Recently, Pennsylvania enacted a new law that allows the transfer of a “Qualified Family-Owned Business Interest” (QFOBI) to one or more “Qualified Transferees” without being subject to Pennsylvania inheritance tax upon the death of the transferor. (72 P.S. § 9111(t)) The new law applies to estates of decedents who die after July 2013 and own a business.

In order to understand this inheritance tax exemption, it is necessary to examine the definitions of a QFOBI and a Qualified Transferee. A QFOBI is defined as an interest in a sole proprietorship or entity carrying on a trade or business, if at the date of the decedent’s death:

1. The proprietorship/entity has fewer than 50 full-time equivalent employees;
2. The proprietorship/entity has a net book value of assets totaling less than $5,000,000;
3. The proprietorship/entity has been in existence for five (5) years;
4. The entity is wholly owned by the decedent or by the decedent and members of the decedent’s family that meet the definition of a Qualified Transferee; and
5. The entity is engaged in a trade or business the principal purpose of which is not the management of investments or income-producing assets owned by the entity.

A Qualified Transferee is defined as a decedent’s:

1. Husband or wife;
2. Lineal descendants;
3. Siblings and the sibling’s lineal descendants; and
4. Ancestors and the ancestor’s siblings.

It is crucial that the net book value of the entire business must be less than $5,000,000. This limit is with respect to the business value as a whole, and not just the decedent’s interest in the business. Also, this amount is based on the net book value, rather than the fair market value. Many family-owned businesses will have balance sheets with a book value that is significantly lower than the fair market value.

The statute also requires that the QFOBI continue to be owned by a Qualified Transferee for a minimum of seven (7) years after the decedent’s death and that the QFOBI is reported on a timely filed inheritance tax return. Inheritance tax returns are due nine (9) months from the decedent’s date of death. However, the exemption does not apply to property transferred by the decedent into the business within one (1) year prior to death of the decedent, unless the property was transferred for a legitimate business purpose. The exemption does not limit the decedent to one QFOBI. Therefore, several transfers can be exempt, so long as each transfer meets the statutory criteria for a QFOBI. As further discussed below, there are annual reporting requirements of the QFOBI to ensure compliance.

A QFOBI that was exempted from inheritance tax that is no longer owned by a Qualified Transferee at any time within seven (7) years after the decedent’s date of death is subject to inheritance tax in an amount equal to the inheritance tax that would have been paid or payable on the value of the QFOBI at the time of death, plus interest calculated from the due date of the decedent’s inheritance tax return.

Each owner of a QFOBI exempted from inheritance tax has to certify annually, for seven (7) years after the decedent’s date of death, that the QFOBI continues to be owned by a Qualified Transferee, and must notify the Department of Revenue within thirty (30) days of any transaction or occurrence causing the QFOBI to fail to qualify for the exemption. An owner’s failure to comply with the certification or notification requirements will result in the loss of the exemption, and the transferee of the QFOBI will be subject to inheritance tax, plus interest.

Each year, the Pennsylvania Department of Revenue will inform all owners of a QFOBI exempted from inheritance tax of their obligation to provide an annual certification. The certification and notification must be completed in the form and manner as provided by the Department.

Any inheritance tax due as a result of a transaction or occurrence that disqualifies a QFOBI from the exemption, plus the interest on the tax, shall be a lien in favor of the Commonwealth of Pennsylvania on the real and personal property of the owner of the QFOBI at the time of the transaction or occurrence. The inheritance tax and interest due is the personal obligation of those owners. The lien will remain until the inheritance tax and interest are paid in full.

It is important to be clear about who qualifies as a Qualified Transferee. Clearly the statute envisions familial ties, so transfers to unrelated key employees would not be exempt. Further, although some family members qualify, their spouses may not. For example, although children qualify, spouses of children would not. So a transfer to a son-in-law or daughter-in-law would not qualify. Similarly, while siblings and sibling’s children qualify, their spouses do not. Therefore, brothers-in-law and sisters-in-law would not qualify, nor would the spouse of a niece or nephew. Although a decedent’s parents would qualify, the parents of the decedent’s spouse would not. Finally, it should be noted that trusts are not Qualified Transferees. Thus, business owners need to be careful not to disqualify the QFOBI exemption unintentionally by using a common planning technique in a Last Will and Testament to leave assets in a testamentary trust to a surviving spouse or children.

If you are contemplating utilizing this exemption in your estate plan, an attorney should be contacted to assist you in navigating the complexities of this new law. Please feel free to contact one of Reger Rizzo & Darnall’s Estates & Trusts attorneys today with any questions you may have.