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1 TRANSFER OF PROPERTY AFTER DEATH: Guide to Estate Settlement Prepared by: John C. Becker and Anthony D. Kanagy The Pennsylvania State University University Park, Pennsylvania March 2002

2 TRANSFER OF PROPERTY AFTER DEATH: GUIDE TO ESTATE SETTLEMENT Transfer of Property After Death... 1 By Operation of Law...2 By the Intestate Law...3 By a Last Will and Testament... 4 By a Living Trust... 7 Inheritance Tax Effects of the Transfer... 8 Federal Estate Tax Effects of the Transfer Federal Gift Tax Effects of the Transfer The Steps Involved in Estate Settlement Initial Decisions Appointment of Personal Representative Beginning the Administration Review of Income Tax Issues Valuing Property in General Date of Valuation...21 Fair Market Value Value of Types of Property Notification of Heirs...27 Settlement of Small Estates on Petition Filing the Inventory...28 Initial Payment of Inheritance Tax Administration of Assets Preparation of the Pennsylvania Inheritance Tax Return Payment of Pennsylvania Inheritance Taxes Preparation of Federal Estate Tax Returns Payment of Federal Estate Taxes Preparation of Account, Schedule of Distribution Audit Family Settlement Agreement Receipt and Release The Final Steps...40 Summary Levels of Property Distribution Under the Intestate Law of Pennsylvania Glossary Endnotes Prepared by John C. Becker, professor of Agricultural Law and Economics, Director of Research for the Agricultural Law Center of the Dickinson School of Law of the Pennsylvania State University and Anthony D. Kanagy, Research Assistant for the Agricultural Law Center. Revised March, i

3 A death is a traumatic event for most families. Whether the death is sudden or expected, most people need an adjustment period to cope with the reality of the death of a family member. While this period runs its course, surviving family members may be distracted and have difficulty dealing with business and personal problems. Nonetheless, during the adjustment period, distribution of property owned by the deceased must be considered. In some families this is cause for anxiety because the situation involves the legal system and the services of an attorney. For some people, death of a family member may bring them in contact with the legal system for the first time. Inexperience with the legal system and the emotional adjustment to the death can combine to create even greater anxiety for a bereaved family. This publication will address legal issues and procedures for the settlement of an 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 estate situation and will refer to the steps needed to complete the process. The discussion is general and does not cover all possible contingencies. Some situations may require additional steps to complete the process. Anyone who has questions concerning a procedure used in a particular case should consult someone familiar with the situation or his or her personal attorney. This publication does not provide legal or tax advice to the reader and is not intended to be a substitute for such advice or service. The reader should seek such advice or service 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's death? A simple answer to this question is that all items of property are owned at all times by someone, or something such as a corporation. When a person dies owning property, some disposition of the property must be made to provide a new owner for the property. When an artificial person such as a corporation that owns property goes out of business, dissolution of the business will address the question of transfer of property. When property is abandoned by its owner, the original ownership continues. But someone who finds the property and controls, uses, and protects it may acquire an ownership interest, if the original owner fails to exercise control of the property. Each of these examples points to the need to identify the owner of property at all times. This publication discusses the transfer of property owned by people at their death and the tax consequences of the transfer. This can generally take place in one of four ways: by operation of law, by the intestate law, by a last will and testament, or by a trust created during their lifetime that provides for this transfer. 1

