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The Family Exemption to the Pennsylvania Inheritance Tax as Applied to Revocable or Living Trusts by The New Pennsylvania Uniform Trust Act

by Peter Klenk, Esq. & Kathleen Maloles, Esq.

Pennsylvania levies a tax on the estate of each of its citizens called the Pennsylvania Inheritance Tax.  This tax varies in amount depending on whom is inheriting from the estate (4.5% for children, 12% for siblings, 15% for friends) and is levied on every cent of the estate.   Given that every dollar is taxed, it is important that each estate maximize available deductions and exemptions.

The Law Offices of Peter L. Klenk focus exclusively in the areas of Wills, Trusts, Will Challenges and Estate Administration.  Over the years working for Executors, Trustees and Administrators we have learned how to maximize the available deductions and exemptions for our clients.  One problem with the Family Exemption has been that it was not allowed by the Pennsylvania Department of Revenue if a client’s estate passed by a Revocable or Living Trust.  As Revocable or Living Trusts have become more popular, the unfairness of denying the Family Exemption became more and more apparent, especially given the purpose of the Exemption.  This inequity has been addressed by Pennsylvania’s recent adoption of the Uniform Trust Act.  This article is meant to give a short introduction to the Revocable or Living Trust and its connection to the Family Exemption.

A Revocable or Living Trust is a trust formed during a person’s lifetime and in most cases its primary purpose is to avoid the probate process.  As the name implies, it can be revoked at any time.  This option allows a client to place all his or her assets into the trust, serve as the sole trustee and beneficiary with the option to end the trust whenever the client wishes.  When the client dies he or she dies penniless… the trust owns all the assets.  Because the trust owned the assets there is no need to file a Will.  Instead, the successor trustee takes over the Revocable or Living Trust and begins to pay creditors, taxes, etc. just as if the trustee had been the executor.   Because no Will is filed, the probate process is avoided.

It is important for clients to understand that while the Revocable or Living Trust has many uses, it has no effect what-so-ever on avoiding neither the Pennsylvania Inheritance Tax nor the Federal Estate Tax.  Because during the client’s lifetime he or she could “revoke” the trust at any time, the assets have not been completely given away.  This means creditors can still access the assets in the trust and for tax purposes the assets are still considered owned by the client.  Unfortunately, we commonly have people contact us with Revocable or Living Trusts drafted by other attorneys who have been told, incorrectly, that their Revocable or Living Trusts would reduce the Pennsylvania Inheritance Tax and the Federal Estate Tax.

Revocable or Living Trusts are very useful tools.  Besides avoiding probate they also are very useful in managing the assets of a client who has diminishing capacity and to counter a foreseen Will Challenge from a disinherited child or other disgruntled relative. If you happen to meet with an attorney who tells you that a revocable or living trust helps avoid the Federal Estate Tax or the Pennsylvania Inheritance Tax I suggest you do two things; first, check to see if you still have your wallet and second, run.

Though the Revocable or Living Trust has its uses, one past negative was that if all a deceased person’s assets passed outside of probate (did not pass through a Will) then the Family Exemption was lost.  The Pennsylvania Department of Revenue would only allow the exemption on the PA Form 1500 against probate assets.

As the popularity of Revocable or Living Trusts increased, it became apparent that not giving the Family Exemption for Revocable or Living Trusts was not fair and change was needed.

The Family Exemption was created to help the people who lived with the deceased and relied on that person’s assets or income to survive, such as a child or surviving spouse.  At death a person’s assets are frozen until the Commonwealth recognizes an executor, administrator.  During this time period the dependent spouse or child might find himself or herself without a way to pay for even the most meager of necessities.  In the alternative, if a person’s assets were small, an executor might hesitate to distribute any assets to a dependent child until the Pennsylvania Inheritance Tax was paid in full making the child wait months for a distribution. To guard against this possibility the Pennsylvania legislature created the Family Exemption, which is a right of a person living in the same household with the decedent to retain or to claim real or personal property of a decedent in a certain amount (presently $3,500.00) under the theory that this is enough to allow the person to survive until the estate is opened.  Executors can feel comfortable distributing this amount to a dependent child knowing that it will not be subject to the Pennsylvania Inheritance Tax.

Who is eligible for the Family Exemption?  Family members of a decedent may claim the Family Exemption in the following order:  A spouse of the decedent, or if there is no surviving spouse of the decedent, then children who are members of the same household as the decedent, or if there is no such children, then the parent or parents of the decedent who are members of the same household as the decedent.  Live-in girl or boyfriends do not qualify.

Since its inception, the family exemption was legally payable only from the probate estate of the decedent.  Furthermore, this exemption could not be claimed as a deduction on Schedule H of the Pennsylvania Inheritance Tax Return (Rev-1500) except to the extent that sufficient probate assets existed to satisfy the exemption.  Revocable Trust assets are not probate assets, so if the deceased’s assets all passed through the Revocable or Living Trust, there was no probate estate and the Family Exemption could not be claimed for Inheritance Tax purposes.

In the past, though creditors has been collecting debts against Revocable or Living Trusts, the actual law in Pennsylvania that gave them that right was unclear, although the creditor’s rights in a decedent’s estate have long been established and clarified in Pennsylvania’s Probate Estates and Fiduciaries Code.

However, on July 7, 2006, Governor Edward Rendell signed the Pennsylvania Uniform Trust Act which covers a wide range of issues concerning the administration of trusts.  The Pennsylvania Uniform Trust Act became the first comprehensive uniform body of trust law in Pennsylvania because it clarifies several areas of the law that were unclear and inconsistent.

Thus, under Section 7745 of the Pennsylvania Uniform Trust Act, after the death of a grantor, and subject to the grantor’s right to direct the source from which liabilities will be paid, the property of the trust that was revocable at the grantor’s death is clearly subject to claims of the grantor’s creditors, costs of adminstration of the grantor’s estate, the expenses of the grantor’s funeral and disposition of remains and the Family Exemption.  This is to the extent the grantor’s probate estate is inadequate to satisfy those claims, costs, expenses and exemption and no other statute specifically exempts the property from such claims.

In consequence, since the Pennsylvania Uniform Trust Act took effect in November 6, 2006, trustees may now pay any claims for the Family Exemption from the assets of the revocable trust, which became irrevocable at the decedent’s death.  In keeping along this same line of thought, should the family exemption be paid from the revocable trust of the decedent, the exemption may now be claimed as a deduction for inheritance tax purposes even though it is not paid from the probate estate of the decedent.

Long overdue, these changes made under Uniform Trust Act make clear that the intention of the Family Exemption, to assist family members immediately after the death of someone on which they were dependent, should not be thwarted simply because the deceased chose to use a Revocable or Living Trust.  It also gives the Trustee of the Revocable Trust the ability to make the distribution to a needy child or surviving spouse without fear that the Department of Revenue will reject the exemption on the Pennsylvania Inheritance Tax Return (Rev-1500).

This article is not intended to constitute legal advice, and should not be construed as a substitute for professional legal advice from a licensed attorney.