Tax Planning in California: Everything You Need to Know

As we near the end of the year, it’s important to consider tax planning for your estate and for your business. 

Very few people enjoy figuring out their taxes, and when you have added complications of a business, real estate, or an estate and assets, it can feel even more complicated.

Not to mention that many of these laws are changing in the near future as a result of the Biden administration’s new tax plan.

In this blog, we’ll cover the basics of tax planning and gifts in California, as well as some of the changes that have been brought about by Biden’s new tax plan. If you have further questions, San Diego tax and estate planning attorney Jennifer Reardon is happy to guide you through the process.

Estate planning allows you to plan for the future of your family, deciding what will happen to your assets after your passing.

After you die, a federal estate tax will have to be paid if your estate exceeds $11.58 million. (California does not currently have a separate state-level estate tax.) Realistically, that’s only about 2 out of every 1,000 estates in the U.S. 

However, estate taxes are typically pretty high, and should be paid in cash roughly nine months after you die. So it’s important to do what you can to minimize those taxes so that your beneficiaries won’t suffer these losses later on. 

If the total value of your assets is over the estate tax exemption amount, you’ll also have more complicated tax requirements you’ll need to be sure to meet.

• Many analysts expected the Biden administration to lower the exemption amount– some speculated as low as $3.5 million– but that didn’t happen. No changes have yet been made to the estate tax rate or the exemption amount.

There are a few main things you can do to help reduce your San Diego estate so that your beneficiaries won’t have to worry once you’re gone. These include:

Gifting something out of your estate can be an excellent way to reduce your taxable estate, transfer tax obligations to your children, or give to a charitable cause you care about. 

In some situations, gifts made while you are still alive are subject to gift taxes. According to the 2020 gift tax law, people can give away or leave up to $11.58 million without owing federal gift and estate tax. (This amount changes depending on inflation.)

Let’s say you give your $2 million house to your children, as well as an additional $6 million in stocks and bonds. Since this only adds up to $8 million, no federal gift tax would be necessary. However, if you give your children your $2 million house plus $10 million in stocks and bonds, the total would be $12 million, and the federal gift tax would kick in. 

It’s also important to note that gifts to a spouse are not subject to the gift tax, and charitable gifts, tuition gifts, and medical expense gifts are unlimited (if you give them directly to an institution).

Giving away assets in this manner can help reduce your estate, which can help ensure you will not be over the estate tax exemption.

There are certain exemptions that allow you to reduce what you owe for the federal estate tax, or even avoid it altogether.

• Marriage Exemptions

In 2020, estates worth more than $11.58 million were subject to the federal estate tax. If you and your spouse have a shared estate of $20 million, you of course will be subject to it, as well.

However, there are exemptions in place that allow you to use tax-planning living trust to split your estate into two trusts of $10 million each. That way, when the first spouse dies, their trust uses an exemption for their $10 million. When the second spouse dies, their trust uses their $10 million exemption. This leaves no taxable estate, and everything can go to their beneficiaries. 

• 1031 Exchange Exemption

This exemption deals with exchanges of like-kind properties (real estate assets of a similar nature) and allows for the deference of any taxable gains 

Through this process, taxpayers can reinvest proceeds from these capital gains instead of having to pay taxes on them, but it’s important to work with a qualified San Diego tax planning attorney to ensure you’re doing everything correctly.

What qualifies for a 1031 Exchange exemption:

• Corporations
• Partnerships
• Limited liability companies
• Trusts 

What does not qualify:

• Business inventory
• Stocks and bonds
• Debt notes
• Securities
• Interests in partnerships
• Certificates of trusts

The taxpayer has 45 days after the sale of the property to identify possible replacement properties through written notice. The taxpayer should then secure a replacement property and finalize the entire exchange within 180 days of (1) the original sale date, OR (2) the deadline of the income tax return for the year the asset was sold (whichever comes first).

The major changes made by the new Biden tax plan that estate planners need to keep in mind involve capital gains tax. Under the new plan, the capital gains tax rate will nearly double, from 20% to 39.6%.

In addition, the plan gets rid of the “step-up in” basis for capital gains taxes. The “step-up in” basis means that heirs may defer taxes on inherited home gains until they sell the property. As a result, they only pay taxes on the value of the estate on the date of death, rather than paying taxes on the value of the estate at the time of the sale.

The new plan gets rid of this exception altogether. This change is expected to raise a lot of money for the government through an effective increase on both capital gains and estate taxes.

For example, under the current system, inheriting a million dollar house would cost approximately $20,000 in capital gains tax, but under the new system, it could cost as much as $70,000.

With 20 years of experience as a Certified Public Accountant before she became a lawyer, San Diego attorney Jennifer Reardon is here for all your tax planning needs.

If you are having trouble with any aspect of your taxes — particularly in regards to estate planning or business transactions — Jennifer Reardon is ready to help. Contact the Reardon Law Firm today.