4 By Operation of Law A transfer by operation of law takes place when a person makes a lifetime decision 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 person is treated as the owner of an equal share in the property. This property can be either real or personal property, or tangible or intangible personal property. During the lifetime of the joint owners, their rights to the use of the jointly-owned property are dependent on the intent of the property owners when the joint ownership interest was created. In the case of a bank account, unless there is clear and convincing evidence of a different intent at the time of creation of the account, each joint owner has access to the account in an amount that equals their net contribution to the account.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 be whether the original owner intended to give the added owner a present gift of a one-half interest in the account, or did the owner simply intend that the new owner receive whatever balance remains at the original owner's death? If clear and convincing evidence of an intent to create a present gift is established, then each owner would have access to an equal share of the account. Each owner would be treated as having contributed an equal amount to the account. If such evidence cannot be established, then each owner would have access to the account in whatever 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 to contribute 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 the death of one of the owners, the survivorship feature transfers the deceased owner's share to the surviving owner(s), who acquire an equal share of the portion previously owned 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 between the surviving owners. Their ownership share would increase by one-sixth; their new ownership share would be one-half (1/3 or 2/6 + 1/6 = 3/6 or 1/2). At the death of one of the two owners, the surviving owner would become the sole owner of the property by receiving the deceased's one-half share and adding it to his or her one-half share. Transfer takes place automatically upon the death of a person who owns property as a joint owner with the right of survivorship. Documents which show ownership must specifically state that it is owned as joint tenants with right of survivorship. Property owned by a husband and wife is generally classified under a special form of joint ownership called tenants by the entireties. At the death of the first spouse, the surviving spouse becomes the owner of the property automatically. 2

5 When two people are married and property is placed in the names of both of the persons, a presumption arises that the property is held in a joint tenancy by the entirety 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 be determined which owner died first. Since surviving the death of the other owner is the key requirement to transfer of ownership, time of death of the first party to die must be established to make that determination. To resolve the problem Pennsylvania law provides that, unless a will, living trust, deed, or insurance contract provides otherwise, when there is no sufficient evidence 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 survived and one-half as if the other had survived.4 If there is a joint tenancy of more than two 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, a person can change this result by specifying in a will their own rule for determining the order of death in such situations. This decision is frequently made when planning to minimize federal estate taxes. By the Intestate Law If a person owns property in his or her name alone, the transfer of ownership will be made either under a will prepared during the person's lifetime or under the provisions 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 of separately owned property. Within the schedule, the statute specifies who is to receive the property, how much they are to receive, and any special conditions that apply to this transfer.7 For example, under Pennsylvania's intestate statute, the following distribution would be made of the sum of $70,000 owned by a person at death when the person is survived by a spouse and two children who are children of the marriage. Following the payment of debts, administrative expenses, and an exemption, the spouse receives the first $30,000 plus one-half of the difference.8 The children share equally the remaining one-half of the difference. If $70,000 remains after the obligations 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 deceased person and the surviving spouse, but was born from a prior marriage or other relationship, then the shares of the spouse and children change. The spouse is entitled to one-half of the amount or $35,000 (1/2 of $70,000). Each child s share increases to $17,500 (1/2 of $35,000).10 3

6 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. The deceased person's parents receive the remaining one-half of the difference. The surviving spouse receives the entire estate only when the deceased spouse is survived by the spouse but no surviving children, grandchildren, or parents.11 In addition to provisions for surviving spouses, children, grandchildren, and parents, the intestate law controls the distribution of property when none of the previously listed relatives survive the deceased. Additional provisions cover distribution to brothers, sisters, and their children; grandparents; aunts, uncles and their children; children of first cousins; and finally the Commonwealth of Pennsylvania. If a person dies but is not survived by a relative who is closer in relation than grandchild of a first cousin, ownership of that person's property passes to the Commonwealth.12 Except when the Commonwealth would receive the property, each listed heir must survive the deceased for at least five days in order to receive the share designated by the schedule.13 The intestate statute can be revised by the legislature, and the distribution of property described above can change. Since this plan of distribution applies to those people who have not made their own decisions about the transfer of their property, it can be said that we all have an estate plan-- either one that we have prepared 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 death can do so by preparing a will. Like the intestate law, a will only provides for the distribution of separately owned property. Unlike the intestate law, which primarily benefits family members, a will can bestow benefits and property on family members, strangers, corporations, charities, churches, and other beneficiaries. A valid and enforceable will in Pennsylvania is one prepared by a person eighteen years of age or older and of sound mind and understanding.14 The document must recognize an intent to distribute property after death and be signed at the end by the person making the will.15 A will can be formally prepared by an attorney trained in these matters or by the property owner.16 Pennsylvania, unlike other states, does not require that people witness the signature of the person who prepared the will. Although witnesses are not required in order to have a valid will, most wills are witnessed by several people since the signature of the person who prepared the will must be proven when the will is filed with the Register of Wills after a person's death. At that time the witnesses will come to the Register's office to sign a document that confirms their role as witness and the validity of the person's signature.17 4

