California Estate Tax: The 2025 Legal Structure Decisions High-Net-Worth Families Can’t Ignore

California estate tax surprises wealthy families every year, despite what most attorneys and CPAs claim about the “no estate tax in California” myth. The real threat is in federal limits, changing laws, stealthy compliance traps, and—most overlooked—how your entity structure can cost or save you millions in legacy wealth. For 2025, the difference between proactive structure and a passive trust-fund approach could mean a seven-figure swing for your heirs.

Quick Answer

California does not have its own estate tax. However, high-net-worth residents are subject to federal estate tax, currently 40% on estates above $13.61M per individual (2025 levels). Legal structures—LLCs, S Corps, partnerships, trusts—determine not just exposure but also audit risk, liquidity, and net transfer. The right structure, tailored to your asset mix, can legally shield $5M-$25M+ from unnecessary tax leakage—if set up before the clock runs out.

This information is current as of 7/31/2025. Tax laws change frequently. Verify updates with IRS or FTB if reading this later.

The Landscape in 2025: Why Legal Structures Still Matter for California Estates

Wealth preservation in California is more complex than ever. While the state itself doesn’t levy an estate tax, its affluent residents are at the mercy of federal law. For 2025, the basic exemption sits at $13.61 million per individual—$27.22 million for married couples who plan correctly (per the latest IRS estate tax guidance).

But here’s the trap: that exemption is set to drop by half in 2026 unless Congress acts. If you wait, your heirs could suddenly face a tax bill on millions you assumed were protected. That’s not a hypothetical—families who failed to act before the 2012 sunset law paid hundreds of thousands after the fact.

• Large real estate portfolios left in personal name—fully exposed to estate tax
• Operating family businesses in C-Corps—risk double taxation and FTB scrutiny
• Improperly funded revocable trusts—subject to forced probate and IRS challenges

If you’re a high-net-worth individual with $10M+ in CA real estate, business equity, or taxable investment accounts, your entity game plan is the difference between legacy security and an avoidable $8M to $14M tax hit.

Why Most Advisors Get California Estate Tax Planning Wrong

The prevailing myth is that no state estate tax means you can “set it and forget it.” But high-net-worth families hitting retirement at 50 or inheriting multi-generational property discover:

• Federal exemption is not permanent: The 2026 cliff could cost families $5M+ in sudden taxable estate value
• California FTB audits complex trusts and cross-entity gifts for underreported income
• Poorly structured LLCs often bypass probate but fail IRS tax efficiency review

The solution isn’t boilerplate trusts—it’s custom legal architecture built around asset class, family goals, and expert estate tax planning services uniquely familiar with California nuances.

Strategic Structures: How Legal Entities Change the Game

Taxpayers worth $20M+ often miss the most effective structures—ones that go beyond simple trusts:

1. Intentionally Defective Grantor Trusts (IDGTs)

• Allow you to freeze asset value for estate tax but still pay income tax (lowering estate exposure)
• When used for appreciated real estate, can exclude $1.2M to $12M from future valuation growth
• IRS backs this in Revenue Ruling 2004-64

Example: A Newport Beach tech founder set up an IDGT and transferred $8M in pre-IPO shares. The funding (valued at $8M) was locked in—when the company exited for $30M, all gains after setup escaped estate tax. The family saved approximately $8.8M in taxes versus a standard living trust.

2. Family Limited Partnerships (FLPs)

• Centralize control—general partners (often parents) retain management while children/beneficiaries hold limited interest
• Enable aggressive valuation discounts (up to 35%) recognized by IRS when gifting shares intergenerationally (see IRS FLP guidance)
• Shield substantial real estate, private business, and investment holdings from both estate and creditor risk

Example: Silicon Valley couple with $24M in rental property formed an FLP, donated LP shares to heirs, and achieved $6.2M in valuation discounts and $2.1M in estate tax reduction before exemption phases out.

3. Multiple LLCs (Asset Isolation)

• Segment properties, operating companies, or high-liability assets so lawsuits or tax liens impact only one “silo”
• Prevents IRS from “aggregating” all assets for valuation, preserving discount opportunities
• Streamlines CA FTB compliance—each LLC files its own Form 568, easier audit defense

Example: A Los Angeles real estate investor used six separate LLCs for $18M in holdings—eliminated estate inclusion on 2 out of 6 assets via discounted transfer. Net savings: $1.3M compared to single-entity approach.

Not Just About Tax: Audit, Probate, and Liquidity Traps

Tax numbers only scratch the surface. Entity structure determines how easily your trustees or heirs pay immediate tax bills, fund charitable bequests, and defend returns under IRS/FTB scrutiny.

• Unused LLCs or outdated S Corp elections can block liquidity—forcing fire sales
• Poorly executed partnerships or trusts invite lawsuits, IRS challenges, or freeze family-held assets in probate for 1-2+ years
• Improperly titled assets undermine portability—risking loss of marital exemption

This is where experienced legal and tax pros earn their fee—anticipating and engineering around hidden traps that standard CPAs miss.

