Earlier this year, State Senator Scott Wiener (D – San Francisco) introduced legislation to dramatically increase taxes on wealth transfers by California residents. This follows the failure of a proposed California Estate Tax initiative to qualify for the 2018 ballot. His bill, SB 378, would put a referendum on the 2020 General Election ballot to adopt a 40% “transfer tax” effective January 1, 2021 if approved by a majority of the voters in that election.
His bill would tax lifetime gifts through a gift tax, transfers at death through an estate tax, and transfers that skip a generation through a generation skipping transfer tax. All of these taxes are referred to as “Transfer Taxes.”
SB 378 would dedicate the taxes it raises to a fund for “programs and services that directly address and alleviate socio-economic inequality and that build assets among people that have historically lacked them. It suggests that the funds be allocated to black and Latino families that historically have received minimal inheritances from their heirs.” Short version: To support wealth redistribution to minorities.
Background
By virtue of 2012 and 2017 Federal tax changes, each American resident can exclude from estate, gift and generation skipping taxes $11.4 million in 2019. These exclusions increase automatically with inflation. If subject to tax, the rate is 40% (equivalent to 64% if the transfer is also subject to the generation skipping transfer tax).
The effect of these laws allows Americans to each transfer up to $11.4 million to their heirs and beneficiaries, while a married couple can transfer up to $22.8 million, without worrying about transfer taxes. This means that about 99.8% of Americans, and a substantial majority of apartment owners, do not need to worry about confiscatory transfer taxes at the Federal level.
Currently, 18 other states (and the District of Columbia) impose some kid of wealth transfer taxes, although only Connecticut imposes these taxes on lifetime gifts. Generally, in these states, the state transfer tax adds to the Federal transfer taxes, with no credit or deduction for Federal transfer taxes paid.
However, since 2001, California has had no effective Transfer Taxes. Senator Weiner’s proposal would change this and impose significant Transfer Taxes on California residents.
How SB 378 Would Increase Transfer Taxes
SB 378, if put on the ballot by the state legislature and adopted by the voters, would impose three separate taxes on wealth transfers by California residents.
- First, for transfers during life, it would impose a tax on the giver equal to 40% of lifetime gifts made after January 1, 2020 to the extent such gifts exceed a lifetime exclusion of $3.5 million. Gifts subject to the annual exclusion of $15,000 per giver per recipient would not be counted. It is unclear whether gifts made before 2020 would be aggregated with those made after 2020 for the purpose of calculating the lifetime exclusion.
- SB 378 would also impose an estate tax on transfers at death by California residents which, with gifts not subject to annual or spousal exclusions, exceed the same $3.5 million exclusion threshold.
- Finally, to add insult to injury, an ADDITIONAL generation skipping transfer tax, with the same $3.5 million lifetime exclusion, would be imposed on transfers that skip a generation.
Credit for Federal Gift, Estate and Generation Skipping Taxes
To prevent “double taxation,” each of these new state taxes, as proposed, would provide a credit for all taxes paid to the United States under the parallel tax provision.
As a result, the California transfer taxes will add nothing to the bill for the richest Californians, while having a major adverse impact on those who have built modest levels of wealth (over about $3.5 million per person, or about $7 million per married couple).
Sadly, I believe that a majority of the burden of these transfer taxes will fall on California owners of residential and other income property.
No Portability or Inflation Adjustments
Federal estate tax law now allows for “Portability” of exclusions between spouses. This permits one spouse to transfer property to the other at death along with any unused transfer tax exclusions. As I explain in my AOA lectures, this makes sense for most apartment owners, as it can allow for better income tax treatment after the death of the second spouse at no anticipated estate tax cost. Unless SB 387 is amended before passage, this will make for very difficult planning situations related to the use of portability.
SB 378 also fails to provide for inflation adjustments to the California Transfer Tax Exclusion. Thus, the burden of these taxes on an inflation adjusted basis will probably grow over time.
Finally, SB 378, unlike the law in many states with a local estate tax, fails to provide for a separate marital deduction that would permit optimizing the estate of a decedent spouse for both Federal and California purposes.
Example
Suppose a single person gives his children, other than annual exclusion gifts, $1 million during his life after 2020, and leaves them another $10 million when he dies later in 2021. For Federal transfer tax purposes, he would have no transfer tax under today’s law.
But, if the SB 378 bill becomes law, his/her heirs would get stuck for 40% of $7.5 million, or $3 million in California estate taxes.
On the other hand, if such person moves his/her residence outside California before he or she dies, the family would face no California estate taxes.
If the same transfers were made in 2026, they would probably produce Federal estate taxes of approximately $2 million (assuming inflation brings the Federal exclusion to $6 million) and California estate taxes of about $1 million.
What Should You Do?
My estate planning motto continues to be “If You Fail to Plan Well NOW, Plan to Fail,”
While we do not know if SB 378 will pass the legislature and get approved by voters, the SB 378 California Transfer Taxes will be extremely difficult to plan for. The fate of any proposal that gets on the 2020 ballot will likely be unknown until after the election on November 3, 2020. That leaves a very short period of time to make gifts or change your residence before 2021 begins.
If SB 378 passes in time to get on the ballot for 2020, apartment owners should promptly meet with experienced estate planning attorneys to try to evaluate the risk of passage and the benefits and detriments, both tax and non-tax, of various gifting strategies, restructuring their living trust or moving out of state.
Some gifts may reduce exposure to Federal and California transfer taxes. However, such lifetime gifts may also reduce the ability of your heirs to benefit from step-ups in basis that can otherwise lower your heirs’ income taxes by reducing capital gains or increasing depreciation.
Unfortunately, we suspect that some property owners will just decide to cease being California residents, and move to states with a more favorable tax structure. But, it may be difficult to accomplish this in the short window between passage in November and the end of 2020.
And, IF YOU THINK YOU WILL SURVIVE PAST 2025, you probably need to plan for reduced Federal Transfer Tax exclusions scheduled for 2026.
Ken is an estate planning attorney who focuses on integrated estate and tax planning for apartment owners. He also assists owners’ families with probate and trust administration. He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, and a perfect 10 out of 10 rating from legal website AVVO.COM.
Ken’s website has information about his estate planning process and reviews of his work by his clients. www.ZiskinLaw.com. He meets with clients in Sherman Oaks, Orange County, Oakland and San Jose by appointment and offers free Living Trust planning consultations for AOA members. Call (818) 988-0949.