Along with making decisions regarding the distribution of your estate assets, your estate plan calls for other important decisions to be made. For example, the impact taxes will have on your plan should also be taken into consideration. Specifically, you need to know if your beneficiaries will owe taxes on the assets they inherit. Let’s look into California’s laws regarding inheritance taxes.
The Federal Gift and Estate Tax
The federal gift and estate tax is a tax that is imposed by the federal government on all qualifying gifts made by a taxpayer during his/her lifetime and all assets owned by the taxpayer at the time of death. For example, if you made gifts of assets during your lifetime valued at $6 million and you owned assets valued at $8 million at the time of your death, your estate would be subject to federal gift and estate taxes for the combined value of $14 million at a tax rate of 40 percent. Therefore, without any deductions or planning ahead for the impact of taxes on your estate, your estate would lose a shocking $5.6 million to federal gift and estate taxes. Any federal gift and estate taxes that are due from your estate must be paid during the probate of your estate after your death.
The good news is that every taxpayer is entitled to make use of the lifetime exemption to reduce the amount of gift and estate taxes owed by their estate. A 2012 tax law set the lifetime exemption amount at $5 million, to be adjusted for inflation each year. However, in 2017, newer tax legislation into law changed the lifetime exemption amount for several years to come. Under the new law, the exemption amounts doubled. These exemption amounts are scheduled to increase with inflation each year until 2025. On January 1, 2026, the exemption amounts are scheduled to revert to the 2017 levels, adjusted for inflation. As of early 2021, new bills are pending in Congress that could further modify these federal tax laws.
Do States Impose an Estate Tax?
Although every taxpayer is potentially subject to federal gift and estate taxation, each individual state decides whether state residents are also subject to a state-level estate tax. In most states that impose an estate tax, the tax is similar to its federal counterpart. For example, most states only tax estates valued over a certain dollar value. As of 2021, 12 states plus the District of Columbia impose an estate tax; however, California is not among them.
Does California Impose an Inheritance Tax?
People often use the terms “estate tax” and “inheritance tax” interchangeably when, in fact, they are distinct types of taxation. Although both impose a tax on assets left behind by a decedent, the similarities end there. Gift and estate taxes – both at the federal and state levels– are calculated based on the total value of probate assets left behind by a decedent. If a decedent’s estate does owe estate taxes, that tax must be paid during the probate of the estate using available estate assets. For example, if Sarah passed away and left behind an estate valued at $20 million, the full amount (minus the lifetime exemption) would be subject to federal and Illinois estate taxes and the tax must be paid prior to the assets leaving the estate.
An inheritance tax, on the other hand, is a tax imposed only on the value of assets inherited from an estate by a beneficiary. Moreover, the tax is paid by the beneficiary after the assets have been transferred out of the estate. Using the above example, imagine that Sarah was a resident of a state with an inheritance tax and that she bequeathed $5 million to her daughter Beth. Beth would be responsible for paying the tax. As of 2021, only six states impose an inheritance tax and California is not one of them.
Please download our FREE estate planning checklist. If you have additional questions or concerns about estate planning or estate taxes, contact us at the Northern California Center for Estate Planning & Elder Law by calling (916)-437-3500 or by filling out our online contact form.