California does not impose a state inheritance or estate tax, no matter how massive your net worth is. However, your estate may still have to pay a federal estate tax, and your heirs might be subject to an inheritance tax if they live in a different state that levies an inheritance tax on its residents. Whatever your situation, it is useful to know how you can reduce inheritance taxes.
Some strategies to reduce taxes involve gifting during your lifetime to bring your estate below the federal estate tax exemption amount, or to at least minimize the amount of your assets that will be subject to the federal estate tax. Other techniques for reducing inheritance taxes involve having a California estate planning attorney draft documents during your lifetime that can help achieve this important goal.
The Federal Estate Tax
For 2021, the federal estate tax threshold is $11.7 million for individuals and $23.4 million for married couples. If your estate exceeds the federal tax threshold, however, you will only get taxed on the amount that is over the $11.7 million or $23.4 million cutoff. Even though our state does not have a state estate tax, California residents are subject to the federal estate tax, just like everyone else.
The Federal Gift Tax
You can get hit with a federal gift tax penalty if you give away too much money within any given year. The federal gift exemption for 2021 is $15,000 per person per year. If you exceed this amount, the Internal Revenue Service (IRS) requires you to notify them of the gifts, and may later charge you or your estate taxes on the excess amount.
Gifting During Your Lifetime
Let’s say that you have a married child who has two children. You could give your child and son or daughter-in-law reach up to $15,000 per year. You could also give each of your grandchildren up to $15,000 per year. This technique will allow you to reduce your estate by $60,000 per year and $600,000 per decade.
Your gift recipients do not have to be family members. You can give money to friends, charitable organizations, or anyone else without incurring gift taxes as long as you do not exceed the annual limit per person. If your tax year runs from January 1 to December 31 and you decide late in the year to reduce your estate size, you could give any given person $15,000 in December and another $15,000 in January. With careful planning, it’s possible that none of these gifts will be included in the value of your estate when you die.
How an Irrevocable Trust Can Reduce Estate Taxes
Many people set up irrevocable trusts as a way to reduce taxes. Here is how this strategy works: Your estate is the amount of net assets you own at the moment you die. If you transfer your assets to someone or something else, then you no longer own those assets. When you set up an irrevocable trust, the trust owns those things, not you.
The sticking point of an irrevocable trust for many people is the word “irrevocable.” You can never, ever change your mind. If you need those assets for medical bills or some other pressing financial hardship, you are out of luck, unless you can persuade a court to save you from your own decisions. Otherwise, you cannot take back the assets. If you left assets to someone with whom you later had a falling out, you cannot change the beneficiary.
A California estate planning attorney can explain which options will work best in your situation. Call our office today to schedule a consultation.