California Estate Tax
Is There an Estate Tax in California? Proposed California Estate Tax for 2020 Did Not Make Ballot. Federal Estate Tax Explained.
An estate tax is a special, one-time tax levied by the government on an estate, based on that estate’s total value at the time of death. It is, however, levied only if that total value exceeds a certain threshold set by law. An estate tax strategy is an essential part of estate planning.
Estate taxes have always been a hot-button issue. Some say it’s like taxing people twice on the same money—once when they earn it and then again when they die. Others say it punishes people for doing well in life. Then of course, there is the argument that being taxed for dying just seems patently unfair.
To add insult to injury, the final tax bill usually comes due just nine months after a loved one’s death, which means a grieving family has to file estate taxes just around the time people stop bringing over casseroles.
Aside from any moral arguments one could make against estate taxes, the laws around which they are established are constantly changing. State-level estate taxes, where they exist, are also completely different from federal estate tax laws, making the subject very difficult for the layperson to understand.
That said, if you are subject to Estate Taxes, they can be incredibly high—as much as 40% in some cases.
So What Is the Estate Tax in America?
Technically speaking, the federal estate tax, or “death tax” as it is often called, to paraphrase the government, “a tax on your right to transfer property at your death.”
You’re probably thinking, “What does that mean? I understand the IRS taxing my income or my property, but the IRS can tax my rights!?!”
Well, yes. In plain English, the government is taxing you for the act of passing your assets on to your heirs, probably because if they weren’t passed on to someone, your assets would be “escheated,” which is a fancy way of saying the state in which you live would be the beneficiary.
How Do Estate Taxes Work?
State and federal laws vary, but the general idea is that only estates valued at or above certain amounts are subject to estate taxes. This is true on both the state and federal level.
The amount an estate must be worth to incur estate taxes is called the threshold. This amount is also referred to as an exemption.
For example, if you live in a state where the threshold for estate taxes is $5 million and your estate is worth $4 million, your estate is not subject to any estate taxes on the state level.
If in that example your estate is worth $6 million, your estate is subject to estate taxes on the state level.
What Is the Federal Estate Tax Threshold?
The threshold for the federal estate tax is presently $11.58 million for individuals, $23.16 million for married couples, plain and simple.
Again, the federal estate tax rate can be as high as 40%.
What’s the Difference between Estate Taxes and Inheritance Taxes?
You might be wondering if there is a difference between an estate tax and an “inheritance tax.” There is.
Estate taxes are incurred by the estate of the person who died, and are based on the gross value of the entire estate at the time of death.
Inheritance taxes are other specific taxes incurred by the person who inherited part or all of an estate. As of this writing, only six states levy a specific inheritance tax: Maryland, Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania.
How much is the inheritance tax in California? There is no specific inheritance tax here. That’s not to say that beneficiaries of estates may not otherwise incur taxes as an indirect result of inheriting money—for example, when they cash in an IRA—but that is a separate subject.
What States Have Estate Taxes?
Just as you pay separate state and federal taxes each year, state and federal estate taxes are also two separate things.
Not all states have their own estate taxes. In fact, as of this writing, only twelve states plus the District of Columbia impose estate taxes. Each of those states has a completely different set of laws about how those estate taxes work, different threshold levels, and different tax rates.
For example, at this writing, the threshold in the state of Washington is $2.193 million, with estate tax rates of between 10% – 20%.
New York State has a threshold of $5.85 million, with estate tax rates of between 3.1% – 16%.
And if you’re thinking of moving, consider staying away from Maryland, which has both a death tax and an inheritance tax!
Does California Have an Estate Tax?
As of this time in 2020, California does not have its own state-level estate tax, and has not had one since 1982, when it was repealed by voters. That may change, however, in the future.
In 2019, a bill (then labeled S.B. 378) was introduced to levy a new California estate tax, and for a time it appeared to have legs—and at one point it was expected to appear on the 2020 ballot. But it has so far failed to receive a floor vote. This measure would have imposed a new CA Estate Tax or “CA Death Tax” on estates larger than $3.5 million (for individuals). If eventually passed, the revenue collected from these taxes would be expected to reach as much as $1 billion annually.
As originally designed, new 2020 California estate taxes would have phased out once an estate hit the current federal level requirement to avoid double taxation. In other words, under the proposed legislation, if an estate in California met the $11.58 million federal threshold, it would not also pay the California estate tax rate, just the federal estate tax.
