Unknown to many of us, the government does not take money from a person’s estate most of the time. In fact, 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. The two main types of tax to consider are income tax and estate tax.
Estates and trusts pay income tax like you do as an individual or married couple. However, most of my 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 $200,000, but it is now worth $1,000,000, your survivor(s) get to step-up (or change) the cost from $200,000 to $1,000,000 (the current market value). Thus, if the cost is now $1,000,000 and the sales price is also $1,000,000, then there would be no capital gains tax due on the sale of the house ($1,000,000 sales price – $1,000,000 cost basis = $0 taxable gain).
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.
In 2022, individuals may have $12,060,000 in assets, or over $24,000,000 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 exemption, before your estate will pay estate tax—at roughly 40%. If your estate exceeds these figures, your estate will only be taxed on the amount that your estate exceeds the figure. Almost all people I meet with are worth less than the estate tax exemption figures, so this is not a tax most people need to fear.
Regardless of your net worth, I recommend discussing the advantages of having a living trust drafted, or having your existing estate plan reviewed, to ensure your loved ones are properly protected.