Do You Owe Taxes on Your Inheritance? What Beneficiaries Need to Know

Nobody likes paying taxes. When an individual passes away and their personal property passes to others, they may be forced to pay an inheritance tax. People often call this the death tax, which applies to property over a specified amount. What should a person know about this tax if they receive an inheritance from a loved one who has passed?

The Inheritance Tax

When a person dies, the government may assess a tax on anything they owned or had an interest in when they died. This tax covers transferring assets or property to beneficiaries named in an individual's estate plan. The federal inheritance tax is assessed on estates worth more than $12,920,000 if the owner died in 2023. The tax is separate from the income tax the estate must file on behalf of this individual. A person must understand that all taxes must be adequately paid to receive your rightful inheritance. Doing so will help prevent future issues associated with receiving this inheritance. 

Beneficiaries must report their inheritance on their income tax return. They use schedule K-1 to report these funds. When doing so, they must report any property they received and value it at the fair market value on the date the individual died. Men and women must take this step regardless of whether the federal estate tax will be assessed. Property includes any bonuses they received, installment obligations, crops and livestock, and more.

Bequest Taxes

A person might find they are not assessed an immediate tax liability, but a legacy that produces income must be reported on income tax returns. When reporting this income, the person must also consider property provided to a trust or held in the estate. The income must be reported if paid, credited, or distributed to a beneficiary.

In Respect of a Decedent

People often wonder what to do with income received after an individual passes. The IRS considers this income the same as it would if the individual had received it before their death. The person responsible for filing their income tax should similarly list it on the tax forms. 

Sale of Inherited Property

A person might inherit property and decide not to keep it. When they sell the property, they must determine if it produces a gain. If so, they must report the gain as income on their federal income tax return. To determine if the property made a gain, the individual must know its fair market value on the date the individual passed or the fair market value on a different date if the executive uses an alternate valuation. 

Property Received Via a Trust

A person might put property into a trust rather than gifting it to an heir outright. The heir will use this property for a fixed term or until they pass. The property is then transferred to another individual. However, many beneficiaries need clarification on what to pay taxes on and when. Working with a qualified tax advisor is beneficial when making this determination. 

Heirs must understand they may also owe a state inheritance or estate tax. States that impose an estate tax include Connecticut, Massachusetts, and Oregon. Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania all have inheritance taxes. As tax laws are complex and change frequently, any person who receives an inheritance should work with a tax professional to ensure the funds are reported accurately for tax persons. Any mistakes could lead to significant penalties.