Taxation with Representation

Have you made a loan to family and/or friends, such as a mortgage?  You are currently requiring payments on that mortgage from your family and/or friends, but do you want to forgive that debt, if a balance remains, upon your death?  If you are a Pennsylvania resident, there are a few key pieces of information that you and your family and/or friends paying that loan should be aware of.

If you are a Pennsylvania resident, then your estate is subject to Pennsylvania inheritance tax upon your death.  Generally, Pennsylvania inheritance tax is imposed starting at dollar $1 of your estate.  And the rate of tax depends on the beneficiary’s relation to you, the decedent.  A beneficiary does not avoid paying Pennsylvanian Inheritance Tax if they themselves are not a Pennsylvania resident, only the residency of the decedent matters.  The Pennsylvania Inheritance Tax Return, PA REV-1500, (“PA ITR”) must be filed, and the tax paid, within 9 months after date of death.

Normally, a debt owed to a Pennsylvania decedent is reported as a taxable asset of the estate on Schedule D of the PA ITR.  If you forgive the debt upon your death (i.e. in your will, a trust, etc.), you and your family and/or friends may think that they do not owe anything.  However, such a forgiveness of debt is treated as a gift for Pennsylvania Inheritance Tax purposes.  And forgiven loans upon death are reported as a taxable asset of the estate on Schedule G of the PA ITR.

What if a mortgage payable to you is secured by real estate located outside of Pennsylvania?  Generally, there is no Pennsylvania Inheritance Tax owed on real estate owned by the decedent located outside of Pennsylvania.  However, a mortgage payable to a Pennsylvania decedent is treated as a personal interest and asset of the estate subject to Pennsylvania Inheritance Tax.  It does not matter that the real estate that the mortgage is secured by is located outside of Pennsylvania.

This means that you should prepare your family and/or friends that you made the loan to that they will be responsible for paying the Pennsylvania Inheritance Tax that is owed upon the date of death value of the debt that will be forgiven at your death.  While they may be upset at the thought of paying this tax, remind them that they will no longer have to pay the balance of the loan itself.  Seems like a good trade!

Let’s Get Planning Today!

This is just one example of Pennsylvania Inheritance Tax and its effect on your family’s planning.  Contact a member of our experienced Tax Team to discuss your family's unique estate planning needs.