California is not known as one of the most tax-friendly states in the U.S. But how much do you know about the California Inheritance Tax?
As an estate planning CPA firm, our job is to answer questions from our clients in California. In this guide, we will discuss the inheritance tax and discuss specific tips and strategies along the way.
Table of contents
What Is Inheritance Tax?
Inheritance tax is a type of tax assessed on people who receive cash or other assets from the estate of a person who has passed away. The tax rate will depend on various issues, such as the inheritance amount and state of residence. But the most critical factor is the recipient’s relationship to the decedent (the person who passed away).
The inheritance tax is sometimes called the death tax. But this usually results from a confusion between the inheritance tax and the estate. We will address the difference shortly.
How does the California Inheritance Tax Work?
The good news is that the U.S. does not have a federal inheritance tax. So if you receive money from a deceased person, you will not pay the IRS for any amount received.
Certain states only impose an inheritance tax. It is typically assessed by the state where the beneficiary or heir lives and resides.
But the good news is that California does not assess an inheritance tax against it’s residents. There are only 6 states in the country that actually impose an inheritance tax.
How is Inheritance Tax Calculated?
Inheritance tax is calculated based on a tax rate applied to the amount that exceeds an exemption amount. The tax is usually assessed progressively. This means that the tax rate gets higher as the amount exceeds the threshold.
Tax rates usually start around 5% to 10% and generally rise to about 15% to 18%. The exemption amount and the rate assessed often depend on the relationship to the deceased.
As a general rule, the closer your relationship was to the decedent, the higher the exemption amount and the lower the tax rate. Surviving spouses are exempt from the tax in all states.
Inheritance Tax vs. Estate Tax
The inheritance tax and the estate tax are often confused. They certainly are not the same thing. The estate tax is levied against the entire estate itself before the assets are distributed to the beneficiaries. In contrast, the inheritance tax is assessed against an heir when they receive assets.
But the two different taxes do have a few similarities. They are both assessed based on fair market value.
If you are the sole recipient of estate assets, you might assume that the taxes are the same. But the application can be quite different. Under some circumstances, the money could be subject to both estate and inheritance taxes.
If a person inherits an estate that is large enough to trigger the federal estate tax and lives in a state with an inheritance tax, they face both taxes. The estate is taxed before it is distributed, and the inheritance is then taxed at the state level.
They could also face a state estate tax. There are a dozen states that have an estate tax.
If you reside in a state with an estate tax, you’re more likely to be taxed. This is because the exemptions in many states are often far less than the federal exemption.
By now, you have a basic understanding of the inheritance tax. The final tax will be determined by the value you received, the relationship to the decedent, and the laws in the state where you reside.