Inheritance and estate planning can be complex processes, and often, the person drawing up the estate plan wants to find a way to enable beneficiaries to avoid paying estate or other types of taxes. Here’s what you need to know about what’s possible in California.
What Is an Inheritance Tax?
An inheritance tax is a tax assessed on an inheritance a beneficiary receives from someone in a specific state. For example, if someone lives in a state where inheritance taxes are collected and passes away, their beneficiaries would likely have to pay that state inheritance taxes on the inheritance.
Does California Collect Inheritance Taxes?
California does not levy estate or inheritance taxes. That means that if the person with the estate (known as the testator) dies in California and leaves money to beneficiaries, the state won’t collect estate or inheritance taxes on it. Those funds are not considered income by California.
However, if someone lives in California and inherits money from someone who dies in a state where such taxes are collected, they will likely have to pay them in that state. Some states have exemptions for small inheritances, such as $10,000, while others don’t.
If California Doesn’t Collect Estate or Inheritance Taxes, Does That Mean the Inheritance Is Tax-Free?
Not necessarily. When talking about California’s inheritance tax policies, we’re only talking about taxes on the state level. There are also taxes on the federal level to consider. While the Internal Revenue Service (IRS) does not tax inheritance as income, meaning the beneficiary doesn’t have to report it on their tax filings in the year they received it, the IRS may view it through the lens of capital gains. Capital gains occur when someone inherits something, such as property, and later sells it at a profit. The amount of the profit could be taxed as capital gains by the IRS.
The IRS will also seek an estate tax on estates valued at more than $12.92 million (in 2023). If the estate’s overall value is lower than that, it will not assess the estate tax.
How Can I Find Out if an Estate Tax Will Affect Me or My Beneficiaries?
This is when it’s an excellent time to work with an experienced estate planning attorney. When people think about their own estates, they often only consider certain bank accounts. In fact, legally, an estate is much more than cash. An estate is comprised of anything of value, including real estate, valuable artwork, vehicles, business interests, copyrights, and annuities–and these are only a few of the things that make up an estate. It’s possible that even if bank accounts don’t add up to the minimum estate tax level, adding in the actual value of these other assets could push it over the limit and lead to a taxable situation. A knowledgeable estate planning attorney can help you identify assets you may have forgotten about or didn’t realize would be included in the definition of “estate.”
How Can Estate Taxes Be Avoided or Minimized?
If your estate reaches the federal threshold for estate tax, there are steps you can take to minimize the tax impact. While a will is a valuable document for estate planning, putting assets into a trust is another avenue. Using a trust may not avoid all the federal estate taxes, but there are times when it can help reduce them. Here are some types of trusts that may help. Every estate is unique, so the solutions mentioned here are not one-size-fits-all, nor are all these the only solutions available.
These are simply examples of different options:
- Dynasty trust. This is sometimes referred to as the generation-skipping trust, which unfortunately doesn’t accurately portray how the trust works. In this trust, the estate is put into a trust that has a maximum amount allowed, and the trust passes that amount to the estate owner’s child and then to their grandchild.
- Irrevocable gifting trusts. These gifts are given to others that can’t exceed $15,000 per year and have a lifetime cap. As long as those maximums aren’t exceeded, the recipients should receive the money without taxation.
- Irrevocable life insurance trust (ILIT). A life insurance policy that names a spouse as the beneficiary won’t owe taxes when paid out. But if the policy lists someone else, such as the policyholder’s children, they could be expected to pay tax. An ILIT is a workaround for that.
- Spousal lifetime access trust (SLAT). A SLAT allows someone to put large amounts of assets into this trust to benefit the other spouse (or sometimes children). That allows the amount to be reduced from the shared estate. Only one spouse controls the trust.
- Personal residence trust. This allows someone to put personal real estate into a trust and give it to their children while retaining the right to continue to live there.
It’s important to understand that all of these trusts have numerous, complicated requirements to fulfill. Contact us with any questions.
What Should I Do if I Need Help Setting Up an Estate Plan?
Call Cava & Faulkner at 916-685-1225 for a free consultation. Our team of knowledgeable, experienced estate planning attorneys understands how important it is for you to have your estate distributed according to your wishes and that you want to take every step possible to ensure that happens. Every estate is unique, and we can guide you through the specifics of yours to determine the best approach that could potentially minimize any tax liabilities for the beneficiaries.