Will I Have To Pay Taxes On My Inheritance?

“Will I have to pay taxes on my inheritance?” This is a question we hear all the time. With that in mind, we have written this article to help educate you on basic tax issues and inheritance.

Inheritance tax, death tax and the estate tax are all terms used to mean the same thing, the tax due on the transfer of assets to an heir or beneficiary after the death of the owner.

The Estate Tax: The estate tax is a transfer tax that is paid by the estate based on the total value of the assets in the estate.  There are two types of estate taxes, Federal and State.

Federal Estate Tax:  The federal estate tax is only charged when an estate (as of 2019 law) is over $11,400,000.  This is called the federal estate tax exemption, any estate under this amount does not pay any federal estate taxes.  

Estate Taxes By States: Most states have a coupled tax rate with the federal estate tax, that is the exemption is the same ($11,400,000).  However some states have uncoupled estate tax exemptions: ME, VT, CT, MA, RI, NY, NJ, MD, TN, IL, MN, OR, WA and HI.  Each have their own exemption amount and tax rate, ranging from the most taxed (NJ) with an exemption of only $675,000 to the $5,430,000 (HI).

Inheritance Tax: The inheritance tax is tax charged to the recipient of the estate.  This tax is only charged by 6 states: PA, NJ, MD, KY, IA and NE. Inheritance tax is often on every dollar inherited and only the surviving spouse and minor children are exempt.

Death Tax: The death tax is just a popular term used to described to any number of taxes one might encounter as the recipient of an inheritance.  Besides the Estate and Inheritance taxes other taxes you may pay are the following:

Capital Gain Tax:  The capital gain tax is the tax you pay on the gain of an asset.  When you inherit property you will receive a step up in basis in all assets to the date of death valuation.  So if you sell an inherited asset only the change from the date of death value to the sale value will be taxed.  ex:

If your mom passed away leaving you the family home, you can ignore what your mom had originally paid for the home. Instead, from a tax perspective, what matters now is the fair market value of the home at the date of her death. Let’s go through an example.

If mom paid $100,000 for the home 40 years ago, but the home is worth $400,000 the day she died, and you sell the home three months after she died for $400,000, you would pay no taxes on the sale of the home. If the home sold for $410,000, there would be a capital gain tax on the $10,000 difference (i.e. $410,000 sales price - $400,000 date of death value). This would also be true if the asset was a portfolio of stock, farm land, or a collectible car, rather than a home.

Retirement accounts: 401ks and traditional IRAs are different from all other assets as they are taxed as ordinary income when withdrawn. For example, if mom died and left you a 401k, that asset is taxable, but only on the money you withdraw from the account. Thus, if mom left you a $400,000 retirement account, and you withdraw $10,000 from it, the $10,000 withdrawal will be taxed as ordinary income (not the preferred capital gains tax treatment the family home gets). One wrinkle to note here is a Roth IRA is funded with after-tax dollars, so withdrawals from Roth IRAs are not taxed, unlike a traditional IRA or 401k.

Life insurance: Proceeds from life insurance are not subject to income tax, however may count toward the taxable estate for estate/inheritance tax purposes.