Pennsylvania inheritance tax: a $1.2 billion burden

(The Center Square) – Pennsylvania created an inheritance tax in 1826 to build a canal connecting Lake Erie to the Ohio and Susquehanna rivers, imposing a 2.5% levy on inheritances that went to those who weren’t direct descendants.

Today, the Commonwealth receives about $1.2 billion in revenue with an inheritance tax that ranges from 4.5% to 15% and affects all inherited wealth. Pennsylvania is one of only six states that still has an inheritance tax, and with no exclusions that limit when the tax is applied middle-class inheritors can be hit with an unexpected tax burden after a death.

Generally, the taxes were a way to shift the burden of funding state government onto the rich, and away from the average taxpayer.

“In Pennsylvania, it’s actually different where the Pennsylvania inheritance tax falls on more people than most other states,” said Katherine Loughead, senior policy analyst at the Tax Foundation. “It definitely hits much more of the middle class than most other estate or inheritance taxes do.”

As a result, Pennsylvania’s inheritance tax revenue stands out compared to its neighbors. New Jersey generates $468 million from its inheritance tax, while Maryland produces just under $59 million. Maryland also realizes $139 million from an estate tax.

“It also has a particularly harmful impact on businesses,” Loughead said. “If someone is in line to inherit a business, if they don’t have enough liquid assets to immediately pay that inheritance tax liability, they’re going to be in a bind.”

Paying the tax, she noted, could force inheritors to sell or downsize the business.

The tax has also encouraged some residents to leave, preferring to retire in states such as Florida that have no inheritance tax. If someone leaves assets to their spouse, child under 21 years of age, or charity, the inheritance tax is 0%. However, if someone who is childless wants to leave assets to a niece or nephew, the tax is 15%.

While wealthy Pennsylvanians can use estate planning to avoid some of the inheritance tax, middle-class Pennsylvanians whose wealth resides in a small business or a house will carry the burden. To avoid the deadweight loss of people trying to avoid the tax, or avoid adding a tax that burdens the middle class, states could look at other, less distortionary taxes.

“The best approach, of course, is just to repeal [inheritance taxes] or phase it out over time,” Loughead said.

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