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Inheritance Tax Exemption
LEGISLATION EXEMPTING FARMS FROM INHERITANCE AND REALTY TRANSFER TAX LIABILITY BRIGHTENS THE FUTURE FOR PENNSYLVANIA’S FARM FAMILIES
Pennsylvania enacted landmark state tax legislation that should greatly enhance the ability of farm families’ ability to organize their farm businesses and pass their farms to future generations. Farm Bureau has been fighting for a number of years to achieve the two farm exemptions from inheritance tax and realty transfer tax provided in Act 85 of 2012. The discussion below attempts to help readers better understand the farm tax exemptions provided under this new law.
Farm Exemption from State Inheritance Tax
Act 85 will exempt from inheritance tax any real estate “devoted to the business of agriculture” transferred by death of the owner to “members of the same family.” For purposes of the inheritance tax exemption, Act 85 recognizes that a farm is “devoted to the business of agriculture” if the deceased owner had leased the farm to members of the same family or to a partnership or corporation owned by members of the same family, if the farm was directly and principally used for agricultural purposes.
Act 85 also defines “members of the same family” to include parents and grandparents, brothers and sisters, aunts and great aunts, and uncles and great uncles of the deceased owner, as well as all ancestors and offspring of those persons mentioned and spouses. Adopted and half-blood members are also considered part of the same family.
But Act 85 does limit the “farm” areas that may qualify for the exemption. Consistent with other state tax laws that providing “family farm” exemptions from state tax, Act 85 specifically recognizes that “agriculture” does not include the use of land for recreational activities, raising game animals or animals for sporting or recreational purposes or use as pets, fur farming, stockyard or slaughterhouse operations or manufacturing or processing operations.
Act 85 requires that, in order for the inheritance tax exemption to fully apply on transfers of farms to “members of the same family,” the farm must continue to be “devoted to agriculture” for seven years after the owner’s death and must generate a yearly gross income from agriculture of at least $2,000 during this period. Each year, the surviving owners must certify to the Department of Revenue the farm in question continues to qualify for the inheritance tax exemption. If the farm does not meet the use in income requirements during the seven-year period, the surviving owners must pay the inheritance tax they would have normally paid, with interest.
Just before final passage of Act 85, an amendment was added to provide:
"A transfer of an agricultural commodity, agricultural conservation easement, agricultural reserve, agricultural use or a forest reserve, as those terms are defined in Section 2122(a), to lineal descendants or siblings is exempt from inheritance tax."
It is not entirely clear how this added amendment is to be generally interpreted in the overall context of Act 85’s farm inheritance tax exemption. More specifically, it is unclear whether or not a requirement for seven-year continued use of the land in “agricultural use,” “agricultural reserve,” or “forest reserve” applies to transfers by death to “lineal descendants” (such as children and grandchildren) or “siblings” (brothers and sisters). It is reasonably possible that courts interpreting this provision that a seven-year continued use requirement as a condition does not apply. Farm families should at least be aware of this added amendment and the benefit it can potentially provide.
Act 85’s farm exemption from inheritance tax applies to estates of persons dying after June 30, 2012.
Farm Exemption from Realty Transfer Tax
Act 85 attempts to correct the inequity in tax treatment that had developed between farm families trying to convey farm property in the course of reorganization of the family business to a limited or limited liability partnership and families of other businesses trying to convey business property in the course of their family business reorganization.
Existing law before Act 85 provided an exemption from realty transfer tax to conveyances of farm property between an individual and a partnership or corporation primarily owned by the individual’s family. But the law did not specifically provide for an exemption for transfers of farm property from one family partnership to another. Interpretations of the RTT law by the Department of Revenue determined that a family farm partnership’s exemption status ended with the end of the partnership, and conveyances of farms to a succeeding partnership were subject to realty transfer tax, including conveyances to a succeeding partnership owned by the same family.
Act 85 makes it clear that conveyances of assets held by one “family farm business” to another “family farm business” is not a taxable “transfer” under the realty transfer tax law, if the same family members are holding at least 50 percent of the ownership interest in each business. Additionally, Act 85 specifically repeals the regulation containing the Department of Revenue’s interpretation that states transfers to succeeding partnerships are taxable.
Act 85 makes several changes in definitions provisions of the RTT law. The new law replaces the terms “family farm partnership” and “family farm corporation” with a single term, “family farm business,” whose definition essentially incorporates and consolidates the definitions contained in the old terms. Other changes in definitions made in Act 85 clearly recognize that the types of “family farm business” that may be eligible for exemption from realty transfer tax include limited and limited liability partnerships.
Act 85, however, essentially retains the same minimum requirements as existing law, with respect to the percentage of ownership interests that members of the same family must hold and in percentage of business assets that must be “devoted to agriculture” in order to be eligible for the farm exemption from realty transfer tax. To be eligible for RTT exemption as a “family farm business,” members of the same family must hold at least 75 percent of the ownership interests in the business, and 75 percent of the business’s assets must be “devoted to the business of agriculture
Act 85 also does not change the scope of persons considered under existing law to be members of the same family. An individual and his or her parents and grandparents, brothers and sisters, aunts and great aunts, and uncles and great uncles, as well as all ancestors and offspring of those persons mentioned and spouses are all considered part of the same family. Adopted and half-blood members are also considered part of the same family.
And Act 85 change what is considered under existing law to be “devotion to the business of agriculture” for purposes of the realty transfer tax exemption. The “business of agriculture” includes leasing the farm to members of the same family or to a partnership or corporation owned by members of the same family, if the farm is directly and principally used for agricultural purposes.
Consistent with other tax laws providing “family farm” exemptions, Act 85 also does not change the limitations in activities considered to be “agriculture” under existing RTT laws. For purposes of the farm exemption from realty transfer tax, “agriculture” does not include recreational activities, raising game animals or animals for sporting or recreational purposes or use as pets, fur farming, stockyard or slaughterhouse operations or manufacturing or processing operations.
Act 85’s farm exemption from realty transfer tax retroactively applies to conveyances of farms qualifying for the exemption that occurred on or after July 1, 2010.
Act 85 is a new law, and future interpretations of this law may differ significantly from people’s initial beliefs and understandings about the exemptions provided. As with most tax laws, it is recommended that you consult with tax professionals to best ensure you and your family receive the greatest tax benefit.
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