Legal Information Notice
This guide provides general educational information about federal estate tax planning. It is not legal or tax advice. Estate planning strategies are complex, tax laws change, and the suitability of any strategy depends on your individual circumstances. Consult a licensed California estate planning attorney and tax advisor before implementing any estate planning strategy. Reading this does not create an attorney-client relationship.
California Has No State Estate Tax
The first thing to understand: California does not have a state estate tax or inheritance tax. Only the federal estate tax applies to California residents. This is one area where California is actually more favorable than many other states.
However, the federal estate tax is significant — with a top rate of 40% on taxable estates above the exemption threshold. For California families with high-value real estate portfolios, business interests, and investment accounts, federal estate tax planning can be essential.
The Federal Estate Tax Exemption: What You Need to Know in 2025
The federal estate tax exemption for 2024 is $13.61 million per individual, adjusted for inflation annually. Married couples can effectively shelter up to $27.22 million through portability or bypass trust planning.
However — and this is critical — the Tax Cuts and Jobs Act of 2017 doubled the exemption temporarily. This elevated exemption is currently scheduled to sunset on December 31, 2025, reverting to approximately $7 million per individual (inflation-adjusted) unless Congress acts to extend it.
For families with estates between $7 million and $13.6 million, the window to make gifts or take other planning steps while the elevated exemption is available may be narrow. Even if Congress extends the exemption, using it proactively is generally advisable.
The 2025 Sunset: Why Planning Now Matters
A married couple with a combined estate of $18 million faces very different outcomes depending on whether the exemption stays elevated or reverts:
If elevated exemption continues (2 × $13.6M = $27.2M): No federal estate tax owed.
If exemption reverts to ~$7M per person (2 × $7M = $14M): $4 million above the shelter is potentially subject to 40% federal estate tax = $1.6 million in federal tax.
For families in the $14M–$27M range, the next 12 months may be the most important planning window of their lifetimes.
Illustrative only. Actual calculations depend on individual estate composition and tax law changes. Consult an estate planning attorney and tax advisor for your situation.
Key Estate Tax Planning Strategies
The following strategies are commonly discussed with California estate planning attorneys. Each involves significant legal and tax complexity — none should be implemented without professional guidance.
1. Married Couple Exemption: Portability vs. Bypass Trust
Married couples have two primary tools to preserve both spouses' exemptions:
- Portability: A simplified federal rule that allows the surviving spouse to use the deceased spouse's unused exemption. It requires filing an estate tax return (Form 706) within 9 months of death, even if no tax is due. Portability does not lock in today's exemption amount — if the exemption later decreases, the ported amount may be reduced.
- Bypass Trust (Credit Shelter Trust / AB Trust): At the first spouse's death, assets up to the exemption amount are placed in an irrevocable bypass trust for the benefit of the surviving spouse and/or children. Those assets are permanently excluded from the surviving spouse's taxable estate. This strategy locks in the current exemption and may be preferable if the exemption is expected to decrease.
2. Annual Exclusion Gifting
Every individual can give up to $18,000 per recipient per year (2024 annual exclusion, adjusted for inflation) without using any lifetime exemption or filing a gift tax return. Married couples can combine their exclusions for $36,000 per recipient per year.
For families with large estates and multiple children and grandchildren, systematic annual gifting can meaningfully reduce taxable estate value over time. However, gifts during life use carryover basis — recipients do not get a stepped-up basis, which creates a capital gains tradeoff.
3. Irrevocable Life Insurance Trusts (ILIT)
Life insurance death benefits, if owned by the insured at death, are included in the taxable estate. An Irrevocable Life Insurance Trust (ILIT) owns the policy outside the taxable estate — providing tax-free death benefits to beneficiaries while keeping the proceeds out of the estate. ILITs require careful drafting and administration and the transfer of an existing policy involves a 3-year look-back rule.
4. Charitable Remainder Trusts and Charitable Lead Trusts
Charitable planning strategies allow families to transfer wealth, provide income streams, and achieve charitable goals while reducing estate and income taxes. A Charitable Remainder Trust (CRT) converts appreciated assets into an income stream while reducing current income tax and removing the asset from the taxable estate. A Charitable Lead Trust (CLT) provides income to charity for a period, with the remainder passing to heirs.
5. Qualified Personal Residence Trust (QPRT)
A QPRT allows a homeowner to transfer a residence to an irrevocable trust while retaining the right to live there for a term of years. The gift to the trust is discounted for tax purposes because the grantor retains a life interest. This can be an effective strategy for California families with high-value primary residences — though it has implications for stepped-up basis and Prop 19 that require careful analysis.
6. Grantor Retained Annuity Trusts (GRAT)
A GRAT allows a grantor to transfer appreciating assets to an irrevocable trust, receive an annuity payment for a fixed term, and pass any appreciation above a government-set hurdle rate to beneficiaries estate-tax-free. GRATs work best when interest rates are low and assets are expected to appreciate significantly.
The Capital Gains vs. Estate Tax Tradeoff
Many estate tax planning strategies involve a fundamental tradeoff: reducing estate tax exposure often means making gifts that remove assets from the taxable estate — which forfeits the stepped-up basis those assets would receive at death. Heirs who receive gifted (not inherited) assets carry over the donor's original basis, potentially facing large capital gains taxes on eventual sale.
Whether it makes more sense to pay estate tax on an asset and give heirs a clean stepped-up basis, or to gift the asset during life and avoid estate tax at the cost of embedded capital gains, depends on the asset's appreciation, the heir's plans, applicable tax rates, and many other factors. This is exactly the kind of analysis a California estate planning attorney and CPA should model together for families with significant assets.
This is general educational information. Do not implement any estate tax planning strategy without guidance from a licensed estate planning attorney and CPA.