People can name virtually anyone as beneficiaries when they make wills and other estate arrangements. Beneficiaries can be non-family members, organizations – even beloved pets. You may find yourself the recipient of money or property left to you by an old friend or other non-family member. The money you inherit isn’t included when you file your tax return, whether it's from a family member or not. However, there are still tax issues you have to consider.
Inherited Money Isn't Income
The Internal Revenue Service doesn’t count inherited money as income, so you don’t pay federal income tax on it. It doesn’t matter who left you the money. The deceased can be a non-family member as well as a spouse or relative. This rule applies to any assets, not just money. The cash value of real estate, stocks, jewelry or any other asset you inherit from a non-family member also is not income for tax purposes.
What an Inheritance Is Worth
According to TurboTax.com, the value of an inheritance is the fair market value on the date of death. For instance, if the money is in the form of 100 shares of stock selling at $50 per share on the day the non-family member passed away, the total inheritance is valued at $5,000. If you later sell the asset for more than the inheritance value, the difference is a taxable capital gain. Suppose that stock goes up to $60 per share and you sell it. You’ll have a $1,000 capital gain. This capital gain is income and must be reported on your tax return. Gains on inherited property are always counted as long-term by the IRS, so the maximum tax rate is 20 percent as of 2014.
The IRS Gets First Crack
When someone leaves a big enough estate, the IRS imposes an estate tax. This only happens when the total value of the estate tops $5.34 million as of 2014. The heirs of the estate don’t pay the estate tax, however. The executor of the estate takes care of sending the IRS the estate tax. Part of the process of probating a will is figuring out how much estate tax is due, so you and other heirs won’t get any money until the estate tax is taken care of. The executor divides up what’s left among the heirs according to the terms of the will. Some states also levy estate taxes. State estate taxes are also the responsibility of the estate, not the heirs.
And One More Tax
There’s one more kind of tax related to inherited money and that’s the inheritance tax. The federal government doesn’t have an inheritance tax, but some states do. With an inheritance tax, beneficiaries might have to pay when a non-family or family member leaves you money. Sometimes a will directs the estate to pay inheritance taxes. If not, and you live in a state with an inheritance tax, you’ll have to pay it. According to TurboTax, as of 2013, eight states imposed an inheritance tax: Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee. Many beneficiaries in these states are exempt from paying the inheritance tax, though these are typically family members. TurboTax reports that higher rates of tax will usually be paid by those who inherit property from a non-family member.
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