Inheritance Tax in California: What You Need to Know

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

Inheritance and taxes often feel complicated, especially when combined. This guide simplifies the process for Californians by explaining inheritance tax rules, their absence in the state, and other considerations like federal estate taxes, Proposition 13, and trusts. With clear examples and actionable tips, you’ll have the tools to navigate these issues confidently.

Key Takeaways

• No Inheritance Tax in California: Beneficiaries inherit assets tax-free at the state level.
• Federal Estate Tax: Only applies to estates exceeding $13.61 million in 2024.
• Proposition 13 and Property Taxes: Be aware of reassessment rules for inherited properties.
• Estate Planning Tools: Trusts, wills, and gifting are critical for efficient wealth transfer.
• State-Specific Rules Matter: Verify inheritance laws in other states when dealing with out-of-state estates.

What Is Inheritance Tax?

Inheritance tax is a levy on the assets beneficiaries receive after someone’s death. The tax amount depends on the relationship between the deceased and the beneficiary, as well as the value of the inheritance. It’s critical to note that inheritance tax is state-specific in the U.S., with rules varying widely across jurisdictions.

Does California Have an Inheritance Tax?

California does not impose an inheritance tax, which is great news for state residents. This means assets inherited from someone who lived in California are tax-free at the state level.

However, if you inherit from someone residing in a state with inheritance taxes — like Pennsylvania, Kentucky, or Nebraska—you may need to pay taxes in that state. Always verify the inheritance tax rules for the state where the deceased resided.

Federal Estate Tax: A Different Consideration

While inheritance tax affects the heirs, estate tax applies to the overall value of an estate before it’s distributed. It’s paid by the estate, not the beneficiaries.

• Federal Estate Tax Threshold: As of 2024, estates valued at over $13.61 million are subject to federal estate tax. This threshold is indexed annually, so it’s wise to confirm current limits.
• Implications for Large Estates: High-value estates can benefit from estate planning tools like irrevocable trusts to minimize taxes and ensure smooth asset transfers.

Hypothetical Example Scenario: Taxes on Inheritance

Imagine Maria inherits $500,000 from her aunt, a California resident. Since California doesn’t have inheritance tax, Maria owes nothing to the state. Additionally, her aunt’s estate is below the federal estate tax threshold, so Maria keeps the full $500,000.

Now, suppose Maria inherits the same amount from an aunt in Pennsylvania, which imposes inheritance taxes. Depending on Pennsylvania’s rates and her relationship to the deceased, Maria may owe taxes to Pennsylvania, even though she lives in California.

Key Considerations for Estate Planning in California

While inheritance tax isn’t an issue in California, other financial and legal considerations still apply:

1. Federal Estate Tax Planning

• What is the Federal Estate Tax? The federal estate tax applies to estates valued above $13.61 million in 2024. If your estate exceeds this amount, it may be subject to taxes before distribution to heirs.
• Why Do Gifting and Irrevocable Trusts Matter?

• Gifting: The IRS allows you to give up to $18,000 per person annually (2024) without triggering federal gift taxes. Over time, this gradual wealth transfer reduces the size of your taxable estate, minimizing the tax burden when your estate is passed on.
• Irrevocable Trusts: These trusts permanently transfer assets out of your estate. Once placed in the trust, the assets no longer belong to you, meaning they won’t count toward the taxable estate value.some text
  • Why It Reduces Taxes: By transferring assets early, their future appreciation is also excluded from your estate, saving significant taxes for heirs.

2. Property Tax Reassessments Under Proposition 13

What is Proposition 13? Proposition 13 is a California law that limits how much property taxes can increase annually. It allows properties to be taxed based on their purchase price rather than their current market value, with only minor yearly increases.

How Does It Affect Inherited Properties?

• When property is inherited, it’s often reassessed at the current market value unless an exclusion applies. This can lead to significant increases in property taxes.
• Parent-to-Child Exclusion: If a child inherits their parent’s primary residence and meets residency requirements, they may avoid reassessment, keeping the original (lower) property tax rate.