7 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 the will 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 done voluntarily.18 Witnesses then sign an affidavit stating that they were present and saw the person sign the will; that it was signed voluntarily; that the witnesses signed the will in the hearing and sight of the person who made the will; and that to the best of their knowledge the person who made the will was eighteen years of age or older at the time, of sound mind, and under no constraint or undue influence. The acknowledgement and affidavits are notarized and attached to the will. When the will is ultimately filed, the register of wills can accept the acknowledgement and affidavits to support the statements made therein.19 This procedure eliminates the need 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 months after the date of probate, whichever is later, a surviving spouse has a right to elect against what the will provides and take what Pennsylvania law has designated as a surviving spouse's share.20 This election requires the surviving spouse to give up his or her claim to certain property in return for a statutory share of one-third of certain other specifically identified property.21 In deciding whether to elect against a will, a surviving spouse should calculate what the spouse s share would be with an election and without an election. Whichever choice provides the surviving spouse with the most beneficial treatment can be selected. A surviving spouse s right to elect against a will can be forfeited for failure to financially support the deceased spouse, for desertion, and for participation in the willful or unlawful killing of the deceased spouse.22 In addition, the right to elect can be waived, as in the case of an agreement made by two parties before they marry.23 This agreement, which is often called a premarital agreement, is subject to its own standards and rules for enforcement. Other family members do not have this right to elect against what the will provides. Although a will provides some assurance that a person's property will be distributed according to its terms, a will can be challenged either before or after it is presented to the register of wills after the person's death. Some of the people who can challenge the will are beneficiaries who are named by the decedent in one will but not in another, the intestate heirs of the decedent, and beneficiaries whose share would increase or decrease depending on which will is admitted to probate. Some of the common grounds for a challenge to a will are that the decedent was not of sound mind when the will was prepared, that someone unduly influenced the decedent to prepare his or her will with particular terms, fraud practiced on the decedent, that the decedent intended to give property away during lifetime rather than at death, and that the decedent failed to properly execute the document. 5

8 In addition to cases where a will is challenged, a will can also be modified as a result of certain events. For example, if a married person prepares a will that provides for his or her spouse, and the marriage is later ended by divorce, the termination of the marriage voids all provisions in the will for the divorced spouse.24 In 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 of the decedent's property if the person has not provided for the spouse in a will.25 If a person prepares a will and a child is born to or adopted by that person's family after the will is prepared and before the person dies, the share of the after-born or adopted child could be either an intestate share comparable to that of all of the children, a share mentioned in the will, or nothing if the person clearly expressed an intention to leave nothing to after-born children.26 If a person participates in the willful and unlawful killing of someone, the slayer will be prevented from receiving any 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 beneficiary of a life insurance contract, annuity, pension or profit-sharing plan or any other contractual arrangement that provides benefits to the spouse, the designation of the divorced spouse to receive the benefit will not be effective.28 An exception to this result applies where the document that designates the spouse to receive the benefit, or a court order, or written contract between the parties clearly expresses the intention that the designation is to survive the divorce.29 Transfers by a will have other advantages that are important to the estate and the heirs. A person with a will can name a guardian for the children and thereby somewhat reduce the time and expense involved to obtain the necessary court appointment. Guardians have legal authority to hold property for a minor child until the child reaches eighteen years of age.30 At a person's death, a personal representative is appointed to deal with the deceased's separately owned property. The personal representative has the authority to deal with the estate assets and the obligation to administer the assets according to the will or intestate law. This obligation includes filing all necessary estate, inheritance, and income tax returns for the estate. The person who prepares a will can select the personal representative to perform these duties and responsibilities. If the deceased did not have a will, the personal representative is appointed from a list of those eligible to petition the court for appointment to this position. 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 the opportunity to name a personal representative to operate the business for the benefit of heirs or other beneficiaries. Without such authority the personal representative must seek court approval to get the authority.32 This procedure may be time consuming and expensive. 6

