By Debra Doyle, David Berek, Jack Newlin and Spencer Guillory
The California Senate recently introduced a bill, California SB 378, which would impose a California gift, estate and generation-skipping transfer (GST) tax beginning on Jan. 1, 2021, on all gratuitous transfers during the life and on death of a California resident. Under the proposed California law and similar to the federal transfer tax law, all California transfer taxes will be imposed at a rate of 40%. However, unlike the federal transfer tax system providing for a basic exclusion of $11.4 million, which is adjusted for inflation, the proposed California law would provide for a more limited exclusion of $3.5 million with no future adjustments for inflation. If the proposed legislation is successfully enacted, California would join ranks with 12 states that currently impose a state estate or inheritance tax and just one other state (Connecticut) that imposes a gift tax.
Gift and Estate Tax
The proposed California gift and transfer tax rate will be equal to the marginal federal transfer tax rate imposed on lifetime gifts and transfers at death—essentially a 40% tax. While the current federal exclusion for gift and estate tax is $11.4 million, California SB 378 provides for a much lower exclusion of $3.5 million. The Senate bill provides for a full credit given for all federal estate and gift tax paid, meaning only that portion of the estate of a California resident or gifts from a California resident having a value between $3.5 million and $11.4 million will be subject to California state transfer tax. Practically speaking, a California resident with an estate of $100 million would pay the same California estate tax as a California resident with an estate of $11.4 million.
In addition to levying a gift and estate tax, California SB 378 would impose a state GST tax at a 40% rate. The GST tax is imposed on transfers to related persons more than one generation younger to the donor, such as grandchildren, and gifts to unrelated persons who are more than 37.5 years younger than the donor. Again, the proposed legislation would provide for a separate $3.5 million exclusion for the GST tax, with no index for inflation, compared with a federal inflation-adjusted GST exclusion of $11.4 million. Similar to the state gift and estate tax, the California bill provides for a full credit for any federal GST tax paid.
No Proposed Provision for Marital Deduction or Portability
Although California SB 378 mirrors many portions of the federal estate and gift tax regime, there are a few notable deviations. In its existing form, California SB 378 doesn’t provide for a separate state marital deduction, commonly referred to as the qualified terminable interest property election. This is most likely an oversight and is expected to be corrected in future versions of the California bill. Additionally, there’s no provision for the executor of a deceased spouse’s estate to port or transfer the deceased spouse’s unused $3.5 million California exclusion to the surviving spouse. Without the availability of these two important estate-planning tools, the planning and administration of estates for married couples residing in California will likely become increasingly complex.
Children's Wealth and Opportunity Building Fund
California SB 378 also proposes creating the "Children’s Wealth and Opportunity Building Fund," a special fund in the state treasury that would receive all of the taxes, interest, penalties and other amounts collected as a result of the state gift, estate and GST tax. The purpose of this fund is to “directly address and alleviate socioeconomic inequality and build assets among people that have historically lacked them.”
Probability of Passage and Implementation
The proposed bill, if passed by California's Legislature and signed by Gov. Gavin Newsom later this year, will have to be ratified by voters in the November 2020 statewide election. While it’s becoming increasingly clear that both the legislature and the governor are proponents of this new tax, it’s less clear whether California voters, already facing some of the highest taxes in the country, will be keen to endorse yet another layer of state tax. However, the inclusion of the Children’s Wealth and Opportunity Building Fund may have some impact on convincing more voters to support the bill.