When property is transferred whether as an “inter vivos” meaning during life transfer, or as a result of death, it may be subject to taxes like property taxes and transfer taxes. When property is transferred as a result of death in some states an inheritance tax may apply to the heir or person receiving the property. This is important because it may be an unexpected cost to the heir. Often following death, property is distributed in accordance with a trust or will. In California, there is no inheritance tax but taxes on estates do apply.
What is inheritance tax?
Inheritance tax is a type of tax on transfers by will, succession or survivorship. (Estate of Thurston (1950) 36 Cal.2d 207, 209.) In California this acted as an excise tax on the privilege of succession. (Estate of Bloom (1931) 213 Cal.575, 581.) This tax would be computed according to the value of the property transferred to each beneficiary or heir. (Estate of Madison (1945) 26 Cal.2d 453, 456.) This inheritance tax always applied to the beneficiary not a cost on the estate or administration of the will or trust. (Cohn v. Cohn (1942) 20 Cal.2d 65, 68.)
Does California have inheritance tax?
California does not have any inheritance tax so any tax on property transferred post-death is an estate tax or applicable federal taxes. The California Inheritance Tax law was repealed in 1982. Now, the Revenue Code section 13301 dictates the state will not impose any tax on the estate or inheritance of a person for any transfer occurring because of death. However, California does allow an estate tax equal to the maximum credit for state death taxes allowed under federal law. (Estate of Claeyssens (2008) 161 Cal.App.4th 465, 469.) This means if you are receiving something from the distribution of an estate whether by will or trust, there may be an estate tax.
How does inheritance tax apply in states that do have it?
Where states have an inheritance tax, like was the case formerly in California, the tax is imposed at the time of a decedent’s death. (Odle v. Indiana Dept. of State Revenue (2013) 991 N.E.2d 631, 633-634.) In some states the tax is on the receipt of property. (Nance v. Iowa Department of Revenue (2018) 908 N.W.2d 261, 270-271.) In other states it is on the transfer of property on the estate. (Indiana Dept. of State Revenue, Inheritance Tax Div. v. Estate of Pickerill (2006) 855 N.E.2d 1082, 1085.) An inheritance tax is always on the beneficiary. The amount of tax is determined according to the relationship of the parties and the value of the transfer or gift. (Matter of Jacobs' Estate (1979) 92 Wis. 2d 266, 270-271.) The tax is collected through the representative of the estate. (Matter of Stevens' Estate (1976) 74 Wis. 2d 1, 11-12.) In a state where inheritance tax is collected, the tax may be collected where the property is being transferred by trust following the grantor’s death.
Applicability of inheritance tax to a trust
A state inheritance tax will apply when a property interest passes by will, intestacy, or a form of inter vivos transfer designated by statute. As such, a transfer through a living trust or inter vivos trust may be taxed. (Bouse v. Hutzler (1942) 180 Md. 682, 684-685.) Inheritance tax is not meant to reach “absolute” inter vivos transfers, where the transfer is being a substitute for testamentary disposition, like a will or trust, a tax will apply. (Matter of Bannon's Estate (1976) 171 Ind.App. 610, 614; In re English's Estate (1973) 206 N.W.2d 305, 308 [Iowa].) If a transfer through a trust is made in contemplation of death it may be reached by an inheritance tax. (Wilson v. Lewis (1988) 311 Md. 547, 536, 554; Page v. Commissioner of Revenue (1983) 389 Mass. 388, 394; Matter of Moody's Estate (1980) 25 Wash.App. 329, 334.) Further if the trust is meant to take effect after the transferor’s death that will be taxed as well. (In re Renz' Estate (1953) 338 Mich. 347, 358-359; State by Tax Commissioner v. Tuchscherer (1964) 130 N.W.2d 608, 615 [North Dakota].) To determine whether this tax applies the donor’s state of mind at the time of the transfer is considered. (Berg v. Director, Div. of Taxation (1998) 17 N.J. Tax 256, 263.) However, if adequate and full consideration was paid for the property at the time of transfer it will not be subject to the tax. (Armstrong v. Lindley (1983) 10 Ohio App. 3d 320, 323-324.)
What is an example of what inheritance tax as applied to a trust might look like?
For example, “Julie” is a beneficiary meant to receive property from a trust due to the death of “Shawn.” Julie may need to pay tax on it depending on the state she was in. If she was in California, no tax would apply. However, if the property in trust was being administered as part of an estate, an estate tax may apply as to the value of the whole estate. Otherwise in a state with inheritance tax, based on those state tax rates, Julie would be taxed on her inheritance. This would be determined based on the value of the property she inherited.
If Shawn had meant for the property to pass at his death, then it would be taxed as inheritance. Alternatively, if Julie paid for the property or gave some sort of valuable consideration in exchange it would not be taxed as inheritance.
Conclusion
When property is transferred as a result of death it may be subject to taxes like inheritance tax. If you are in a state that imposes this tax, being aware of it is important because it may be an unexpected cost to you as an heir. In California, there is no inheritance tax but taxes on estates do apply. If you have inherited property and are experience disputes around costs or property interest, a partition action mat be a solution. At Underwood Law, our partition attorneys can help you navigate your partition action efficiently and with care. We are here to help.
