Do Beneficiaries Pay Inheritance Tax

Herman just received a call – a frantic one. His mother passed away, leaving a codicil to her Trust that attempted to change the distribution of her rental properties. Unfortunately, the codicil wasn’t properly witnessed, rendering it invalid. Now, Herman and his siblings are facing a costly and protracted legal battle to enforce their mother’s final wishes, a battle that could easily exceed $50,000 in attorney’s fees and delay access to the inherited assets for over a year. This scenario, sadly, is far too common when estate planning documents aren’t executed with meticulous care.

What Exactly Is Inheritance Tax, and Who Pays It?

The term “inheritance tax” is often misunderstood. Federally, there is no longer a federal inheritance tax. What most people refer to as inheritance tax is actually estate tax levied on the estate of the deceased before distribution to beneficiaries. However, California does not have a state-level estate tax either. What we primarily deal with here in California are potential income tax implications for beneficiaries receiving inherited assets. These are typically capital gains taxes, and the rules can be surprisingly complex.

How Do Inherited Assets Get Taxed as Income?

When you inherit assets – stocks, bonds, real estate, business interests – you generally receive them with a “step-up” in basis. This means that for capital gains purposes, your cost basis in the inherited asset is equal to its fair market value on the date of the decedent’s death. This is where my dual role as both an Estate Planning Attorney and a CPA becomes particularly valuable. The step-up in basis can significantly reduce or eliminate capital gains tax when you eventually sell the inherited asset.

For example, if your mother purchased stock for $10,000 and it was worth $50,000 when she died, your cost basis is $50,000. If you sell it for $52,000, you only pay capital gains tax on the $2,000 difference. Without the step-up in basis, you’d be taxed on the entire $42,000 gain. Correctly valuing assets at the date of death is crucial, and a CPA with estate planning experience can ensure that valuation is defensible to the IRS.

What About Inheriting Real Estate?

Inheriting real estate often involves unique tax considerations. As mentioned earlier, the step-up in basis applies. However, California law now has an important update regarding primary residences. For deaths on or after April 1, 2025, a primary residence worth $750,000 or less (gross value) may qualify for a simplified transfer under AB 2016 (Probate Code § 13151), bypassing formal probate. This can save time and expense, but it doesn’t change the capital gains calculation if the beneficiary later sells the property. Rental properties, even those inherited, are not eligible for this simplified transfer and will likely require probate or a Trust transfer.

What if the Beneficiary is Already Receiving Government Benefits?

Inheriting assets can have unintended consequences for individuals receiving needs-based government benefits, such as Medi-Cal or Supplemental Security Income (SSI). Receiving an inheritance outright exposes those assets to Medi-Cal Estate Recovery claims upon the beneficiary’s death; a Special Needs Trust is required to protect the assets from the state. While California eliminated the asset test in 2024, an inheritance can still disqualify a beneficiary from receiving ongoing benefits. Utilizing a Special Needs Trust can help shield the assets and ensure the beneficiary continues to receive necessary care.

What Happens with Inherited Business Assets, Like an LLC?

Inheriting a business interest, particularly an LLC, requires careful consideration. The step-up in basis also applies to business assets, but determining the accurate value of a closely held business can be challenging and require a professional business valuation. Furthermore, as of January 1, 2026, non-exempt LLCs must comply with FinCEN’s Beneficial Ownership Information (BOI) reporting; executors and beneficiaries managing inherited entities must file updated reports within 30 days of ownership changes to avoid significant civil penalties.

What About Digital Assets and Online Accounts?

Digital assets – online accounts, photos, cryptocurrency – are often overlooked in estate planning. Under California’s RUFADAA (Probate Code § 870), beneficiaries and executors are legally barred from accessing digital accounts, photos, and crypto-wallets unless the decedent explicitly granted authority in their Will, Trust, or via an ‘online tool’. This highlights the importance of including provisions for digital asset access in your estate plan.

How Much Does it Take to Trigger Probate?

Even with a Will or Trust, assets without valid beneficiaries may trigger probate if the total value of personal property exceeds $208,850 (for deaths occurring on or after April 1, 2025); a Will alone does not bypass this limit. Properly funding a Revocable Living Trust is crucial to avoid probate altogether.

I’ve been practicing Estate Planning and acting as a CPA for over 35 years, and I’ve seen countless estates needlessly burdened by taxes and legal complications due to a lack of proper planning. My combined legal and financial expertise allows me to proactively address these issues, minimize tax liabilities, and ensure your assets are distributed according to your wishes, avoiding the heartache and expense Herman’s family is now facing.

What does a California probate court look for when interpreting testamentary intent?

In California, a last will and testament is reviewed under probate standards that focus on intent, capacity, and execution. Clear drafting reduces ambiguity, limits misinterpretation, and helps families avoid unnecessary conflict during estate administration.

• Preparation: Review estate planning regularly.
• Validation: Check legal requirements.
• People: Update personal information.

For California residents, understanding how intent, authority, and compliance interact is one of the most effective ways to protect family harmony and estate integrity. A will that anticipates probate scrutiny is far more likely to be honored as written and far less likely to become the source of unnecessary conflict.

Official Resources for Probate, Legal Standards, and Tax Rules

• Probate / Beneficiaries:
  Riverside Superior Court – Probate Division:
  Provides essential Riverside-specific “Local Rules” (Title 7) and forms effective January 1, 2026. This portal includes the mandatory eSubmit protocols for Temecula filings and the calendar for the Probate Division at the Historic Courthouse.
• Legal Standards:
  State Bar of California:
  The official regulatory agency for California’s 270,000+ attorneys; use this portal to verify a lawyer’s license status, check for a history of disciplinary actions, and access the 2026 guidelines for ethical attorney-client fee agreements.
• Tax / Estate Tax:
  IRS Estate Tax Guidelines:
  The authoritative federal resource for estate and gift tax filing; this page reflects the permanent exemption of $15 million per individual (effective Jan 1, 2026), which replaced the scheduled “tax cliff” from previous legislation.
• Self-Help / Forms:
  California Courts – Wills, Estates, and Probate:
  The Judicial Council’s primary self-help center offering standardized forms for 2026, including the updated $208,850 “Small Estate Affidavit” and the $750,000 “Primary Residence” simplified transfer procedure (AB 2016).