9 By a Living Trust Transfer of property under terms of a living trust reflects the owner s lifetime decision to use the trust vehicle to own, control, and manage property, and to designate 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 of the 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 provide for 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's ownership of the property, and its eventual distribution to a beneficiary. A trust created during an owner's lifetime is called a living trust in contrast to a testamentary trust which is created in a will. Under a living trust arrangement, an owner may reserve the right to receive some benefit from the trust property during his or her lifetime. If the owner becomes disabled, incapacitated, or simply does not want to be responsible 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 accomplish the same thing. The appointment of the trustee s a decision made by the person who creates the trust. The decision to name a guardian is made by a court.at the owner's death, the trust agreement would direct the trustee to distribute the property to an eventual beneficiary. In this context, a living trust becomes an effective way to transfer the property to the designated beneficiary after the owner's death. Many living trusts also grant the property owner the right to terminate the trust and re-acquire the property. This gives the property owner flexibility to deal with changing circumstances. Such trusts are commonly called revocable trusts. Trusts that 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 trust both 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 in the trust will be subject to inheritance and federal estate taxes if the value of the property is large enough for these taxes to apply. The applicable exclusion amount under federal estate tax, which is discussed below, is available in both cases. Distributions by will follow a process that allows creditors of the decedent to present their claims to the personal representative of the estate. This is also described below. In living trust cases, these creditors present their claims to the trustee on the basis of the decedent s failure to fulfill the terms of a contract or agreement. This may allow the creditor a longer period of time in which to file the claim and take the claim out of the procedure normally followed for estates. 7

10 Under income tax law, income that is generated by an estate or trust and is subject to 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. Trusts have a similar opportunity. During the lifetime of the owner who created a revocable living 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 a person who is subject to federal estate tax often reflects the time, effort and expertise of the person providing the service. This cost is generally higher than the cost 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 fees to the trustee for the service the trustee provides. These fees are most common when a financial institution is named as a trustee. The cost of settling an estate that is subject to federal estate taxes will also reflect the time and effort involved as well as the expertise of the person who is providing the service. This is a post death expense 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 Register s office after the person dies, the will becomes a public document. When a petition for Letter Testamentary is filed at the same time as the will, a fee is paid to the Register of Wills. A revocable living trust generally is not filed on the public record if the trust does not own real estate. If the trust is not recorded it does not pay a filing fee. In the case of revocable living trust, after an owner s death the trustee files the inheritance tax return and distributes the property to those identified in the trust agreement This may give the property owner a greater degree of privacy than the decedent whose property is transferred under a will or the intestate law. If a person owns property in several states, having the out of state property owned by a revocable trust can avoid the necessity to have a separate probate proceeding opened in each state where property is located. This is accomplished by the fact that the trust owns the property. If a trustee is authorized to act, the trust can transfer the property without having the personal representative be given the same 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 tangible personal property located in the state, an inheritance tax is imposed on the transfer of property following an owner's death. The tax is imposed at one of four rates. Tax-free transfers include transfers to recognized charities; to federal, state, or local governments; transfers to a surviving spouse which occur on or after January 1, 1995; transfers from a child aged 21 or younger to his or her natural or adopted parent(s) or stepparent, transfers of life insurance proceeds and social security death benefits.33 No inheritance tax is imposed on these transfers. 8

