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Tax Strategies & Credits

Understanding How Inheritances Work

by
Tom Gargiulo, E.A.
on
4/13/2015
Understanding How Inheritances Work

Coming into an inheritance is not as simple as having somebody hand you a check or the title to a piece of property. There are complex rules and tax liabilities that may be associated with the process, so if you have recently received an inheritance or are anticipating receiving one, it is a good idea to learn all of the tax ramifications so that you know what to expect.

The first thing that you need to know is that you generally will not come into possession of an inheritance until all of the taxes on the estate have been paid. This may include estate returns, estate or trust income tax returns, back taxes that the decedent may have owed, and the filing of the decedent's final tax return. You also will likely not receive your inheritance until all outstanding liabilities have bee paid. Much of the determination of how the distribution of inheritance is handled will depend upon how the decedent held their assets, specifically whether they held them individually or in trust.

The rules of estates, trusts and probate are complicated and as a beneficiary of an estate it is not necessary for you to understand them completely. What is important to know is that if you inherit something on which taxes have already been paid and on which any appropriate estate taxes have been paid, then you have no tax liability on them. Inheriting something on which taxes have not been paid, as well as any profit or loss on those assets, will be taxable to the beneficiary.

Here are some examples:

- If you inherit a bank account, it is likely that it will not pass into your possession until the estate is fully resolved. Once it passes into your possession, any interest that has accrued on it is taxable as interest income.

- If you inherit a capital asset such as a piece of land, a collectible, or stock, it is important to get a qualified appraisal on it for the time of the decedent's death. This is because as beneficiary, any gain or loss that results from its sale belongs to you, and is based upon the value at the time of death. To understand exactly how this works, let's assume that you have inherited an antique car with an appraised value of $50,000 at the time of the decedent's death. Selling the vehicle for that amount means that as beneficiary, you are entitled to the $50,000 with no tax liability. However, selling it for more or less than the $50,000 would result in a tax liability for any surplus or a loss for any amount under. These would be classified as capital gains or losses, and the amount of time that the property had been held since its initial purchase is key to the amount of tax owed. Assets that are held for more than one year pay lower taxes; property that is inherited is automatically qualified as having been owned for more than one year. In calculating profit and loss in the sale of an asset, any costs associated with the sale are deducted against the gain or loss. It is also important to note that if the beneficiary chooses not to sell the asset and instead holds onto it and passes it on to his heirs, the process begins again and the property is valued at its appraised value at the time of his death.

- Qualified retirement plans such as IRAs can be inherited, and the distributions to the heir are taxable in the same way that they would have been to the decedent. As IRAs are funded by non-taxed dollars, there is still a tax liability, but the government has established methods of disbursing the income in installments that minimize the tax burden for the beneficiary.

- When you are the named beneficiary of a life insurance policy, the monies that you receive are generally not taxable, though any interest that accrues between the time of the decedent's death and the time that the proceeds are distributed is subject to tax.

- If you are the beneficiary of an annuity or an installment sale note on a property that the decedent had previously sold, then it is important to know what the basis was on the annuity. On an annuity, a basis is the amount that the decedent originally paid, while on an installment note the basis is the portion of the payment that represented the asset's cost. The other part of the payments are the portion from the asset's prior sale, which is taxable as a capital gain, and any interest on the note, which is also taxable. As heir, you will be liable for taxes on the difference between the basis and the amount you receive.

When a person dies, the process of settling the estate or trust requires that the trustee files an income tax return and reports all income earned before distribution to any beneficiaries. Each person who will receive an inheritance will be sent a Schedule K-1 (1041) form that details what they will be receiving. This inheritance must be listed on each individual's tax return, though in some cases the estate will pay the tax on behalf of the beneficiary. It is the duty of the estate's trustee or executor to ensure that all of these forms are distributed and that appropriate tax returns are filed.

Taxes pertaining to inheritance can be extremely complex and confusing, and we have not addressed all possible issues here. There are even some instances in which a beneficiary may be required to pay taxes on an inheritance that has not yet been distributed to them. If you are anticipating an inheritance or have received an inheritance and you need assistance in understanding your tax liabilities, call Saint Petersburg Tax Preparation expert Tom Gargiulo, EA today to set up a consultation.

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Tom Gargiulo, E.A.

Tom Gargiulo, E.A.

Tom Gargiulo, E.A. is a tand Quickbooks accounting professional based in St. Petersburg, Florida. Tom is a Member of the National Society of Tax Professionals and has been Enrolled to Practice before I.R.S. since 1986. Specializing in Quickbooks Accounting, Consulting and Training, he has many QuickBooks certifications. National Tax, Accounting & Financial is a family business started over 25 years ago. If you could summarize our firm in one word, it would be "personalization". Our firm gets to know our clients as people and uses our personalized service to best meet their needs in all facets of our business. This translates into savings for our clients. We bring unique solutions to complex problems by applying years of experience and the latest technologies. We can assist you with your tax preparation and accounting needs.

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