Inheritances are not considered income for federal tax purposes, whether you inherit cash, investments, or property. However, any subsequent gain from inherited assets is taxable, unless it comes from a tax-free source. In short, yes, your inheritance is taxable. However, the whole story is more complicated than a simple yes or no answer.
Whether you will pay inheritance tax and how much you will pay depends on a variety of factors, including the state in which the deceased lived and what your relationship was to the deceased. You could not pay anything or you could pay up to 18% of the value of the estate. Read on for a full introduction to inheritance-related taxes. Because an estate is not considered taxable income, you don't need to report it on your tax return.
Twelve states and the District of Columbia impose their own wealth taxes, with the highest rate in Washington State ranging from 10% to 20%. Income tax is due to the state in which the beneficiary lives, not the state where the deceased lived. For example, if you inherit a house and rent it to tenants, you must pay income taxes on the rent payments you receive. Those considering legacies that could be subject to an inheritance tax could consider estate planning strategies, including donations, insurance policies, and irrevocable trusts.
Inheritance tax only applies if the deceased lived in one of the six states that collect inheritance tax. If the estate reported a decedent's income on your tax return, you don't need to report it as income on your income tax return. With inheritance tax, the tax is collected after the inheritance is divided and distributed to the beneficiaries. The main difference between an inheritance tax and an inheritance tax is that the former comes directly from the deceased person's estate before that asset is distributed to its beneficiaries.
The most common “death taxes” Americans might see are inheritance and estate taxes, although the two are different. Similarly, if you inherit a bank account, you don't pay taxes on the funds in the account, but if they start earning interest, interest payments are your taxable income. Money contributed to traditional IRAs and 401 (k) plans is generally not taxed prior to your income. Whether a beneficiary has to pay taxes on the income of a life insurance policy depends on whether the income is paid in a lump sum or in installments with interest.
Unlike inheritance tax, which is collected from the decedent's assets before they are handed over to beneficiaries, inheritance tax is applied after distribution. An estate tax is a tax on the value of the deceased's property; it is paid by the estate and not by the heirs, although it could reduce the value of their inheritance. You may hear that the terms are used interchangeably, but inheritance tax and inheritance tax are two separate taxes.