11 Transfers under a trust for the sole use of a surviving spouse are not necessarily taxable in the estate of the first spouse who dies, but can be included in the surviving spouse s estate when that spouse dies.34 The exclusion of the asset from the estate of the first decedent may be bypassed if the estate elects to include the trust in the first decedent s estate. This election is made on a timely filed inheritance tax return in the first decedent's estate.35 Retirement benefits and individual retirement accounts may also be exempt from inheritance tax if the decedent was younger than age fifty nine-and-one-half years at death, or otherwise did not have the right to withdraw the retirement funds without penalty.36 Transfers taxed at 4.5 percent include transfers to decedent's grandparents, parents, lineal descendants, or to the wife or widow, husband or widower of a child.37 Lineal descendants, for inheritance tax purposes, include natural children and their descendants, adopted children and their descendants, and stepchildren and their descendants. Adopted children are considered to be natural children of their adoptive and their natural parents for inheritance tax purposes.38 Transfers taxed at 12 percent include transfers on or after July 1, 2000 from a decedent to a sibling. A sibling is considered to be a person who has at least one parent in common with the decedent, whether by blood or adoption. Transfers taxed at 15 percent include transfers to any other person or entity that 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 family members, 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 death and the value of the property given away to a single person is more than $3, In this context, the property transfer means to give away something of value yet receive nothing in return, such as a gift. If something is given in return, the amount of the gift equals the difference between the value of the item given away and the value of the item received in return. Other provisions of the inheritance tax law affect transfers that restrict the right of the person receiving the property to immediately use and enjoy it, that reserve a right to use the property during the original owner's lifetime, or that reserve the right to alter, amend, or revoke a gift.41 In the case of jointly owned property with the right of survivorship, the transfer of the deceased owner s interest to the surviving owner or owners is subject to inheritance tax in an amount equal to the value of the deceased owner s share.42 In cases in which the joint ownership interest is created within one year of the deceased owner s death, the full value of the property above $3,000 may be subject to inheritance tax if the decedent was the person who created the joint ownership by giving the interest to the surviving owner. 9

12 Pennsylvania law also provides for an estate tax. This tax applies only in situations where federal estate tax is payable and the amount of the inheritance tax paid to the Commonwealth and other states is less than the state death tax credit amount that is allowed under federal law.43 For a person who resides in Pennsylvania at death, the amount of the Pennsylvania estate tax is equal to the difference between the amount of the state death tax credit allowed by federal law and the total amount paid in inheritance taxes and state death taxes. For a resident of Pennsylvania who dies owning property in Pennsylvania, as well as other states, the Pennsylvania estate tax is reduced by the greater of either the amount of death taxes actually paid to other states, or an amount computed by multiplying the state death tax credit by a fraction of the numerator of which is the value of property located in other states and the denominator of which is the value of the decedent's gross 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 for federal estate tax purposes. This ratio is then applied to the allowed state death tax credit under federal law. If the amount of Pennsylvania inheritance taxes paid does not exceed the amount determined by applying the ratio above, then a Pennsylvania estate tax in the amount of the difference is applied.45 For example, if assets subject to Pennsylvania inheritance tax comprise 50 percent of the assets in the federal gross estate, 50 percent of the state death tax credit is allowed against these assets. If the Pennsylvania inheritance tax paid is less than the death tax credit allowed, the difference in amount is imposed as the Pennsylvania estate tax. The amount of state death tax credit allowed under federal law is calculated as a percentage of the taxable estate of the deceased and is limited to taxes actually paid. The first $60,000 of the taxable estate is not considered when calculating the credit. Percentages used to calculate the credit range from 0.8% to 16%.46Beginning in 2002, the state death tax credit will be reduced by 25% each year until the tax is repealed in its entirety for the estates of people dying after After the tax credit is fully repealed, decedents will be allowed to deduction state death taxes when calculating federal estate tax. In 2011, the amending law will expire 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 transfer of property following an owner's death. In 2001, Congress amended the Federal Estate tax in very dramatic ways. Beginning in 2002 and continuing until 2009, the law will undergo a variety of important changes. In 2010, the law that creates the tax will be repealed. However, for individuals who die after December 31, 2010, the law that is in existence in 2001 will return. This is due to a sunset provision that 10

