The complicated world of Trust and Estate taxation can be hard to navigate at times, but taxation has gotten a bit easier now that the Federal Estate Tax applies to far fewer estates.
Basically, there are two broad categories of possible taxes: Estate Tax and Income Tax. Estate taxes only apply to estate with a gross value of $5,430,000 or higher. That means if you die owning assets worth less than $5,430,000, then there is no Estate Tax. If you are married, you can double that amount and still be free of Estate Tax. That means a vast majority of people have nothing to worry about when it comes to Estate Taxes.
Income Tax is another issue altogether. When assets transfer from one person to another at death, there generally is NO INCOME TAX due as a result of that transfer. Let me repeat that because this is by far the most misunderstood area of taxation: if you inherit property you WILL NOT pay income tax on the receipt of that property.
The only exception to that rule is if you inherit retirement assets, such as 401k’s, IRA’s, anything where money was set aside pre-tax during the decedent’s lifetime. Since these types of accounts allow people to contribute money to them pre-tax, you are required to pay income taxes when the money is distributed out of the account. Therefore, if you inherit a retirement account, you may owe income tax to the extent money is distributed out of such an account.
Other than retirement assets, however, there is no income tax due to your receipt of inherited assets. There may be income tax if the Trust or Estate to which you are a beneficiary generates income after the decedent’s death, but that is usually rather small. In other words, if your Trust generates interest income from the bank or it triggers a gain on the sale of stocks, then that income or gain would be taxes to you as the beneficiary. But this is a rather small tax considering that your receipt of the underlying stock or the underlying money was tax-free. It is only the income the assets generate after death on which you owe an income tax.
And that’s about it. California does not have an inheritance tax, like many other states. That means state and Federal income taxes are the only issues most people need to address. Yes there are a few more esoteric taxes out there (like the Generation Skipping Tax for estates in excess of $5.4 million), but they affect so few people that it does not pay to get too deeply into it.