case of federal estate taxes. Each of these tax laws has itsown requirements and conditions for special use valuation.

For example, under federal estate tax provisions, the valuation technique islimited to land used for a purpose that qualifies either as a farm for farming purposes

or in some other trade or business.99 The valuation technique requires that the landdevoted to farming or other trade or business comprise at least 25 percent of theentire estate value.100 The value of the land and personal property combined andused in the farm or other business must exceed 50 percent of the entire estatevalue.101 The deceased owner of the land or a member of his or her family musthave materially participated in the operation of the farm or other trade or businessfor at least five of the last eight years before the deceased owner's death, retire-ment, or disability.102 Material participation is a term with special meaning underthis provision. In deciding if material participation exists, factors such as thedeceased's active involvement in the business by providing labor, management, andcapital are considered.103 The deceaseds tax returns showing self-employment

income from the business are also considered. To be eligible for this treatment, theland that is specially valued must pass to or be acquired from the estate by a quali-fied heir, as that term is defined in the tax provision.104 As a condition of the use ofthis provision, the qualified heir and all others who have an interest in the land mustagree to continue to own and use the land in the qualified use or face a recapture ofthe tax benefits gained by use of this provision.105 Under the federal provisions, therecapture period runs for a period of ten years after the deceased's death (or afterthe qualified heir has taken over the business that makes the land eligible for thisprovision).106 Another factor that one must consider when valuing property under2032A is that the beneficiarys basis in the property will be limited to the value givento the property under 2032A.

This description covers only a few of the requirements, and those whoconsider use of the tax provision are well advised to carefully review all of therequirements for its use and the conditions imposed to avoid the recapture of the taxbenefit.

Under the state Clean and Green provision, land that is used for agriculturalpurposes, as an agricultural reserve, or as a forest reserve may qualify for specialvaluation.107 In addition, land that is devoted to an agricultural use must have beenin such use for three years preceding the owner's death, and be not less than tencontiguous acres in area, or have an anticipated yearly gross income of $2,000derived from agricultural use.108 If land is devoted to use as an agricultural reserveor a forest reserve, the tract must be not less than ten contiguous acres in area. Ifany of the land valued under this provision is applied to a use other than the threeuses listed above, within seven years of the death of the decedent, the owner of theland at that time is liable to repay the amount of the inheritance taxes saved by useof this provision.109 This brief summary of the requirements indicates that theserequirements are substantially different from those of the federal provision. Manyestates may be able to take advantage of this valuation provision; and those who


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consider it should carefully review all of the requirements and the conditionsimposed in order to avoid the recapture of the tax benefit.

Section 2057. A new tax law provision introduced in the 1997 TaxpayerRelief Act and later amended by technical corrections found in the Internal Revenue

Service Restructuring and Reform Act offers some additional federal estate tax relieffor owners of family owned enterprises.

The new provision, which is structurally similar to the special valuationapproach under section 2032A, allows a federal estate tax deduction for qualifiedfamily owned business interests.110 The amount of the deduction is coordinatedwith the amount that is passed tax free under the unified credit against federal andestate gift tax and is capped at $675,000.111 The maximum family owned businessdeduction allowed under section 2057 is $675,000, and if the deduction applies, thenthe maximum exclusion of property under the unified credit is $625,000.112 If thededuction allowed under section 2057 is less than $675,000, or the deduction does

not apply at all, the amount of the applicable exclusion under the unified credit will beincreased to the maximum amount which would apply without regard to 2057.113The addition of the family owned business exclusion is important for it will aid familybusinesses by allowing an additional amount of business property to pass free offederal estate taxes at the death of the business owner. This will enable the nextgeneration family business owner to acquire the business interest in a more intactform and at a lower transfer tax cost.

To be eligible for the exclusion, an estate must meet four requirements: (1)The decedent must be a United States citizen at death; (2) The estate executor mustmake a 2057 election and file a recapture agreement; (3) the adjusted value of the

qualified family-owned business interest must exceed 50% of the decedentsadjusted gross estate; and (4) the decedent or members of the decedents familymust have materially participated in the operation of the business in an aggregate ofat least five years of the eight-year period ending on the decedents death.114

Three important concepts in this set of qualifications are the includible giftsof interests, the decedents adjusted gross estate,and the adjusted valueof the qualified family owned business.

