If you live in California, you’re probably already well aware that it’s one of the most taxed states when it comes to income. However, if you’re planning your estate, we have good news: it’s a different story where estate and federal gift taxes are concerned. However, this doesn’t mean your estate or gifts will be tax-free. Understanding federal estate and gift tax rates in California can help you make the wisest decisions for your estate.
With the right knowledge, you can minimize, if not avoid, gift, property taxes, and federal estate taxes. In this article, we explore gift and federal estate taxes in California. Let’s delve in!
How Estate Tax Works in California and the US at Large
California’s representative government doesn’t levy any estate taxes/death taxes. However, Californians are still subject to federal limits, so that’s what we’ll focus on for most of this article.
To understand the federal estate and gift tax rates, you first have to take a good look at federal gift taxes in general. The federal gift tax is a form of inheritance tax enforced by the government. It applies to assets left by a decedent at their death or assets given by an individual during their lifetime.
In essence, whether you give your assets away while you are still living or give them away when you die, they are subject to tax. After all, if there were no gift tax, anyone could completely avoid estate tax by giving everything away just before death. The federal gift tax applies to lifetime gifts, whereas the estate tax/death taxes applies to assets left at death.
What Is a Gift on a Federal Level?
The Internal Revenue Service (IRS) handles gift taxes, inheritance taxes, and estate tax laws. According to IRS accounting methods, a “gift” transfers money or property from one entity to another without expecting anything in return. Here are some examples:
- Assets such as stocks and bonds
- Financial accounts (accounts for business assets, investment accounts, general bank accounts, etc.)
- Property like a home or a car
- Loans with no or low interest
Examples of Federal Estate Gifts
Although the definition of a gift above is open to some interpretation, here are some instances to consider:
- Perhaps you loan a friend enough money to buy a house without interest. The IRS considers it a gift that can be taxed. If it has an interest but is lower than the IRS federal tax rate limit, it is taxable as a gift (taxable gifts).
- If you have a home worth $400,000 and you sell it for $100,000, the IRS’ basic accounting principles stipulate that as giving a gift of $300,000. However, you can still circumvent paying gift tax if you exceed the annual exclusion limits. Keep reading to find out more.
What Is the Annual Gift Tax Exclusion?
The IRS presents an annual gift tax exclusion so you can give away or receive some assets without ending up with extra income taxes. This taxable income rate does rise from time to time. Here’s what has happened recently:
- In 2019 and 2020, respectively, the tax exclusion sat at $15,000. Essentially, you can give your personal property or cash valued at $15,000 to family and friends without worrying about IRS gift tax.
- In 2022, the tax limit increased to $16,000.
What if you intend to cross the annual limit of $16,000? You must report it as an entity or person on the IRS Form 709. The form is officially called the US Gift (and Generation-Skipping Transfer) Tax Return. This is how the government monitors your lifetime estate and gift tax exemption. We’re discussing that in more detail below.
The Lifetime Estate and Gift Tax Exemption
Think of the annual exclusion described above as a small vessel of water located above a bigger pool, a “lifetime exemption.” When the annual exclusion gets full and overflows, it does so into the bigger pool. However, when the large pool starts to overflow, the IRS starts to charge you.
The gift tax and federal estate tax exemption amount (the size of the larger pool) is regularly adjusted for estates and decedents. Remember that this is a “per person” exemption, so married couples can exclude twice as much in lifetime gifts.
Much like the taxable income rate, this federal level has been adjusted over the years:
- In 2014, the lifetime exemption amount rose from $5.25 million to $5.34 million.
- In 2022, the amount rose to $12.06 million.
In addition to the 2022 $12.06 million exemption, many other gifts are not subject to the gift tax. For example, gifts to a spouse are under a special rule and aren’t considered part of this arrangement. So if you give your $1 million house and $4 million of other property to your children and another $8 million to your spouse, you won’t owe any gift tax.
Gifts Exceeding the Lifetime Exemption
That being said, the IRS can tax any liquid assets or real property that exceed your lifetime exemption. There are cases of tax for wealthy estates reaching up to 40% base rate. However, the tax depends on how much you exceed the life exemption limit.
That can be a concern for the wealthiest estates. For such estates, with the help of a strong estate plan, a married couple can get away with almost twice the lifetime gift and estate tax exemption. We’ll show you how in a bit.
Exceptions from the Gift Tax Lifetime Exemption
There are some entities and individuals to whom you can give gifts that won’t trigger the gift tax and will not affect the lifetime gift and estate tax exemption. Take note of the four such entities below.
Spouse: If your spouse resides in the US, you can transfer any amount in property, retirement accounts, or cold hard cash without triggering wealth transfer taxes. Nonetheless, this doesn’t apply to a spouse outside the country. As of 2022, the limit is $164,000 if your sweetheart lives abroad.
Non-profit Organizations: If you transfer any money to a certified non-profit organization, the IRS won’t levy federal transfer taxation on the said organization.
Educational Institution: Paying your child’s tuition (or even the tuition of a stranger) doesn’t trigger the gift tax. However, you have to transfer the payment directly to the school authorities rather than to the student. Sending it to the student directly affects the lifetime exemption. Also, you have to note that this only applies to tuition fees. You can consult the 529 plan (see below) for other expenses such as books and accommodation.
Medical Institution: Paying someone else’s medical bills won’t count against lifetime limits. However, much like the education exemption, you must directly transfer the money or payment to the caregiver/health professional.
The 529 Plan Gift Tax Exemption
There are several popular methods people use to help avoid estate taxes associated with the lifetime exemption level, but this is perhaps the best one. If you decide to invest in a 529 plan for your child, in the actual sense of things, it’s a gift. However, the IRS permits up you to transfer up to $80,000. This is true as long as you don’t make any contribution of that type for five years after the initial contribution. Essentially, the IRS grants five years’ worth of annual exclusion at a go as long as it is for the 529 plan.
How does this look in action? Suppose you decide to contribute $48,000 (3×$16,000). You have used up three years of the annual exclusion, and you can’t contribute to the 529 plan for the next three years as opposed to five.
The 529 plan also doesn’t take out your lifetime estate and gift tax exemption. If you gave your child $80,000 in tangible property, for example, it comes out of your lifetime exemption. However, if you contributed via a 529 plan, your lifetime gift and estate tax exemption remains unscathed.
How A People’s Choice Can Help You With Gift Taxes
California doesn’t levy gift tax; however, the IRS does. That said, the IRS has certain limits and regulations regarding gifts. As of 2022, the annual gift tax exclusion is $16,000. On top of that, there is the lifetime gift and estate tax exemption.
Consider contacting A People’s Choice if you are considering preparing estate planning documentation such as a living trust, will, or other estate documents for your taxable estates. If your estate isn’t very complex and you’d rather not hire a lawyer, we can help prepare all required paperwork without incurring the high cost of hiring an attorney.
People’s Choice is a great, affordable, and reliable alternative to an attorney while you work around the estate and gift taxation. Reach out to us about your tax situation here, and let us help you get all your legal estate taxation paperwork squared away.