A lot of people have questions about the taxes that enter the picture when someone dies. In this post, we will provide some answers to estate tax questions, starting with the California estate tax myth.
State-Level Estate Taxes
You may have heard about the families of high-profile celebrities who lived in California facing estate tax responsibility. This can lead to the assumption that there is a California estate tax, but this is simply untrue.
There are 12 states in the union that have state-level estate taxes, but California is not one of them. However, a Californian can incur state-level estate tax responsibility in another state.
For example, Oregon is one of the 12 states with a state-level estate tax. The exclusion is a set dollar amount that you can transfer before the estate tax becomes applicable. In Oregon, the state-level exclusion is $1 million.
Let’s say that you own a large piece of property in Oregon that is worth $2 million. The first $1 million in value could be transferred tax-free, and the Oregon estate tax would potentially be applied to the other $1 million in value.
Federal Estate Tax
Californians are potentially subject to the federal estate tax and its heavy 40 percent top rate. That’s the bad news, but the good news is that the exclusion is far higher than the state-level exclusion in Oregon and most other states that have estate taxes.
At the time of this writing in 2024, the federal estate tax exclusion is $13.61 million. This is the highest that it has ever been, and this level was established via a provision contained within the Tax Cuts and Jobs Act of 2017.
That measure is going to expire at the end of 2025. At that time, the exclusion will go back down to the 2017 level, which is $5.49 million. This figure will be adjusted to account for inflation, but it will be less than half of what it is today.
Spousal Considerations
There is an unlimited marital deduction, so you can transfer any amount of property to your spouse tax-free if your spouse is an American citizen. The exclusion is portable, so the exclusion that was allotted to a deceased spouse could be used by the surviving spouse if the surviving spouse properly files an estate tax return.
Federal Gift Tax
Lifetime gift-giving would be a logical reaction to the federal estate tax. When the estate tax was first enacted in 1916, there was no gift tax, so people could transfer assets to loved ones while they were still living to avoid the estate tax.
This arrangement stayed in place for about eight years, but in 1924, a gift tax was enacted. It was repealed two years later, but it was reenacted in 1932. The gift tax has been in place since then, and in 1977, the gift tax and the estate tax were unified under the tax code.
As a result of the unification, the $13.61 million exclusion that we have this year applies to lifetime gifts and your estate. However, there is an additional $18,000 annual exclusion that is separate from the unified exclusion.
You can transfer this much to an unlimited number of people within a calendar year free of taxation. There is also an educational exclusion that allows you to pay school tuition for others without being taxed, and you can pay medical bills for other people in a tax-free manner.
State-Level Inheritance Taxes
Many people would assume that an estate tax and an inheritance tax are the same thing. Actually, these taxes work in different ways. As we have stated, an estate tax is applied to the taxable portion of the estate in its entirety. In other words, there is just one instance of taxation.
With an inheritance tax, transfers to each individual beneficiary can potentially be taxed. There is no federal inheritance tax, and in 2024, there are six states that have state-level inheritance taxes.
The states are Nebraska, Kentucky, Iowa, New Jersey, Maryland, and Pennsylvania. Iowa’s inheritance tax has been repealed via legislative mandate, and the repeal will go into effect next year.
Income Taxes
While we are looking at taxes on inheritances, we should cover the other possibilities. When you inherit assets, generally speaking, you do not have to claim the inheritance when you file your state and federal income taxes.
There is an exception if you receive a distribution of a trust’s untaxed earnings. In addition, if you inherit a traditional individual retirement account, you have to pay taxes on the distributions because the contributions were made before taxes were paid on the income.
Capital Gains Tax
If you inherit assets that appreciated during the life of the person who left you the inheritance, are you required to pay capital gains taxes on the gains? The answer is no – the assets would get a stepped-up basis.
For capital gains purposes, the value of the inherited assets would be equal to the value at the time of the receipt of the inheritance. If you hang onto the asset after it has appreciated beyond the stepped-up value, you would be responsible for subsequent realized gains.
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Need Help Now?
If you have already decided that you are ready to work with an attorney to put a plan in place, we can help. You can call us at 408-356-9200 to schedule a consultation at our Campbell, CA estate planning office, and you can alternately use our contact form to send us a message.