Qualified family owned trade or business interests can be carried on as soleproprietorships or as other entities.115 In regard to other entities, the decedent, or a

member of his or her family must own (1) at least 50% of the entity or (2) at least30% of an entity in which members of two families own 70%; or (3) at least 30% ofan entity in which members of three families own 90%.116 For corporations, thefamily must own the required percentage of the total combined voting power of allclasses of stock entitled to vote and the required percentage of the total value ofshares of all classes. For partnerships, ownership is determined by the percentageof capital interests of the partnership.117


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Certain interests can not be qualified as family-owned business interests,such as (1) interests in a business whose principal place of business is outside theUnited States; (2) interests in a business whose stock was readily tradable on anestablished securities market or secondary market within three years of thedecedents date of death; (3) the portion of the interest that is attributable to cash

and/or marketable securities in excess of the reasonable expected day-to-dayworking capital needs of the business or certain passive assets; and (4) an interestin a business if more than 35% of the adjusted ordinary gross income of thebusiness for the year of the decedents death was personal holding company incomeas defined by section 543 of the Internal Revenue Code.118

As is the case of the special valuation opportunity under section 2032A, theestate tax benefit of using the exclusion is recaptured if within 10 years after thedecedents death and before the qualified heirs death: (1) the material participationrequirements are not met with respect to interests acquired from the decedent; (2)the qualified heir disposes of a portion of the qualified family-owned business

interest, and other than to a member of the qualified heirs family or a qualifiedconservation contribution; (3) the qualified heir loses U.S. citizenship or no longer isa U.S. resident; or (4) the principal place of business ceases to be located in theUnited States.119 The adjusted tax difference attributable to a qualified family-owned business deduction is recaptured as the personal responsibility of thequalified heir to the extent of the heirs interest in the qualified family-ownedbusiness if the recapture occurs within six years following the decedents death.120The percentage recaptured thereafter is annually reduced in 20% increments, until20% is recaptured in the tenth year. Interest on the recaptured amount is also dueat the rate set for underpayment of taxes for the period beginning on the date theestate tax liability was due under this chapter and ending on the date such additional

estate tax is due.121 One difference between 2032A and 2057 is that basis inproperty is not reduced when taking the 2057 deduction.122

Note: For decedents who die after 2003, the qualified family owned businessdeduction will no longer be available as the provision will be repealed. In caseswhere estates qualified for the deduction in years prior to its repeal, the full 10 yearrecapture period described above will continue to be applied. In 2001 theamendments that repealed this deduction will expire and the law in place in 2001 willreturn and become effective.

Land subject to a qualified conservation easement. Section 2031 of theInternal Revenue Code allows a valuation deduction for land that is subject to aqualified conservation easement.123 This deduction can be up to 40% of the valueof the land. In order to be eligible for this treatment in the case of transfers before2001, land must be (1) located within 25 miles of a metropolitan area, (2) locatedwithin 25 miles of a national park or wilderness area that is under significantdevelopment pressure, or (3) located within 10 miles of an Urban NationalForest.124 For transfers in 2001 and later years these distance requirements are


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eliminated. However, the law that introduced the elimination of the distances willexpire in 2011 and the law in place in 2001 will return and become effective.

In addition, the land must have been owned by the decedent or a member ofthe decedents family for 3 years before the decedents death.125 A number of

other requirements exist before this deduction can be taken. The requirements arecomplex, and one should consult a professional before attempting to take thisdeduction.

Corporate stock. Corporate stock can be valued according to the amount itwould generate if sold. Stock sold on any of the stock exchanges is valued at theaverage of the high and low selling prices on the date in question. If no sales weremade on that day, stock is valued at the average price on the nearest sale daysbefore and after that date.126

For stock sold on the over-the-counter market with a bid and asking price, the

average between these prices on the valuation date can be used. If no prices werequoted for that day, the stock is valued at the average price on the nearest sale daysbefore and after the valuation date.127

Other methods may be needed for stock of a closely held corporation that hasnot had recent sales. Stock can be valued according to the company's net worth(assets minus liabilities) or its history of earnings and dividend payments.128 In aclosely held business, an existing buy-sell agreement may specify the amount to bepaid for the stock of an owner who withdraws from the business. Other factors to beconsidered are the nature of the business, its history, the economic future of thebusiness, values set in the corporation's own books and records, goodwill as carried

on the corporation's books, voting authority of stock, and the power of the votingauthority to control corporate decisions.129

The concept of goodwill involves a comparison of one business's performance tothat of other businesses of the same type in the same area. A business's greatersuccess may be used to determine its goodwill when compared to other businesses.

