Someone asked me this exact question over the weekend, and it dawned on me that I have been asked this question a lot over the course of my career. It’s a good question. Here’s the short answer: It depends on what you inherit and what you do with it. In essence, there are three types of taxes to be aware of when you inherit money, investments, and/or property. They are capital gains taxes, inheritance and estate taxes, and income taxes.
Capital Gains Taxes On An Inheritance
This is the easiest one to explain. If you inherit something valued at $100, say a pair of Jordan sneakers, then you sell them for $150, you will probably be subject to capital gains taxes on the $50 profit you made. Now, there are many factors as to what the tax will be, and at which rate. Check out this article if you’d like to know the exact rates and how much you may have to pay.
Inheritance Taxes & The Estate Tax Exemption
On the federal level, if you inherit a gross estate valued at less than $11.4 million from someone to whom you’re not married, then you will not owe any immediate taxes on said gross estate.  the $11.4 million is commonly referred to as the estate tax exemption amount. This is nice, because anything over that $11.4 million number can be hit with a tax as high as 40%. 
However, each state differs. Here in Illinois, where I’m currently hanging out, the estate tax exemption is only $4 million. So, if you inherit under $4 million here in the Land of Lincoln, then you generally will not owe any state estate tax. This is a good thing, as it can get as high as 16%. 
If you don’t live in Illinois, first off, congratulations, secondly, check your state’s laws as they most likely differ than the laws in Illinois.
If you’re legally married, then you can inherit an unlimited amount of assets from your deceased spouse tax-free.
Federal & State Income Taxes
This one is pretty easy to explain, as well. Since an inheritance is not considered “income” by the federal government or by any state governments (I know, it’s hard to believe) you don’t have to claim your inheritance as income on your tax return.
With that said, if you inherit an IRA, a 401(k), or a non-qualified annuity from someone you’re not married to, then you will most likely end up owing some income tax either right off the bat or in the very near future due to rules and regulations surrounding such investment vehicles.
Let’s take a quick look at each vehicle and the choices you’ll have to make if you inherit such an investment vehicle from someone you’re not married to.
Traditional & Roth IRA Inheritance Rules
You will have to choose between taking distributions based on your lifetime or withdrawing the entire balance within 5 years of when you inherited the IRA. You will pay federal income tax on any amount you withdraw. In some states you will be subject to state income tax also, but not in Illinois (currently, at least).
Non-Qualified Annuity Inheritance Rules
For all intents and purposes, whether you take a lump sum from the annuity or you decide to start getting monthly payments, you will most likely need to pay federal and state income taxes on any earnings that have been deferred inside the annuity by the previous owner.
401(k) Inheritance Rules
To keep things simple, I will only say that the rules are very similar to the IRA/Roth IRA rules.
Want to learn more about your options regarding taxes on your inheritance? Want to learn how a CERTIFIED FINANCIAL PLANNER ™ can help you with your new inheritance? If so, reach out today. This is my way of asking to help you with your inheritance and help answer any questions you may have, in case it wasn’t obvious. Clink the link below to schedule a call today!
Consult with an estate planning attorney or an accountant before your tax return is filed if you’re unsure if you’ll have to pay taxes on your inheritance.
This article is not intended to be tax or legal advice. State and federal laws change all the time, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For up to date tax or legal advice, contact a qualified accountant or an attorney.
1] Gross estate – the total dollar value of an individual’s property and assets at the time of his or her death. Obtained from Investopedia.com on September 23, 2019.
 Source: https://www.fool.com/taxes/2019/01/10/2019-estate-tax-rates.aspx . Taken on September 23, 2019.
 Source: https://smartasset.com/estate-planning/illinois-estate-tax .Taken on September 23, 2019.