This is something I hear almost weekly in my office. Most clients are surprised to hear that the general answer is “the government will not take your money.” Estates will usually pay little-to-no money to the government through taxes unless there are debts owed to governmental agencies such as Medi-Cal. There are two types of taxes to consider: estate tax and income tax.
- Estate Tax
The State of California does not impose an estate tax, also known as an inheritance tax. However, the federal government does impose an estate tax on residents of California. Estate tax is a value-based tax, unlike our individual tax returns that are based on income. Starting January 1st of this year, individuals may now have approximately $11.2 million in assets, or approximately $22.4 million for married couples, without paying estate taxes. This means that the entire value of your net estate must exceed these figures, also known as the estate tax exclusion, before your estate will pay estate tax—at roughly 40%. If your estate exceeds these figures, you will only be taxed on the amount that you exceed the figure. Almost all people I know are worth less than the estate tax exclusion figures, so this is not a tax most clients need to fear. If you are worth close to or above these exclusion figures, you should contact an attorney or tax professional to properly plan for the future.
- Income Tax
Estates and trusts pay income tax like you do as an individual or married couple. However, most of my estate and trust clients do not pay income tax due to the concept of “step-up in basis.” This concept means that the survivor(s) of a decedent’s estate or trust may change the cost (or basis) of an appreciated asset to the current market value. For instance, if you purchased your house for $100,000, but it is now worth $900,000, your survivor(s) get to step-up (or change) the cost from $100,000 to $900,000 (the current market value). If the cost is now $900,000 and the sales price is $900,000, then there would be no capital gains tax due on the sale of the house ($900,000 sales price – $900,000 cost basis = $0 taxable gain).
In summary, although most of my clients’ estates or trusts do not pay tax, you should consult an attorney or tax advisor to discuss your particular estate or trust.
You should also discuss the advantages of having a living trust drafted to prevent your estate from paying very expensive probate court costs and attorney’s fees.