If you recently learned that you are the beneficiary of real property as part of an inheritance you received, you may have questions about your rights and responsibilities related to the inheritance. Specifically, you may be wondering if you are required to pay an inheritance tax on the property. We’ll explain when inheritance taxes might be owed on the property you inherited.
Federal Gift and Estate Taxes
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 $8 million and you owned assets valued at $10 million at the time of your death, your estate would be subject to federal gift and estate taxes for the combined value of $18 million at a tax rate of 40 percent. Without any deductions, your estate would lose a shocking $7.2 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. ATRA set the lifetime exemption amount at $5 million, to be adjusted for inflation each year. In 2018, the President signed tax legislation into law that 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.
Is There a State Gift and Estate Tax?
Each individual state decides whether to impose a state level gift and 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 2020, 12 states plus the District of Columbia impose an estate tax; however, the State of California is not one of them.
What Is an Inheritance Tax?
The terms “estate tax” and “inheritance tax” are frequently used interchangeably; however, 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 you leave behind an estate valued at $18 million, the full amount (minus the lifetime exemption) would be subject to federal (and sometimes state) estates 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 you were a resident of a state with an inheritance tax and that you made a gift of $5 million to your son Sam. Sam would be responsible for paying the inheritance tax.
Does California Impose an Inheritance Tax?
As of 2020, only six states impose an inheritance tax and California is not one of them. Be careful, however, if you inherited property located in another state. If that state levies an inheritance tax, you could be responsible for paying the tax even though you are not a resident of that state. Always check with an experienced probate attorney if you inherit property to ensure that you understand what taxes, if any, must be paid on the inheritance.
Please download our FREE estate planning checklist. If you have additional questions or concerns about inheritance 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.