California State Inheritance and Estate Tax (2023)
Last Updated: December 10, 2022 • 8 min read
Author: Zach L.
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Residents of California have no need to worry about a state inheritance tax unless they are receiving an inheritance from a resident of a state with the tax.
Unbeknownst to most of us, states often do not collect taxes from a deceased person's estate. Aside from debt incurred by governmental organizations like Medi-Cal, estates often pay little or no money to the federal government in taxes. Income tax and estate tax are the two main tax kinds to take into account.
California residents are exempt from estate taxes up to the federal level value of $11.7 million, and more than $23 million for couples. This means that your whole net estate must be more than these amounts, generally known as the property taxes exclusion, for your estate to be subject to the roughly 40% estate tax rate. Only the portion of your estate that exceeds these sums will be subject to tax if your estate worth is greater than those sums.
This is not a tax that most people need to be concerned about as almost everyone I encounter is worth less than that estate tax exclusion amount. To effectively plan for the future, you should speak with a lawyer or tax expert if your net worth is comparable to or higher than these exclusion amounts.
Does the IRS Tax Inheritance in California?
Your inheritance is not considered income by the IRS for federal taxation and isn't subject to income taxes. No IRS agent will pursue you if your relative leaves you $1 million. Whatever your bequeathed leaves for you is exempt from "inheritance tax," whether it is a city rental property or a ranch with cows and sheep. The IRS will, however, be keeping an eye out for capital gains tax. You must declare taxes on the proceeds you receive when you dispose of the property or when you receive further revenue from it.
What Distinguishes Inheritance Taxes From Estate Taxes?
Estate tax and inheritance tax are two distinct concepts.
The Inheritance Tax
It's a tax at the state level that is levied on the person who inherits or receives money from their estate after they pass away. Each one of your beneficiaries is responsible for paying inheritance tax on the assets they receive as gifts, not you as the grantor. The current California inheritance law states that there is no state inheritance tax in the state of California.
The Estate Tax
Estate taxes must be paid by you, the grantor or donor, not by the heirs or beneficiaries. When you pass away, your executor will pay this tax from your estate before distributing assets to heirs. California has no state-level estate taxes; only the federal estate tax laws are in force.
How Is a Deceased Person's Estate Taxed?
The municipal estate tax is the sole tax that is levied on your property in California when you pass away. Some states may also levy state-level estate taxes and inheritance taxes on your estate if you owned property in their states.
There is no inheritance tax imposed by the federal government. Iowa, Maryland, Pennsylvania, Kentucky, Nebraska, and New Jersey are the states that charge an inheritance tax.
Is The Sale Of a Parent's Home In California Taxable?
The amount of capital gains tax due will depend on the property's valuation at the date of death of the decedent if you inherited the house and later sell it. The capital gains tax on inherited assets is greatly reduced thanks to the stepped-up basis that is afforded to family members or any other
Stepped-up basis refers to the method of calculating taxes on capital gains to be applied to the proceeds using the home's purchase price. The value of the improvements the bequeather completed while residing there is also included in the taxable amount.
In other words, you won't be required to pay taxes on the difference when you inherit family homes, even if it is now valued 20 times what the decedent paid for it. Stocks or other assets are subject to the step-up basis as well.
How May I Leverage California's Portability of The Estate Tax Exemption When Preparing My Estate?
The estate tax legislation includes a provision known as "portability" that enables the surviving spouse to use any unused inheritance and federal gift tax deductions from their deceased partner. When your spouse passes away, you can avoid estate and gift taxes by using the portability estate tax exemption.
The automatic tax exemption clause is present, but living spouses are still required to submit a Federal Estates Tax report. This happens because whenever a spouse passes away, they use a portion of federal estate taxes exemption; you won't know how much of the unused exemption you can carry over until you file IRS Form 706. Any married couple and those with substantial estates should collaborate with knowledgeable lawyers to develop an estate plan that will reduce the federal tax burden.
What Does The California Estate Tax Entail?
The term "estate" does not refer to your property or house. The term "estate" refers to all of your possessions, which include:
- Cash
- Bank statements
- Securities
- Property (Real Estate)
- Trusts
- Business pursuits
- Annuities
- Retirement Accounts
Are There Any Legal Options in California to Avoid Estate Tax?
1. Give Gifts
In 2023, the exemption amount from the gift tax is $17,000. Indeed, the giving hand is blessed. Giving your beneficiary presents from your estate is the best strategy to minimize or cut inheritance taxes in California or other states. As long as you need to lower your overall estate to under $11.7 million, do this during your lifetime, once a year, even as long as it takes.
Giving to someone is tax-free up to $17,000 (or $34,000 for married filing jointly returns). You can give continually up to $11.7 million from your fortune if you possess a $20 million estate throughout your life before being liable to gift tax.
2. Create an Irrevocable Trust
You can lower your chargeable estate to a level under the $11.7 million cap. You transfer funds to a trust when you create an irrevocable trust, thus eliminating them from your ownership and control. The trust is made to be irrevocable, meaning that once assets are transferred to it, they cannot be taken back. Additionally, this clause makes sure that all estate taxes and private debt obligations are not attached to the assets in the trust.
The trust also absolves you (the owner) of tax obligations on the income from the trust assets. Be aware that the benefits of tax elimination are diminished if you, the grantor, also serve as the irrevocable trust's trustee.
3. Millennial-Skipping Trust
Literally "skips" over any estate tax obligations. The purpose of generation-skipping trusts is to distribute assets to your beneficiaries or to anyone who is at least 37 years or younger. GSTs stop the grantor's children from having to incur inheritance tax on the property they would've received. Your offspring does not acquire title to the trust's estate assets, nevertheless, as the GST passes your estate resources to your grandchildren.
4. Organize a Qualified Individual Residence Trust
An irreversible trust enables you to give your primary residence or second home to a charity while continuing to reside there. You are permitted to occupy it for a predetermined period, known officially as the "retained income period."
It lessens the size of your chargeable estate if this agreement is properly created by an experienced estate planning lawyer. Your main or secondary residence is effectively taken out of the total value of the estate. The entire property's appreciation is also taken out of your taxable estate. In practice, your heirs will pay less tax and have a better chance of making more money off of your estate.
Final Thoughts
The good news is that the majority of peoples’ estates or trusts are tax-exempt, you should speak with a lawyer and a financial advisor about your estate, especially given that Congress is presently debating new legislation that includes major changes to our tax rules. To spare your estate against paying exorbitant attorney's fees and court costs associated with the probate process, you should also examine the advantages of having a trust account created.