13 appears in the 2001 amendments. In other words, the 2001 amendments themselves will expire after December 31, 2010 and the law will return to the provisions in place in 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 tax rate of 50%.47 Between 2003 and 2009 the maximum tax rate will fall to 45%. In 2010, the Federal estate tax will be repealed. In 2011 the amending law will be expire and the law in place in 2001 will return. Under federal estate tax rules, the greater 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 can be applied against either federal estate tax liability owed. The amount of this applicable exclusion for 2002 is $1,000, This means that an individual whose gross 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. In 2004, 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 is repealed. In 2011, the Federal Estate Tax law returns and the applicable exclusion will fall to $1,000,000 for people who die in 2011 or later..49 Estates valued below these applicable exclusion amounts will not be subject to estate taxes. The rules that determine whether an estate tax return must be filed reflect the amount of the applicable exclusion. If the estate value does not exceed the amount of the applicable exclusion, there is no need to file a federal estate tax return.50 This rule only applies to the amount of the applicable exclusion that is available to the person's estate. To determine the amount of the exclusion that is available to the estate, 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 to federal tax is the list of available deductions. Current tax law provides that estate administration fees, attorney s fees, casualty losses, debts, and a marital deduction are 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 transfer practically an entire estate to the other spouse and have the full value of the transfer deducted 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's estate and the full value may be subject to tax at that time. Various types of transfers to a surviving spouse can qualify for marital deduction treatment, including transfers to a surviving spouse as a tenant by the entirety or as beneficiary of life insurance proceeds.53 11

14 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 compared to 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 of amount paid or contributed by the decedent toward the cost of an item of jointly owned property.54 If the decedent at the time of death had the right to control the payment of insurance proceeds through a change in beneficiary, a right to cancel the policy, or a right to borrow against its cash value, then the insurance proceeds will be included in the calculation of the gross estate.55 As in the case of the Pennsylvania inheritance tax, if a person restricts the right of the person given the property to immediately use and enjoy it, or reserves a right to use the property during the original owner's lifetime, or reserves the right to alter, amend, or revoke the gift, the value of property transferred under these conditions is included in the calculation of the gross estate of the deceased person.56 This discussion has illustrated several differences in estate, gift and inheritance tax calculations. Many different kinds of property and special rules are included in determinations of the gross estate. Some different rules are used for the federal estate tax system and the Pennsylvania inheritance tax system. The treatment afforded life insurance proceeds is a good example, since the Pennsylvania system excludes these payments from the calculation of inheritance tax while the federal system includes the value of the proceeds if specific conditions are met. Note that including the amount of the insurance proceeds in the calculation of a gross estate does not bring the proceeds back to the estate, but that the value of the proceeds is part of a calculation to determine how much tax is due. The proceeds of the life insurance policy will be paid to the beneficiary named in the policy. 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 generation to a generation of beneficiaries who are more than one generation below the transferor's generation (grandparent and grandchild or lower or a non-family member who is more than thirty-seven-and-one-half years younger than the transferor).57 This tax is a separate tax that is involved in planning for the transfer of property to these younger generations of beneficiaries. Transfers that are typically subject to this 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 the income or principal of a trust. In each case, the transfer must be to a person who meets the generational requirement for the tax to apply. If this tax applies, it is calculated at the flat rate which is equal to the maximum 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 from the generation skipping transfer tax.59 In addition, this tax does not apply to gifts 12

15 that are eligible for the $11,000 per person, per year, federal gift tax annual exclusion, and the tuition and medical expense exclusions, which are discussed below.60 Individuals whose estate values are high enough to merit concern about federal 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 to avoid inheritance taxes. A federal gift tax applies to transfers of real or personal property for less than the value of the property given away.61 For many years this tax was part of a unified Federal Estate and Gift Tax structure that taxed these transfers at the same rates as the federal estate tax.62 In addition the unified credit that was available to federal estates was also available to individuals who faced federal 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 tax at the same rates as the federal estate tax. After 2009, when the federal estate tax is repealed, the federal gift tax will continue and have its own tax rate that will start at 18% and reach a maximum rate of 35% for taxable gifts of $500,000 or more. In 2011 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 to give 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 in upcoming years. It is important to check the statute in order to be sure of the current exclusion 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 loss of the credit. No federal gift tax is due on the transfer and, therefore, no portion of the applicable exclusion is needed to offset this tax liability. The federal gift tax also has an applicable exclusion amount. In 2002 this amount 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 the other spouse.64 This raises the amount excluded in such gifts to $22,000 per person per year. This is called splitting a gift. Similarly, a married couple can write one $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 a substantial amount to be transferred out of one's federal gross estate. If the annual exclusion limits can be followed, then such transfers will also be free of federal gift taxes. One problem in this situation, however, is that the Pennsylvania inheritance tax applies to gifts in excess of $3,000 if they are made within one year of a person's death.65 The federal gift tax annual exclusion amounts may eliminate federal gift 13

