Do you have to Pay Taxes on Inheritance?

There are several factors that determine if an inheritance is taxable or not, depending on the assets you receive, where you live, and how the assets earn income after your inheritance  and for most Americans, the answer is less worrisome than they might think. Is an inheritance taxable? There are a number of factors to consider: federal rules, state laws, and the type of asset that is received, and to determine whether beneficiaries have to pay taxes on inheritance. This blog clearly spells it out for you so you know what you’re doing.

Are There any Taxes to Pay when you Inherit?

An inheritance is not a source of taxable income for the majority of beneficiaries. Is there a federal tax on inheritance? No, typically money or property that you receive as an inheritance isn’t income you report on your own tax return. Any income earned from inherited assets after you receive them, however, is considered ordinary income and is taxable. This income includes rental income, dividends, interests, etc. The most important thing to know as a beneficiary is the difference between an inheritance and income.

Federal and State Inheritance Tax Rules.

• Is there a federal tax for the beneficiaries of a will? Not at all  the federal government doesn’t tax assets that are passed on to the beneficiaries of the estate when the individual dies.
• The amount of inheritance that is taxable is dependent on how the asset performs after the inheritance; an inherited savings account will receive taxable interest on its funds, while the initial lump sum will not be considered taxable income.
• The laws on inheritance taxes also differ from state to state; some states have their own inheritance tax for beneficiaries, so where you live is important in determining how much inheritance is taxable.

What’s the difference between an Inheritance Tax and an Estate Tax?

These are two different taxes that are often confused, and both are levied on different parties. Getting the difference is key for anyone who’s dealing with what to do with inheritance cash to prevent taxes and property the right way after inheriting assets from an estate.

Property tax and sales tax.

• An estate tax is paid by the estate of the deceased before assets are distributed from the estate, based on the total value of the estate and paid from the estate assets – not by the individual beneficiaries receiving their share.
• An inheritance tax is a tax that is levied on the recipient of the inheritance, not on the estate itself; it can be determined by individual states, and rates and exemptions differ across states and in relation to the relationship between the bequeathed assets and the recipient.

What are types of Inherited assets that can have Tax Implications?

Not every type of inheritance is taxable  and understanding which are is crucial for beneficiaries in helping to plan how to use inheritance funds without incurring taxes wherever they can.

CASH, REAL ESTATE, INVESTMENTS and RETIREMENT ACCOUNTS

• Generally, inherited cash is not considered taxable income received, but interest earned in a bank account after the transfer date will be taxable income and must be reported on your annual return.
• Inherited real estate is not taxable upon receipt, but rather it has a stepped-up cost basis – in other words, when the property is sold, any appreciation of the property over the fair market value on the date of death is taxable as capital gains.
• The stepped-up basis rules are applied to inherited investment assets, just like real estate, so that when beneficiaries sell stocks, mutual funds or brokerage accounts that they inherit, the amount of gain realized is significantly reduced.
• One of the most tax significant assets a beneficiary will receive from an estate is an inherited retirement account, such as a traditional IRA or a 401(k), which will be taxable as ordinary income.

Do any States have an Inheritance tax?

Yes  but if the deceased lived in this country in which do beneficiaries have to pay taxes on inheritance become a very real question. Although neither the federal government nor most states have an inheritance tax, some do and it is important that the beneficiaries of inheritance in those taxing states understand the ramifications of their relationship with the deceased on how they will be taxed.

The Impact of state laws on beneficiaries.

As of this writing, only a few states have inheritance taxes, such as Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. All states have their own exemption amount, tax rate and rules for the beneficiaries based on their relationship to the individual who has died. In most states that have the tax, a spouse is usually exempt, and any other close relative or other beneficiaries may be subject to a higher rate and lower exemption, depending on the state’s specific tax laws.

It’s important to note that you will need to check the state laws of the state where the estate owner lived, not where the beneficiary lives, when you know it’s an inheritance that will be subject to state taxes. Professional tax guidance can make a significant and measurable difference in this one area. H&M Tax Group offers Dallas income tax filing services, QuickBooks assistance and bookkeeping services to educate clients about the tax requirements of inheritance and ensure they report inherited income properly, while also advising them on what to do with inheritance money to avoid taxes, while staying within the guidelines of current tax law. Before you make any financial decisions with inherited assets, get professional advice. What you do in the months after an inheritance could impact your tax situation for years.

Conclusion

While most people think of inheritance taxes, they are not as prevalent as they may think, and the amount of income earned from your inheritance, what kind of asset you receive, and your state of residence all determine your actual tax situation. For most Americans, does the government impose inheritance taxes? No, but there are still details to attend to. H&M Tax Group is a Dallas CPA team that ensures beneficiaries understand their obligations clearly, are able to file accurately, and can keep more of what they rightfully inherited.