S.B. 378: The (Proposed) New California Estate Tax – What Does It Mean for You?

This is the first blog in a series that will cover different aspects of the proposed California Estate Tax. This blog article gives you a little background by first going over the highlights of the Intent and Purpose of S.B. 378, then we break down some of the legalese into Definitions you can understand, and finally we run a simple Example of Cal Taxpayer to give you an idea of how Estate Tax works, first with the current federal law and second, with the proposed S.B. 378.

Intent and Purpose of S.B. 378

In 1982, California voters passed Proposition 5 and 6 which repealed the California inheritance tax and gift tax laws at that time and prohibited California from imposing any tax on gifts made or property transferred by reason of death and made future changes require a statewide vote. Since 1982, Californians have been subject to federal Estate Tax, but there has not been any California Estate Tax.

On March 26, 2019, Senator Scott Wiener (D-San Francisco) introduced Senate Bill 378 which creates a California Estate Tax modeled on the federal Estate Tax, but with a lower Estate Tax Exemption amount ($3.5 million instead of $11.4 million per person). See Senator Wiener’s announcement here. SB 378 will have to be passed by the Legislature and by a statewide vote on the November 2020 ballot.

The Bill proposes the Legislature make the following findings, which are largely based on racial assumptions. The text of the Bill assumes “wide-scale racial wealth inequality” here in California. The Bill would use the tax generated to create the “Children’s Wealth and Opportunity Building Fund” with appropriations “to programs and services that directly address and alleviate socio-economic inequality and that build assets among people that have historically lacked them.” (S.B. 378 Cal. Rev. Tax Cd. Sec. 15005(b).)

See the full text of S.B. 378 here. You can decide for yourself if you believe the California Legislature should make these findings as facts in support of this new law:

SECTION 1.

 The Legislature finds and declares the following:

(a) The most significant predictor of the future financial success of a child is the wealth level of the child’s parents with at least 20 percent, and up to 80 percent, of a person’s wealth being the result of an intergenerational transfer.

(b) Throughout history, federal and state governments have provided “wealth starter kits” for some Americans, giving gifts of land, education, government-backed mortgages and farm loans, a social safety net, and business subsidies sometimes exclusively and usually disproportionately, to White families.

(c) According to economist Darrick Hamilton, for communities of color, especially Blacks and Latinos, it has never been easy to build assets of any type because of low levels of intergenerational wealth transfers.

(d) The typical Black or Latino family essentially has no economic cushion. According to the California Family Economic Self-Sufficiency Standard, a measure that quantifies the minimum income necessary to cover all basic expenses, about one-half of Black and Latino households are barely scraping by and unable to meet their most basic financial needs without family or public support.

(e) Given the roles of intergenerational wealth transfer, and past and present barriers that have kept marginalized families from building wealth, private action and market forces alone cannot be expected to address wide-scale racial wealth inequality, and public sector intervention is needed.

Definitions

“Estate Tax” is a tax payable from and as a percentage of your estate (your assets) after you die.

“Probate Assets” are the assets you own that are included in the calculation of your estate that will go through a probate case after you die, unless you have a joint owner or a living trust.

Note: if you haven’t yet set up your living trust to avoid the cost and hassle of probate for your surviving spouse and kids, now is the time.

“Estate Tax Assets” are the assets you own that are included in the calculation of your Estate Tax.

Note: some are not what you would assume. Here’s an example of Probate Assets vs. Estate Tax Assets:

  Probate Assets Estate Tax Assets
Real Estate Fair Market Value Fair Market Value – Debt = Equity
Life Insurance Policies Owned Not Probated – Payable Direct to Beneficiary Death Benefit Value
IRA, 401(k), 403(b), 457, etc. Not Probated – Payable Direct to Beneficiary Fair Market Value
Non-IRA Stocks, Bonds, Mutual Funds Fair Market Value Fair Market Value
Personal Property Fair Market Value Fair Market Value
Cash Cash Value Cash Value

 

“Estate Tax Exemption” also called “Estate Tax Exclusion” is the amount of your estate that is exempt before Estate Tax starts. As of 2019, for people that die in 2019, the Federal Estate Tax Exemption is $11.4 million per person. The proposed SB 378 Estate Tax Exemption is $3.5 million per person.

