You’ve just learned you’re inheriting money or property, but you’re worried that you’ll owe a portion of this windfall to the government. Even though inheritance tax exists, it’s not what you think it is. Here’s what you need to know about whether inheritance is taxable.
The Federal Government Doesn’t Tax Inherited Money
It should come as a relief that the federal government doesn’t impose an inheritance tax. So if your uncle leaves you $50,000, you don’t owe federal income tax on that $50,000.
What the federal government does have is an estate tax, and this is where people get confused. The estate tax is paid by the estate itself before any distributions go out to you. Your executor handles it. If the estate owes tax, it’s already been paid by the time the money reaches you.
Estate Tax vs. Inheritance Tax: Know the Difference
These two terms get used interchangeably, but they’re not the same thing. The estate tax is paid by the deceased person’s estate based on its total value. The inheritance tax, on the other hand, is paid by you, the person receiving the assets.
The federal estate tax kicks in only when an estate exceeds a very high exemption threshold, which is currently over $13 million per person. Most estates don’t come close to that number, which means most people inheriting money aren’t affected by the estate tax.
Some States Do Have an Inheritance Tax
The federal government won’t tax your inheritance, but your state might. A small number of states levy their own inheritance tax directly on the beneficiary. As of now, those states are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. If you live in one of these states (or the deceased person lived there), you may owe state-level inheritance tax depending on your relationship to that person.
Most of these states exempt spouses and children entirely. The tax tends to apply to more distant relatives or unrelated beneficiaries. Rates and thresholds vary by state, so check the specific rules for whichever state is involved.
Income Tax on Inherited Assets Is a Different Story
If you earn capital gains, you owe taxes on those gains, regardless of how you acquired the asset. After all, inheriting an asset and receiving income from that asset are two different things. You don’t pay tax when you inherit a stock portfolio, but if you sell those stocks later, you may owe capital gains tax on any appreciation that happened after you inherited them.
Importantly, the “stepped-up basis” rule exists. This means that when you inherit assets, your cost basis is reset to the fair market value at the time of the original owner’s death, not what they originally paid. That protects you from owing taxes on gains that built up during their lifetime. You’re only responsible for gains that occur after you take ownership.
Get Your Estate Planning Right From the Start
So is inheritance taxable? The main thing to know is that it depends on how much you’re inheriting and what state you live in. But the vast majority of Americans don’t pay taxes on their inheritances, only on the gains they receive from inherited assets. Now, you can turn your attention to things like how you will receive the money, such as in a will or a trust, and how that affects what you receive. This will help you plan a tax-smart financial plan before your bank account receives that inheritance boost.
Image Credentials: photo by KL 1981, license #1237475806
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