Hypothetical Example

Sarah inherits her father’s home, which was assessed at $200,000 under Proposition 13. Without qualifying for the exclusion, the property’s market value of $1 million leads to a reassessment, raising her annual property taxes from around $2,500 to over $12,500. By understanding and qualifying for the exclusion, Sarah could avoid this dramatic increase.

3. Trusts and Wills for Estate Planning

What Are Trusts and Why Are They Useful?

• Living Trusts: These allow you to transfer assets to heirs without going through probate—a potentially time-consuming and costly legal process. Trusts also help maintain privacy and streamline asset distribution.
• Why It Matters: Assets in a trust don’t count as part of your taxable estate, and they transfer more efficiently to beneficiaries.

Why Wills Are Still Important

• Even if you have a trust, a will is essential for covering assets not included in the trust and for appointing guardians for minor children. A will acts as a safety net to ensure all your wishes are honored.

You can also read our full article on Living Trust or Will, by clicking here.

How to Prepare for Inheritance or Estate Planning

For Beneficiaries: Key Steps After an Inheritance

1. Understand State-Specific Rules

• Laws governing inheritance vary widely. Even though California doesn’t tax inheritances, you might face unexpected rules elsewhere. Research the legal and tax implications for the state where the deceased resided.some text
  • Example: If you inherit property in a state with inheritance taxes, such as Kentucky, confirm how much you owe and when it’s due.

2. Evaluate the Financial Impact of Inheriting Property

• Inheriting real estate isn’t just about gaining an asset—it often comes with costs like property taxes, maintenance, and insurance.some text
  • Review your budget to ensure you can handle these expenses without overextending your finances.
  • Explore Proposition 13 exemptions in California to mitigate significant tax increases when inheriting a home.

For Estate Planners: Tools to Protect Your Assets

1. Streamline Asset Transfers with Proper Structuring

• Instead of simply passing assets through a will, consider advanced tools to avoid costly delays and taxes:some text
  • Family Limited Partnerships: Allow fractional ownership, which can reduce estate tax exposure and ensure smooth distribution to heirs.
  • Charitable Remainder Trusts: Donate part of your estate while providing income for beneficiaries, reducing taxable estate value and benefiting a cause you care about.

2. Anticipate Potential Disputes

• Mismatched expectations among heirs can create tension. Proactively communicate your plans to your family and involve them in decision-making where appropriate.

• Example: If one child inherits the family home and others receive financial assets, ensure your reasoning is clear to avoid misunderstandings.

Avoiding Common Pitfalls

1. Failing to Address Liquidity Needs

• If most of your wealth is tied up in illiquid assets like real estate, your heirs might struggle to cover taxes or other obligations without selling valuable properties.some text
  • Solution: Establish a life insurance policy specifically designed to cover estate taxes or create an emergency liquidity fund.

2. Ignoring Long-Term Property Tax Implications

• If you plan to leave real estate to your heirs, ensure they understand the long-term financial responsibilities.some text
  • Example: Without proper planning, inheriting a home in California without Proposition 13 exclusions could lead to dramatically increased taxes over time.

FAQs

1. What’s the difference between estate tax and inheritance tax?

Estate tax is levied on the estate itself before distribution to heirs. Inheritance tax is paid by heirs on the assets they receive.

2. Does California tax inherited property?

California doesn’t have inheritance tax, but property taxes may be reassessed unless specific exclusions apply under Proposition 13.

3. How can I avoid property tax reassessments on inherited property?

Qualify for Proposition 13 exclusions, such as the parent-to-child transfer exclusion.

4. What tools help minimize estate taxes?

Irrevocable trusts and strategic gifting are effective methods for reducing federal estate tax liabilities.

5. Are tax laws consistent across the U.S.?

No, inheritance and estate tax laws vary by state. Always check the rules for the state where the deceased resided.