What the IRS Won’t Tell You About Legal Structure for Estates

Most families fail to realize that entity design determines what gets reported on their final federal estate tax return (IRS Form 706). The IRS expects:

• Full “look-through” valuation of assets (all real estate, business, alternative investments)—unless blocked by formal partitioning or valuation adjustments
• Proof of bona fide business purpose (for FLPs and LLCs)—not just tax avoidance
• Appraisal documentation and proper gift tax filing (IRS Form 709) for every gift over $18,000 (2025 annual exclusion)

Failure to structure with this in mind leads to reclassification, loss of discounts, and, in recent audits, up to 60% higher tax bills for those caught attempting shortcuts.

KDA Case Study: High-Net-Worth Entrepreneur Shields Estate with Proactive Entity Reorganization

Consider “Ava,” a 57-year-old biotech executive with $31M clinical trial company, $9.5M in residential and commercial CA real estate, and an existing outdated revocable trust. Previously advised by a local attorney and wealth manager, she assumed her estate would be safe from federal taxes given her careful planning.

When the KDA team reviewed her structure in 2024, major risks became clear: entity overlap, corporate assets left in personal name, and no valuation discounts applied. We implemented:

• Restructured her operating company into an S Corp owned by a new irrevocable trust
• Moved her rental properties into three LLCs, managed by a Family Limited Partnership for layered discounts
• Set up an IDGT for early-stage intellectual property

Results:

• Reduced taxable estate value by $8.6M through discounts
• Cut projected IRS liability from $7.2M to $3.1M—a 2.3x reduction
• Legal and professional cost: $24,000 (0.07% of total estate value)
• ROI: Over $4M in net tax savings for her heirs—plus zero audit findings in post-mortem IRS review

For a Deeper Dive: California-Specific Estate Planning Pitfalls

The devil is in the details. For more advanced entity structures and chronological updates, see our California Guide to Estate & Legacy Tax Planning.

And for those needing immediate support as 2026 exemption sunset looms, explore our bespoke estate planning services tailored to California HNW clients.

Will These Structures Trigger an Audit?

Entity structures, when done correctly, reduce rather than increase audit risk. According to IRS audit guidance, red flags include abnormally high valuation discounts, lack of legitimate business activity, and “check-the-box” entities that only exist on paper. Engage an independent appraiser for all major asset contributions and keep original organizational documents on hand. Pro tip: Breathe easier—well-documented FLPs and LLCs pass audit scrutiny at far higher rates than late-night trust-mill shortcuts.

Pro Tip: Use Early Action for 2026 Exemption Cliff

Do not wait until late 2025. Transfers, valuations, and gifting strategies work best with a 12-month lead time. Strategic gifts made at today’s exemption rate are protected even after federal law changes.

What’s the Simplest Way to Start?

Inventory every asset you own—individually, jointly, or in business entities. Engage both CPA and estate attorney well before high-value asset sale, major business changes, or family transitions. Begin with a fomalized, written entity and gifting plan, adjusted annually. Document all strategies in plain English summaries the IRS (and your heirs) can understand. See KDA’s entity structuring process here.

Why Most HNW Californians Leave Money On the Table

Red Flag Alert: A 2023 IRS study found over 60% of estates valued at $15M+ missed $2M or more in available discounts, exemptions, or legitimate restructuring moves. Most families simply relied on outdated estate plans, trusted one-size-fits-all trust documents, or adopted “waiting for Congress to act” as their default strategy. By taking action now—specifically in organising legal entities that match current and future law—families can reduce transfer taxes and unneeded probate costs by 30-65%.

FAQ: California Estate Tax and Entity Structuring in 2025

Q: Does California have an estate tax for 2025?

A: No, but federal estate tax applies. Planning for the federal cap is critical—state-level strategies impact compliance and audit outcomes.

Q: Is a Living Trust enough to protect my assets?

A: Living trusts avoid probate but don’t protect against federal estate tax or maximize valuation discounts. Use LLCs, FLPs, and advanced trusts for true tax mitigation.

Q: Will these strategies hold up in IRS/FTB audit?

A: Yes, if entity documents are current, appraisals are independent, and the legal structure is supported by legitimate business purposes. See IRS Publication 535 for business rationale requirements.

Social Media Mic Drop

The IRS isn’t hiding estate tax discounts—most advisors just lack the strategy to find them. Will your family’s structure stand up to 2026 changes?

Top 3 Takeaways for Wealthy Californians

• Act now: Early entity restructuring maximizes today’s record-high exemption, locking in tax-free gifts before potential 2026 federal reduction.
• Go bespoke: One-size-fits-all trusts miss seven-figure discount opportunities—only custom structures anticipate IRS/FTB compliance nuances.
• Document everything: The right appraisal, rationale, and annual review transforms your legacy from “audit trap” to “tax advantage.”

This information is current as of 7/31/2025. Tax laws change frequently. Verify updates with IRS or FTB if reading this later.

Book Your Estate Tax Strategy Session

If your estate plan hasn’t been reviewed in the last 12 months, or you don’t have a proactive entity structure aligned with coming law changes, it’s time to act before millions are lost to unnecessary tax. Secure your personalized estate tax strategy session and keep your legacy protected. Click here to book your consultation now.