16 tax concerns but perhaps not the state inheritance tax concerns. Aside from the inheritance tax treatment of gifts, Pennsylvania does not tax gifts. But other states have separate gift tax laws, and these may entail separate consideration. THE STEPS INVOLVED IN ESTATE SETTLEMENT Immediately after a person's death, the question arises, who will take charge of the situation? The person in charge will have many concerns, such as funeral arrangements, security of property, care for dependent children or adults, and notification of family members. Frequently, the person named as executor in the will is asked to take charge. An executor who is already aware of the appointment and is willing to serve in that capacity usually can take charge soon after the death. Individuals who prepare wills should take time to speak with the person they plan to name as executor to inform him or her of their intentions, to ask if he or she is willing to accept the appointment, and to share information about funeral arrangements and where documents are located. Initial Decisions After the deceased's funeral, the person in charge will survey the deceased's personal papers and other records to identify property owned by the deceased and to locate a will, if one was prepared. This survey is important to the estate for a number of different reasons, including inheritance taxes and distribution of estate property. If a will is found, the document may name the person who will take over administration of the estate. Responsibility may be transferred from the person in charge initially to the person named in the will. The search for a deceased person's will may require access to a safe deposit box. Following a death, access to such boxes is limited until an inventory of the contents is taken for inheritance tax purposes.66 Before the inventory, a family member can open a safe deposit box, but only to review the contents in search of a will or cemetery deed.67 If a will or cemetery deed is found, it can be removed. If neither of these is found, nothing can be removed from the box until an inventory is made. These access rules apply whether the deceased owner is listed as the sole owner of the box or as a joint owner with someone else. If the deceased owned the box jointly with his or her spouse, these access limitations do not apply and the surviving spouse may open the box and remove items from it before an inventory.68 If items removed are subject to inheritance tax, these items must be included when the tax calculations are made. At this point, three questions must be answered. First, how will the deceased's property be transferred after death? Second, will it be necessary to use the estate settlement process to accomplish these transfers? Third, who has the authority to see that the property is transferred? 14

17 The first question requires a review of the property's ownership. If the property was owned 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 by the entirety. This transfer takes place automatically at the moment of death, as described 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, but the survivor controls the situation. Other types of property may pass from a deceased owner without using the formal estate settlement process. These include: living trusts created during a person s lifetime for the purpose of accomplishing this transfer after a person s death; tentative trusts created during a person s lifetime where the trustee s death transfers control of the trust property to the beneficiary, such as an account opened 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 estate settlement 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 any sister or brother, in the order stated. This payment can be made by the employer without regard to whether a personal representative of the estate has been appointed.69 Second, a transfer of up to $3,500 can be made from the decedent's bank or savings account. This amount can be transferred to the spouse, child, father, mother, sister or brother of the deceased in the order stated. The person receiving the funds must present a paid funeral bill or an affidavit showing that arrangements have 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) and owed to the estate of an individual who resided in the Commonwealth may be paid to the spouse, child, father, mother, sister, or brother of the deceased in the order stated. A requirement to receive these funds is that at the time of payment the personal representative has not made a claim for the funds.71 15

