If you live in one of the states that charges inheritance tax, your stock becomes taxable before it gets out of probate. Otherwise there's no taxable income when you inherit. The tax bill comes later. If your stock earns dividends or if you sell it for a profit, the IRS will expect a share.
Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania impose an inheritance tax. If you live in one of these states when you inherit, or the deceased did, the value of anything you inherit is taxable. The more closely you're related to the deceased, the lower your tax rate. Spouses are exempt in all states, for instance and children pay nothing or a reduced rate. Close friends with no blood ties, on the other hand, pay the full tax.
If you inherited a good stock portfolio, you may start receiving dividends from your shares. Dividend income is taxable, usually at your regular tax rate. You pay a lower rate if you hold stock in a company that issues qualified dividends, rather than ordinary dividends. The corporation will send you a 1099-DIV at the end of the year reporting dividend payments greater than $10. Even if you only received $9, though, you still pay tax on it.
When you sell inherited stock, you pay capital gains tax on your profits. With stock you've bought yourself, your profit, or gain, is roughly equal to your purchase price less your sale price. For your inheritance, you can usually use the value of the stock on the day the owner died. You may be able to get that information from the executor, who has to record the value of the deceased's assets when wrapping up the estate.
Reporting Capital Gains
Capital gains tax has two rates, depending whether you buy and sell quickly or hold for the long term. Happily, the rate for inherited stocks is always the lower long-term rate, no matter when you sell it. If you sell right after inheriting, the gain may be so slight you'll pay hardly anything. You figure your tax on Schedule D. If you take a loss when you sell, you can claim a write-off on your return.