Understanding Death and Inheritance Taxes

Understanding Death and Inheritance Taxes in California

Estate planning is a crucial step for individuals and families who want to ensure a smooth transfer of wealth to their heirs while minimizing potential tax liabilities. When it comes to death and inheritance taxes, many Californians have questions about what taxes apply, how they work, and what strategies can help reduce the financial impact on beneficiaries.

Unlike some other states, California does not impose a state-level estate tax or inheritance tax, but federal estate tax laws may still apply, particularly for high-net-worth individuals. Additionally, property tax rules and federal gift tax exemptions play a role in estate planning.

This guide provides a detailed breakdown of California’s approach to estate and inheritance taxes, the implications of federal estate taxes, and key tax planning strategies to help preserve wealth for future generations.

Does California Have an Estate Tax or Inheritance Tax?

1. No State Estate Tax in California

• California does NOT impose an estate tax, meaning the state does not collect any taxes on the total value of a deceased person’s estate.
• However, federal estate taxes may still apply to estates exceeding a certain threshold.

2. No Inheritance Tax in California

• Inheritance tax is different from estate tax; it is imposed on the recipient of an inheritance rather than the estate itself.
• California has no state inheritance tax, meaning beneficiaries do not owe taxes simply for inheriting money or property.
• Some states (e.g., Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania) do impose inheritance taxes, so beneficiaries living in those states may need to check their local laws.

Federal Estate Tax and Its Impact on Californians

Even though California does not have an estate tax, federal estate tax laws still apply to residents with significant wealth.

1. Federal Estate Tax Threshold (2024)

• The federal estate tax exemption for 2024 is $13.61 million per individual ($27.22 million for married couples who utilize portability).
• Estates valued above this exemption amount are subject to federal estate tax at a rate of up to 40%.
• If your estate falls below the threshold, no federal estate tax is owed.

2. How the Federal Estate Tax Works

• When a person passes away, the total value of their estate is calculated, including real estate, investments, retirement accounts, and other assets.
• The IRS applies deductions (such as charitable contributions and debts) before determining if the estate exceeds the exemption limit.
• Any amount exceeding the exemption is taxed at progressive rates up to 40%.

3. The Future of Estate Tax Laws

• The current estate tax exemption is set to decrease significantly in 2026 to around $6 million per individual, unless Congress passes new legislation.
• High-net-worth individuals may want to take advantage of the higher exemption now by making tax-efficient wealth transfers.

Gift Taxes and Lifetime Exemptions

Many individuals use gifting strategies to reduce estate tax exposure. The federal gift tax laws allow individuals to transfer wealth during their lifetime without incurring taxes.

1. Annual Gift Tax Exclusion (2024)

• Individuals can gift up to $18,000 per recipient per year without triggering federal gift taxes.
• Married couples can combine their exclusions to gift $36,000 per recipient annually.

2. Lifetime Gift Tax Exemption

• The lifetime gift tax exemption is linked to the federal estate tax exemption ($13.61 million in 2024).
• Large gifts beyond the annual exclusion count toward the lifetime exemption, reducing the amount of tax-free wealth that can be transferred at death.

Common Tax Exemptions and Exclusions

There are several ways to reduce or eliminate estate tax liability through exemptions and exclusions.

1. Unlimited Marital Deduction

• Spouses can transfer unlimited assets to each other without triggering estate taxes.
• This helps defer estate tax liability until the surviving spouse passes away.

2. Charitable Giving

• Donations to qualified charitable organizations are 100% deductible from the estate value, reducing taxable assets.

3. Step-Up in Basis for Inherited Assets

• Inheritors receive a step-up in basis for capital gains tax purposes.
• Example: If a parent purchased a home for $200,000 but it is worth $1 million at their death, the beneficiary’s cost basis is reset to $1 million, reducing taxable capital gains if sold.

California Property Tax Considerations for Inherited Real Estate

1. Proposition 19 and Property Tax Reassessments

• Under Prop 19 (passed in 2020), property transfers between parents and children are subject to reassessment unless the inherited home becomes the child’s primary residence.
• If reassessed, property taxes increase to market value, potentially leading to higher costs for heirs.
• Before Prop 19, children could inherit property while keeping the original tax assessment in most cases.

2. Strategies to Preserve Lower Property Taxes

• Use a Qualified Personal Residence Trust (QPRT) to transfer property with reduced tax impact.
• Transfer ownership before death under specific estate planning strategies to avoid reassessment.

Strategies to Reduce Estate Tax Burden

Even though California has no estate tax, high-net-worth individuals should consider estate tax planning strategies to reduce federal tax liability.

1. Establish a Living Trust

• Revocable living trusts help avoid probate but do not reduce estate taxes.
• Irrevocable trusts can remove assets from an estate, reducing tax exposure.

2. Use Gifting Strategies

• Annual gifts below the $18,000 exclusion limit reduce taxable estate value over time.
• Consider 529 college savings plans as tax-efficient gifts for beneficiaries.

3. Set Up Charitable Remainder Trusts (CRTs)

• CRTs allow assets to be donated to charity while providing income to heirs.
• CRTs reduce taxable estate size and provide tax deductions.

Planning Ahead for Estate and Inheritance Taxes

Although California does not impose a state estate or inheritance tax, federal estate tax laws and property tax reassessments can significantly impact heirs. Proper estate planning, including trusts, gifting strategies, and charitable giving, can help reduce tax burdens and preserve wealth for future generations.

If you have a high-net-worth estate or complex assets, consulting an estate planning attorney is essential to ensure your assets are protected and distributed efficiently. By taking proactive steps now, you can secure a financially sound future for your heirs while minimizing tax exposure.

Would You Like a Free Consult With an Estate Planning Attorney?

If you wish to speak with an experienced estate planning lawyer, please contact us online or call us directly at (951) 587-3737. Ironclad Living Trusts is honored to serve clients throughout all of Southern California.