18 Fourth, upon the death of a person who is a patient in a county-affiliated nursing home, up to $3,500 from the patient's care account can be paid to a funeral director for burial expenses. The facility may pay these funds to the funeral director and pay an additional amount to the spouse, child, father, mother, sister, or brother of the deceased patient in that order. The total of all payments made by the facility may not exceed $4, In each of these cases, if it is later determined that payment to the person was improper, and payment should have been made to someone else, the person who received the improper payment may have to return the funds. If the decedent owned other property in his or her own name, it may be necessary to use the estate settlement process to transfer the property and to appoint a personal representative to accomplish the transfer by a person who has the authority to do so. If the decedent had a will, that document will determine who is entitled to ultimately receive the property. If the decedent did not have a will, the intestate 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 listed above, no one has the right to deal with separately owned property until a personal representative is appointed. If a person prepared a will, the executor or executrix named in the will is the personal representative. (Executor signifies a man, executrix signifies a woman.) If a person did not prepare a will, the personal representative of the estate is an administrator if a man, or an administratrix if a woman. A personal representative can be a person or a corporation that has authority to act in that capacity, 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 who share the position and authority. To achieve official status, a petition is presented to the register of wills of the county where the decedent has his or her last family or principal residence.73 If the decedent did not have a domicile in Pennsylvania, but had property located in Pennsylvania, the petition can be filed with the register of wills of the county where the property is located.74 If an executor or executrix files this petition, it is called a petition 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 deceased s 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. 16

19 If the deceased was domiciled in Pennsylvania at death, the estimated value of all personal property and the estimated value and location of real property within the state. If the deceased was not domiciled in Pennsylvania at death, the estimated value of 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 property in 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 intends to stay and call his or her home. A domicile is not just a place where a person resides for a period of time. Under the Probate, Estates, and Fiduciaries Code of Pennsylvania, the register of wills of the county where the petition is filed may grant letters of administration 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 nominate someone 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 persons include minors, corporations not authorized to act as fiduciaries in the Commonwealth, people found by the register to be unfit to be entrusted with the administration of the estate, and, in certain cases, the nominee of a beneficiary who is a citizen of a foreign country (if it appears doubtful to the register that the distribution of the estate will actually be received by the beneficiary).78 If a nonresident of Pennsylvania petitions for letters of administration, the register can refuse 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 death certificate is also filed with the petition. The petition can be filed anytime after the deceased's death.80 A personal representative is responsible for the true and faithful performance of his or her duties. In some cases, this security is provided by a bond for twice the estimated value of personal property in the estate.81 The bond is purchased from a company authorized to do business in Pennsylvania. In many situations, however, a 17

20 bond is not needed. This could be a case where the appointed personal representative is a bank and trust company incorporated in Pennsylvania, or a national bank with a principal office in Pennsylvania.82 In addition, the personal representative may be excused from this requirement by the deceased when the executor 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 coexecutor with a resident excused from the bond requirement, the nonresident may also be excused from the bond requirement if the nonresident acknowledges that all assets will remain in the custody and control of the resident co-executor. A bond is not needed by a resident who is granted letters of administration and is the sole heir to the residuary estate or by a resident who is the next of kin. If the court orders the personal representative to be bonded, the requirement must be fulfilled.83 When presented with a petition for letters testamentary and the original copy of the decedent's will, the register will determine whether to accept the will as the last 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 who signed the will themselves, or from persons familiar with the deceased's handwriting.84 If the self-proving procedure was used, the register of wills can accept the acknowledgment and affidavits to support the statements made therein.85 This procedure eliminates the need to locate witnesses to the will and helps the register of wills proceed quickly. The process followed by the register of wills is called probate or probating the will. Probate means that the register of wills is determining the validity of the will. After the petition for letters is granted, the register of wills issues a certificate of authority, which is formal proof of the personal representative's authority to act on behalf of the estate.86 The register issues short-form certificates that the personal representative uses to close bank accounts or otherwise deal with the deceased's property. These certificates are commonly called "shorts" or "short certificates." After letters of administration or letters testamentary are granted, the personal representative arranges to publish a notice of the grant of the letters and the opening of the estate administration. This notice runs once a week for three successive weeks in one newspaper of general circulation published where the deceased resided. If the deceased did not live in Pennsylvania, a newspaper in the county where the letters are granted is selected to publish the notice. In addition to this notice, an advertisement will also appear in a legal periodical once a week for three successive weeks.87 This is a publication designated by the local court as a place where legal notices are published. In many counties, this is a law journal published by the local bar association and distributed to lawyers, other professionals, and libraries. The notice specifies the name of the deceased, the name and address of the personal representative, and requests all people having claims against the estate to make the claims known to the personal representative or the attorney to the estate 18

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