When planning for death, one issue that directly affects beneficiaries is whether taxes will be due on what is left to them. The answer depends on the asset type, the amount transferred, and the tax rules in effect at death. Understanding how different accounts and assets are taxed enables informed decisions that can minimize the overall tax burden on beneficiaries.
This article explains the 2026 federal estate, gift, and GST tax thresholds and summarizes how common asset classes are taxed at death, with California-specific considerations.
Estate Taxes: Will They Apply?
Three variables cannot be known in advance: the date of death, the value of the estate at that time, and the then‑applicable tax laws. That said, as of 2026:
● Federal lifetime exemption (estate, gift, and GST): $15,000,000 per individual. ● Effective married‑couple amount with proper planning and portability: $30,000,000. ● Top federal transfer tax rate: 40%.
● Annual gift tax exclusion (per recipient): $19,000 for 2026.
● Late portability relief: Under current IRS relief procedures, a late portability election is generally available for up to five years after death for estates not otherwise required to file an estate tax return.
If the taxable estate is below the applicable federal exemption, no federal estate tax is owed. If the estate exceeds the exemption, federal estate tax must be paid before distributions to beneficiaries. For married clients, preserving both spouses’ exemptions is critical; ensure timely portability elections and align trust design with current thresholds.
State-level transfer taxes vary:
● California imposes neither an estate tax nor an inheritance tax.
● Several other states impose estate and/or inheritance taxes, often with lower exemption amounts. If owning out‑of‑state real property, that state’s transfer tax regime may apply to that property.
Note that estate tax is only part of the analysis. Income tax, capital gains tax, and (where applicable) trust‑level income tax must also be considered.
Cash and Bank Accounts: The Simple Answer
Cash in checking, savings, or money market accounts generally passes to beneficiaries free of federal income tax. Post‑death interest accrued before distribution is taxable to the recipient who receives that interest. The inherited principal remains income‑tax‑free.
Investment Accounts: The Step‑Up in Basis Advantage
Taxable brokerage accounts (stocks, bonds, mutual funds, ETFs) typically receive a “step‑up” (or step‑down) in income‑tax basis to fair market value at death. If a beneficiary sells immediately at that value, there is generally no capital gain. Future appreciation after death remains taxable when realized.
California community property considerations:
● In California, properly characterized community property typically receives a full step‑up (or step‑down) in basis on both halves at the first spouse’s death if included in the estate. This “double step‑up” can materially reduce capital gains upon a later sale.
Because lifetime gifts generally carry over the donor’s basis, it is often more income‑tax‑efficient to hold highly appreciated assets until death rather than gifting them during life, subject to overall planning objectives.
Retirement Accounts: A More Complex Picture
Traditional IRAs, 401(k)s, and similar pre‑tax accounts do not receive a basis step‑up. Beneficiaries are generally taxed at ordinary income rates on distributions when withdrawn.
SECURE Act framework (as currently applicable):
● Most non‑spouse “designated beneficiaries” must withdraw the entire inherited retirement account by December 31 of the 10th year following death (the “10‑year rule”). If the decedent died on or after the required beginning date for RMDs, annual RMDs may also be required in years 1–9, in addition to emptying the account by year 10.
● Eligible Designated Beneficiaries (EDBs)—a surviving spouse; a disabled or chronically ill beneficiary; a beneficiary not more than 10 years younger than the decedent; and a minor child of the decedent (until age 21)—may qualify for life‑expectancy (stretch) payouts.
● Spousal options include a spousal rollover to the surviving spouse’s own IRA, which can defer RMDs based on the spouse’s age.
Roth IRAs:
● Most non‑spouse beneficiaries are also subject to the 10‑year rule. Qualified Roth distributions are income‑tax‑free. Ensure the Roth 5‑year holding period is satisfied so that earnings are distributed tax‑free.
Income in respect of a decedent (IRD):
● Certain items—traditional retirement accounts, accrued but unpaid interest, unpaid wages/bonuses—are IRD and do not receive a basis step‑up. They remain taxable to the estate or beneficiary when received.
Life Insurance: Generally Income‑Tax‑Free, But Watch Estate Inclusion
Life insurance death benefits are generally income‑tax‑free to beneficiaries. However, if the insured retained “incidents of ownership” in a policy on their life, the death benefit may be includible in the insured’s taxable estate. An irrevocable life insurance trust (ILIT) is commonly used to own the policy and keep proceeds outside the taxable estate.
Three‑year rule:
● If an existing policy is transferred to an ILIT and the insured dies within three years, the proceeds are pulled back into the estate. Having the ILIT acquire a new policy or transferring well in advance mitigates this risk.
California Property Tax Reassessment (Proposition 19)
Separate from estate or income tax, Proposition 19 significantly narrowed the parent‑child exclusion from property‑tax reassessment. Unless conditions are met primarily, the child uses the property as a principal residence and the value‑cap rules are satisfied; an inherited California property may be reassessed at current market value, increasing annual property taxes. Coordinate real property planning with these rules.
Strategic Planning Makes All the Difference
Coordinating estate, income, and property tax considerations can materially affect outcomes. Common strategies include:
● Preserving both spouses’ federal exemptions through timely portability and appropriate trust design.
● Pairing appreciated brokerage assets (that receive basis step‑up) with beneficiaries in higher tax brackets, and allocating tax‑deferred retirement assets to beneficiaries better positioned to manage 10‑year withdrawals.
● Leveraging California’s community property rules to maximize basis adjustments for married clients.
● Integrating Proposition 19 analyses into decisions about retaining or transferring California real property.
● Using life insurance and, where appropriate, ILITs to provide liquidity and mitigate estate inclusion.
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