“Taxable Estate” is that amount of your estate that exceeds the Estate Tax Exemption and is subject to the Estate Tax.

“Estate Tax Rate” is the percentage your estate will be taxed if it exceeds the Estate Tax Exemption. As of 2019, the maximum marginal federal Estate Tax Rate is 40%.

Example of Cal Taxpayer

Here’s a quick example of our local neighbor Cal Taxpayer, who has a nice upper-middle-class home and a vacation home in the mountains or on the coast, a decent IRA and non-IRA investment account but not really massive by today’s standards, showing current federal law (not including California’s proposed new Estate Tax under SB 378).

  Cal Taxpayer Estate Tax Assets
Residence $850,000 Fair Market Value – Debt = Equity
Less (Mortgage) ($150,000)  
Equals Equity $700,000  
     
Vacation Home $750,000  
Less (Mortgage) ($100,000)  
Equals Equity $650,000  
     
Life Insurance Policies Owned $2,500,000 Death Benefit Value
     
IRA, 401(k), 403(b), 457, etc. $750,000 Fair Market Value
     
Non-IRA Stocks, Bonds, Mutual Funds $500,000 Fair Market Value
     
Personal Property $100,000 Fair Market Value
     
Cash $50,000 Cash Value
     
Total Estate Tax Estate $5,250,000  
     
*Federal Estate Tax Exemption $11,400,000  
Less Total Estate Tax Estate $5,250,000  
Equals Exemption Remaining $6,150,000 NO Federal Estate Tax Owed

 

*Note: This Federal Estate Tax Exemption was created under the Trump Tax Cut and Jobs Act of 2018 and, unless extended by Congress, will sunset in 2025, back to pre-2018 levels of approximately $5,600,000.

Here’s that same example showing current federal law AND including California’s proposed new Estate Tax under SB 378).

  Cal Taxpayer Estate Tax Assets
Residence $850,000 Fair Market Value – Debt = Equity
Less (Mortgage) ($150,000)  
Equals Equity $700,000  
     
Vacation Home $750,000  
Less (Mortgage) ($100,000)  
Equals Equity $650,000  
     
Life Insurance Policies Owned $2,500,000 Death Benefit Value
     
IRA, 401(k), 403(b), 457, etc. $750,000 Fair Market Value
     
Non-IRA Stocks, Bonds, Mutual Funds $500,000 Fair Market Value
     
Personal Property $100,000 Fair Market Value
     
Cash $50,000 Cash Value
     
Total Estate Tax Estate $5,250,000  
     
Proposed California SB 378 Estate Tax Exemption $3,500,000  
Less Total Estate Tax Estate $5,250,000  
Exemption Remaining $0 NO Federal Estate Tax Owed
Equals Taxable Estate $1,750,000 YES California Estate Tax Owed
Max Marginal Rate 40%  
Equals California Estate Tax $700,000  

 

What does this mean for you?

Well, if S.B. 378 fails to pass the Legislature and the popular vote in 2020, then it means nothing. However, given the voting history of our state recently and the sheer numbers of voters involved, I think that’s unlikely. So, plug your personal numbers into the framework above and if your Estate Tax Estate with you and your spouse together is less than $3,500,000, it doesn’t matter. Remember the Estate Tax Exemption is personal, that is each spouse receives that Estate Tax Exemption amount, and there is currently also an exemption to pass assets to your surviving spouse.

However, if you and your spouse together have an Estate Tax Estate that exceeds $3,500,000, and you die after January 1, 2021, when S.B. 378 would be effective if passed. Then your family’s inheritance will be impacted by up to 40% of every dollar over $3,500,000.

As trust and estates lawyers at Lawvex, we are analyzing what S.B. 378 means for Californians and we are updating how we handle estate and estate tax planning to address this. Our next blog in the series will address some of the basic estate planning techniques available to minimize your family’s exposure to this new Estate Tax.

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