MYTH :
You Don’t Have to Pay Taxes on Inheritance
REALITY :
Inherited money or property is generally not taxable, but certain types of inherited income, like distributions from inherited retirement accounts, may be taxable.
HOW WE KNOW :
IRS guidelines outline the tax treatment of inherited assets.
KEY TAKEAWAYS :
Inheritance vs. Estate Tax: Beneficiaries generally don’t pay taxes on inherited assets, but the estate itself may be subject to estate taxes.
State Taxes: Some states impose inheritance taxes, which are paid by the beneficiary.
Stay Informed: Understanding the difference between federal and state tax obligations on inherited assets is crucial for accurate tax filings.
One pervasive tax myth is the belief that you don’t have to pay taxes on inheritance. This misconception can lead to serious compliance issues with state tax authorities. Here's what you need to know to stay compliant and avoid these pitfalls.
Origin of the Myth
Confusion Between Taxes: Many people confuse federal estate taxes, which are paid by the estate, with inheritance taxes, which may be imposed by some states on the beneficiaries.
Lack of Awareness: There is often a lack of understanding about the varying tax obligations associated with inheritance.
Reality of Inheritance Tax Obligations
Federal Estate Tax: At the federal level, estate taxes are paid by the estate before the assets are distributed to beneficiaries. Beneficiaries do not pay federal taxes on the inheritance they receive.
State Inheritance Tax: Some states impose inheritance taxes, which are paid by the beneficiaries. The tax rate and exemptions vary by state.
IRS Guidelines on Inheritance
No Federal Inheritance Tax: The IRS does not impose a federal inheritance tax on beneficiaries.
State Inheritance Tax: States like Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania impose inheritance taxes. The rates and exemptions vary by state.
Why the Myth Persists
General Misconceptions: Many taxpayers believe that all inheritance is tax-free without considering state laws.
Anecdotal Advice: Misleading information and anecdotal advice from non-professional sources perpetuate the myth.
Avoiding the Pitfall
Know Your State Laws: Clearly understand the inheritance tax laws in your state.
No Federal Inheritance Tax: You do not pay federal taxes on inheritance, but the estate may have paid federal estate taxes.
State Inheritance Tax: Be aware of state-specific inheritance taxes and their implications.
What You Need to Do
Check State Laws: Research your state’s inheritance tax laws to determine if you owe any taxes on inherited assets.
Report Income: If inherited assets generate income (e.g., rental income from inherited property), that income must be reported on your tax return.
Consulting a Tax Professional
Seek Professional Advice: Given the complexities of state tax laws, consulting a tax professional can ensure that you are meeting all inheritance tax obligations.
Accurate Records: A professional can help you maintain proper documentation and understand the tax implications of inherited assets.