As of this writing, however, the bill is on ice. Regarding a separate inheritance tax, California has no such thing. Be suspicious of anyone saying they will save you from “the California Inheritance Tax” or “California Death Tax” or get you a “California Estate Tax Exemption 2020” For now, no specific death tax, California specific.
How Do I Know If An Estate Tax Will Affect Me?
If you live in California, and you are presently subject only to the Federal estate tax, you might be thinking it won’t affect you if your estate isn’t worth $11.58 million.
But here we need to discuss what constitutes an “estate.” The short answer is: everything. The whole kit and caboodle!
The government will require an accounting which includes your house, assets, trusts, annuities, business interests, debt, mortgages, your car, your baseball card collection, those sweatpants you won’t throw out, your…OK, they might let the sweatpants go, but the bottom line is…
Your estate taxes are based on the total value of every single thing you own or have an interest in at the time of your death. That total is called the “gross estate.”
Why is this important to understand? Because you might think of the value of your estate as just the value of your major assets, when, in fact, it is the value of everything.
And as we often say here at CunninghamLegal: everything eventually sees the light of day.
What Strategies Can Avoid Estate Tax?
Thankfully, even for those with large estates, there are ways to reduce or even avoid estate taxes, but it takes real know-how, experience, and a super-solid understanding of constantly changing laws and decisions at both the state and federal levels. Only a savvy attorney can help you make the estate tax laws work for you and ensure you leave the best possible legacy for your heirs—including indirectly incurred taxes, like from IRAs and retirement accounts.
What Is a Portability Election for Estate Tax Exemptions?
Let’s look at the most important strategy for avoiding estate taxes: “portability,” which refers to the portability of estate tax exemptions under Federal Law, which we’ll break down below.
As we learned, every American is entitled to a $11.4 million exemption from federal estate taxes throughout their lifetime. Married couples are allowed a $28.8 million exemption.
This exemption is portable for spouses of the deceased, meaning that when one spouse in a marriage dies, whatever part of their exemption is unused can be used by the other spouse upon their own death.
Let’s consider the case of Bob and Sue, a married couple who each have individual estates worth $5 million. Bob dies. Since each of us has a lifetime exemption of $11.4 million, that means Bob left $6.4 million of unused exemption.
Portability allows Sue to use that unused exemption, whether or not she herself inherits Bob’s $5 million.
But what difference does it make to Sue if she does not inherit Bob’s money? Sue’s estate is only worth $5 million. Her own $11.4 million exemption will cover it, right?
Yes, Sue’s estate is worth $5 million…now. But let’s say she lives another ten years and in that ten years, that estate grows by another $20 million. Now, instead of $5 million, that estate is worth $25 million at the time of Sue’s death. Sue’s own exemption kicks in ($11.4 million) plus the unused exemption that was carried over from Bob ($6.4 million).
That means Sue’s estate will be taxed on just $7.2 million. Without the advantage of portability and being able to use what’s left of Bob’s exemption, Sue’s estate would be taxed on $13.6 million.
That’s going to make a very big difference to Sue’s heirs, especially given how high the federal estate tax rate can be!
How Can I Make Sure I Get the Portability Exemption?
There is one catch on portability: it does not just automatically kick in. You must pro-actively elect or choose to carry over what’s left of a deceased spouse’s exemption.
There’s also a time element involved. A federal estate tax return must be filed within two years of the deceased spouse’s death in order for the surviving spouse to be able to take advantage of portability upon their own death. Do consult a lawyer.
Are There Other Ways, Beyond Portability, to Reduce or Avoid the Estate Tax?
Again, yes, but they are too complex to cover here, and vary greatly by the individual. That’s why it’s so crucial to work with a good estate attorney who knows all the ins and outs of estate tax laws, keeps up on all the changes, and understands how to use them to their clients’ advantage.
This is going to be even more crucial to Californians if the laws eventually change and the state imposes its own estate tax, as it has done in the past.
Benjamin Franklin said that only death and taxes were certain in life, but perhaps we can modify his saying, just a bit. Why not let us help you avoid the Death Tax?
What Do We Do?
The lawyers and staff at CunninghamLegal help people plan for some of the most difficult times in their lives; then we guide them when those times come.
Make an appointment to meet with CunninghamLegal for California Estate Planning and Trust Administration. We also offer a robust, overall tax-planning service for high net-worth families. We have offices throughout California, and we offer in-person, phone, and Zoom appointments. Just call (866) 988-3956 or book an appointment online.
Please also consider joining one of our free online Estate Planning Webinars.
We look forward to working with you!
James Cunningham Jr., Esq.