Partnerships and sole proprietorships.Ownership of partnerships and soleproprietorships is represented not by shares of stock but by an ownership interest inthe value of the business itself. In a partnership, the value of the business is sharedamong the partners; in a proprietorship, this value is held by the individual owner. Inboth cases, some of the same concepts may be used to assess value when thebusiness has not been sold recently. Concepts such as the net worth of the busi-ness and capitalization of earning capacity can be very helpful in calculating value.Buy-sell agreements or other provisions in a partnership agreement may enable thepartners to calculate the amount due a withdrawing partner.130

Machinery, equipment, and livestock. Value of machinery, equipment, andlivestock is determined by reviewing market value figures for recent sales of similar


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items, especially livestock. People in the business of selling these types of propertycan provide market value information for the estate.

Life insurance. For federal estate tax purposes, the proceeds paid by a lifeinsurance company are the valuation amount.131 Insurance proceeds are not

taxable under state inheritance tax law, and value is not a consideration. For federalestate tax returns, a form 712 should be obtained from the insurance company. Thisform describes the value of the policy that is reported.

Tangible personal property. The fair market value of general personalproperty may be difficult to establish since value drops immediately after sale. If theestate settlement and valuation occur soon after the purchase or sale of theproperty, the sale price may be a factor in valuation. This price, however, should notbe viewed as the only proof of value.

General personal property. General personal property includes such

common items as furniture, clothing, household appliances, and tools. For gift taxpurposes, it may be worthwhile to ask the recipient to place a value on the item.When payment of estate or inheritance taxes is involved, items may be sold at anauction and the value of the property is the proceeds of the sale (before paying theauctioneer's commission).

Antiques, collectibles, special property.If the property includes recognizedantiques or collectibles valued at over $3,000, a qualified appraiser is needed toestablish the fair market value of these items. The appraisal of the expert must befiled with the return.132

Notification of Heirs

Within three months after letters testamentary or letters of administration aregranted, the executor must notify the heirs of the deceased's death and the estateadministration.133 In the case of an estate distributed under the intestate law, thepersonal representative may have to do some investigation to identify the survivingfamily members who will receive property under the distribution schedule. Fordecedents dying on or after January 1, 1999, the personal representative mustdetermine a current address and send the form of notice that is listed in Rule 5.7 ofthe Orphans Court Rules. This required notice is to include information regardingthe date and place of decedents death; whether the decedent died with or without a

will; the name and address of the personal representative; and how the person mayobtain a copy of the will Within ten days of sending this notice to each heir, thepersonal representative certifies having sent the notice by filing a document with thelocal register of wills.134 Heirs may respond to this notice by requesting informationabout the amount they will receive from the estate, although it may be too early todetermine that amount accurately. Communication between the personalrepresentative and the heirs should be continuous throughout the estateadministration.


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Settlement of Small Estates on Petition

If a person who is a Pennsylvania resident dies owning personal propertyhaving a value of not more than $25,000 the orphans' court division of the county

where the person resided may act on a petition to distribute this property to heirsdesignated by the court.135 This procedure is available to settle estates of lowvalue and is not restricted by the fact that the decedent owned real estate,regardless of its value.136

In this simplified and less formal process, any heir or other person who hasan interest in the distribution of the decedent's personal property may file thepetition. The orphans' court division will determine what notice is to be given toother interested parties, and then act on the petition to direct distribution of theproperty to the parties entitled thereto in a decree of distribution. This action can beinitiated and acted upon regardless of whether the decedent's will has been filed for

probate or a personal representative has been appointed.137

Within one year after the court's decree of distribution has been made, anyother party who has an interest in the distribution of decedents personal propertymay file a petition to revoke the decree of distribution on grounds that it ordered animproper distribution. If the court finds the decree of distribution was improper, itmay revoke the decree and direct distribution of the property as it determines to be

just and equitable.138 This may require a person to return property or makerestitution of improperly received funds.

When planning an estate settlement, one should not confuse the provisions in

this section of the Probate Code with the provisions of section 3531. Section 3531can apply when the value of all real and personal property is less than $25,000, butnote that 3531 requires the appointment of a personal representative and thesubmission of the will for probate. One advantage of section 3531 is that theexpense of a formal account is avoided.139

Filing the Inventory

Every representative must file an inventory of real and personal propertyowned by the deceased.140 The inventory also includes a memorandum list of realestate owned by the decedent, but located outside of Pennsylvania. This list mayinclude the value of such property, but the amounts will not be included in theinventory total or as real estate in a later accounting of estate assets.141

This inventory must be filed no later than the date of filing the estate account(described later) or the due date of the inheritance tax return, whichever is earlier.