If you get an inheritance, it should be tax free for you. Typically, inheritance tax is paid by the estate before it makes the distributions, though this rule has some exceptions. Just because you inherit tax free doesn't mean you won't have to pay taxes on the money once you inherit it and it becomes yours.
Inheritance Tax Exclusions
Most inheritances pass without being taxed. The Internal Revenue Service gives everyone a lifetime gift and estate tax exclusion of $5.34 million as of the time of publication. This means that if your Uncle Morty dies and his estate is worth $4.7 million, estate taxes would not be due on it. Furthermore, married couples get to double this exclusion. This means that if Uncle Morty dies and leaves all his money to his wife -- Aunt Mildred -- and she earns another $5 million to have a total estate worth $9.7 million, it would pass tax free to her heirs. The Center on Budget and Policy Priorities estimated that only 0.14 percent of estates actually paid estate tax in 2013, when the exclusion was $5.25 million.
Paying Inheritance Taxes
When someone dies, his estate takes over the management of his assets. The estate is responsible for filing the final tax return, filing the estate tax return and paying the estate taxes. When the estate has an administrator or executor, she would take care of those responsibilities. If no one is designated, the final paperwork is handled by someone who is inheriting assets. That person, whoever it is, pays any taxes from the estate's resources.
When Taxes Aren't Paid
Just because the estate is supposed to pay any inheritance taxes doesn't mean it always fulfills its responsibilities. If money is distributed to heirs without the taxes being paid, the IRS could come after these beneficiaries to get the taxes due. Even if an estate pays its taxes, heirs could end up liable if the IRS audits the estate and decides that the estate underpaid and actually owes more.
Inheritances and Other Taxes
Even if you inherit money tax free, you might owe taxes on it if it changes after the inheritance. For instance, if you inherit 100 shares of stock in ABC Company valued at $45 and you sell them for $4,500, you won't pay any taxes. If they climb in value to $60 per share and you sell them for $6,000, your $1,500 profit would be a taxable capital gain, as only the original value was covered by the estate tax or the exclusion.
- IRS: In 2014, Various Tax Benefits Increase Due to Inflation Adjustments
- MarketWatch: Estate Tax Tips for Married Couples
- Center on Budget and Policy Priorities: Myths and Realities About the Estate Tax
- Intuit TurboTax: Death in the Family
- Forbes: When Estates Don't Pay Tax, IRS Chases Beneficiaries
- IRS: Topics 409 -- Capital Gains and Losses
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.