What is the Death Tax?
The term “death tax” might sound scary, but it’s just a nickname for a tax that can be applied to the wealth or property someone leaves behind when they pass away. The real name for this is either an estate tax or an inheritance tax. In California, people often talk about this tax when discussing what happens to a person’s belongings after they die, like their house, money, or other valuable items.
But here’s the good news: California does not have a death tax! That means if someone dies in California, the state government does not take a portion of the person’s estate as a death tax. This is a huge relief for many families who want to pass on their wealth to their loved ones without losing a chunk to taxes.
However, that doesn’t mean all taxes are avoided entirely. There are other important things to consider when it comes to inheritance and taxes, especially when federal taxes come into play. Let’s explore these details more closely!
Federal Estate Tax
While California doesn’t have a state-level death tax, the federal government has its own rules about taxing estates. This is called the federal estate tax. The federal estate tax applies to very wealthy estates — those worth over a certain amount, which is $12.92 million in 2023. This means if someone leaves behind an estate worth more than $12.92 million, a federal estate tax may be applied.
Most people in California won’t have to worry about this tax because their estates aren’t worth that much. But for the very wealthy, this is an important tax to consider. Also read Understanding the “Death Tax” in California
How Does the Federal Estate Tax Work?
The federal estate tax is calculated based on the total value of someone’s estate. If the estate is valued above the federal threshold (currently $12.92 million), only the amount above that limit gets taxed. For example, if an estate is worth $13 million, the federal tax would only apply to $80,000 (the difference between $13 million and $12.92 million).
The tax rate can be quite high, reaching up to 40% on the portion that’s taxed. So, for very wealthy estates, the federal estate tax can take a significant portion of the inheritance.
California’s History with the Death Tax
You might be wondering why California doesn’t have a death tax today. Well, that’s because California used to have a death tax, but it was repealed. Back in 1982, California voters passed a law that eliminated the state estate tax. This means that for over 40 years, people in California haven’t had to worry about a state-level death tax.
However, the topic of estate taxes often comes up in discussions about tax reform. Some people believe California should bring back the death tax, arguing that it could help generate money for public programs, while others think it would unfairly burden families. As of now, there is no sign that California plans to reintroduce a death tax, but it’s always a topic worth keeping an eye on.
What About Inheritance Tax?
Now that we’ve talked about the estate tax, let’s look at another tax people often confuse with the death tax: the inheritance tax. An inheritance tax is different from an estate tax. Instead of taxing the total value of someone’s estate after they die, an inheritance tax is paid by the person who inherits the property.
For example, if your grandmother leaves you her house, an inheritance tax would mean that you, the person receiving the house, would have to pay a tax on its value. The good news is that California doesn’t have an inheritance tax either! So, if you inherit money or property in California, you don’t have to pay an inheritance tax.
But just like with the estate tax, there are other things to keep in mind, especially when it comes to federal taxes or the rules in other states.
Other States and the Death Tax
While California doesn’t have a death tax, some other states do. If you have relatives in other states and they pass away, you might have to deal with estate or inheritance taxes in that state. States like Maryland, New Jersey, and Pennsylvania have either an estate tax, an inheritance tax, or both.
If you inherit something from someone who lived in one of these states, it’s important to understand the rules there. Each state has its own laws and tax rates, so it’s a good idea to check with a tax expert if you’re inheriting property from someone who lived outside of California.
The Role of Gift Taxes
Another important part of the conversation about estate and inheritance taxes is the gift tax. This tax applies to large gifts given during someone’s lifetime, not just when they pass away. The federal government has rules about how much money or property you can give away without it being taxed. In 2023, individuals can give up to $17,000 per person per year without triggering the federal gift tax.
If you’re planning to pass on wealth or property, it’s good to know these rules so you can avoid unexpected taxes. The good news is, just like with the estate tax, most people won’t have to worry about the gift tax unless they’re giving away large sums of money.
What Happens When Someone Dies in California?
When someone passes away in California, their estate typically goes through a legal process called probate. Probate is the process of sorting out the person’s assets and making sure they go to the right people (called beneficiaries). This can be a complex process, especially for larger estates, and it often involves working with a lawyer.
During probate, all debts and taxes need to be paid before the remaining assets are distributed to the beneficiaries. Even though California doesn’t have a state death tax, there may still be other taxes owed, like property taxes or federal estate taxes, depending on the size of the estate.
Probate can take months or even years to complete, depending on the complexity of the estate. Some people choose to set up trusts to avoid probate altogether, which can make the process quicker and more straightforward for their heirs.
Ways to Reduce Tax Burdens
While most people won’t have to worry about a death tax in California, there are still ways to plan ahead and reduce any potential tax burdens on your heirs. Here are a few strategies people use to make sure their loved ones don’t face high taxes or legal fees:
- Create a Trust: A trust allows you to set aside your assets for specific purposes, like supporting your children or grandchildren. Trusts can help avoid probate and keep your assets safe from taxes and creditors.
- Give Gifts: As mentioned earlier, the federal government allows you to give up to $17,000 per person each year without triggering the gift tax. By giving smaller gifts over time, you can reduce the size of your estate and avoid taxes later.
- Work with an Estate Planner: Estate planning is all about making sure your assets are distributed the way you want, with as little tax and hassle as possible. An estate planner or tax advisor can help you navigate the laws and find the best strategies for your family.
Conclusion
The “death tax” in California is not something most people need to worry about. California does not have a state estate or inheritance tax, and the federal estate tax only applies to very large estates. However, it’s always a good idea to plan ahead and understand the tax rules that apply to your specific situation.
By understanding the differences between estate tax, inheritance tax, and gift tax, and by working with professionals, you can ensure that your loved ones are taken care of without unnecessary tax burdens. While the “death tax” may sound intimidating, with the right planning, you can protect your family and make sure your wishes are honored.
In California, you have the advantage of living in a state that doesn’t impose its own death tax. So, with smart estate planning, you can focus on what really matters: ensuring that your legacy is passed on smoothly to the next generation.