Some choices include creating an emergency fund, paying off high-cost debt, building up retirement savings, saving for kids' educations and buying personal luxuries. While you won't owe taxes on an inheritance, earnings from the funds are subject to income taxes.
The Basic Rule: Inheritances Aren't Taxed as Income
It doesn't matter how the property passes to the inheritor. Whether the property passes under the terms of a will or trust, or the inheritor was a designated beneficiary (for example, a payable-on-death bank account), it's not taxable income.
If you inherit a large amount of money, take your time in deciding what to do with it. A federally insured bank or credit union account can be a good, safe place to park the money while you make your decisions. Paying off high-interest debts such as credit card debt is one good use for an inheritance.
Large inheritances vary considerably, but it's safe to say that anything over $100,000 falls into this category. Whether you inherit a hundred thousand dollars or upwards of a million, a large inheritance can feel intimidating, especially if you don't already have substantial wealth built up.
For the inheritance process to begin, a will must be submitted to probate. The probate court reviews the will, authorizes an executor and legally transfers assets to beneficiaries as outlined. Before the transfer, the executor will settle any of the deceased's remaining debts.
Inheritances are not considered income for federal tax purposes, whether you inherit cash, investments or property. However, any subsequent earnings on the inherited assets are taxable, unless it comes from a tax-free source.
This is done by the person dealing with the estate (called the 'executor', if there's a will). Your beneficiaries (the people who inherit your estate) do not normally pay tax on things they inherit. They may have related taxes to pay, for example if they get rental income from a house left to them in a will.
Economically there is no difference between the two. And as a practical matter, even inheritance taxes are generally paid by the executor of the estate before assets are distributed to beneficiaries.
There is no federal inheritance tax—that is, a tax on the sum of assets an individual receives from a deceased person. However, a federal estate tax applies to estates larger than $11.7 million for 2021 and $12.06 million for 2022. The tax is assessed only on the portion of an estate that exceeds those amounts.
Expectations for an inheritance's size have to be realistic. The Federal Reserve's 2019 Survey of Consumer Finances (SCF) found that the average inheritance in the U.S. is $110,050.
In 2022, an individual can leave $12.06 million to heirs and pay no federal estate or gift tax, while a married couple can shield $24.12 million. For a couple who already maxed out lifetime gifts, the new higher exemption means that there's room for them to give away another $720,000 in 2022.
An Inheritance Can Impact SSI Benefits
If you are the beneficiary of an inheritance, you are required by federal law to report it to the Social Security Administration, even if you choose not to accept the inheritance.
If you die within 7 years of giving a gift and there's Inheritance Tax to pay, the amount of tax due depends on when you gave it. Gifts given in the 3 years before your death are taxed at 40%. Gifts given 3 to 7 years before your death are taxed on a sliding scale known as 'taper relief'.
This means that when the beneficiary withdraws those monies from the accounts, the beneficiary will receive a 1099 from the company administering the plan and must report that income on their income tax return (and must pay income taxes on the sum).
Under current law, the parent has a lifetime limit of gifts equal to $11,700,000. The federal estate tax laws provide that a person can give up to that amount during their lifetime or die with an estate worth up to $11,700,000 and not pay any estate taxes.
In 2021, you can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it. In 2022, this increases to $16,000. If you give more than $15,000 in cash or assets (for example, stocks, land, a new car) in a year to any one person, you need to file a gift tax return.
A: The short answer is NO: you almost certainly will NOT have to pay any gift taxes. Remember, under current law, you can make $11.58 million dollars' worth of gifts in your lifetime without incurring any gift tax liability.
These documents can include the will, death certificate, transfer of ownership forms and letters from the estate executor or probate court. Contact your bank or financial institution and request copies of deposited inheritance check or authorization of the direct deposit.
States With No Income Tax Or Estate Tax
The states with this powerful tax combination of no state estate tax and no income tax are: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. Washington doesn't have an inheritance tax or state income tax, but it does have an estate tax.
For 2018, 2019, 2020 and 2021, the annual exclusion is $15,000. For 2022, the annual exclusion is $16,000.
We find that inheritance size is highly correlated with income, particularly at the top end of the income distribution; the bulk of inheritances are received between the ages of 46 and 75; and that most inheritances come from parents.