Is Inheritance Taxable? What You Need to Know in 2025

No, most inheritances are not taxable as income to the beneficiary. The federal government does not impose an inheritance tax, and only six states have inheritance taxes. However, the estate itself may owe estate taxes before distribution, and inherited assets may have tax implications when you sell them.

Understanding the Difference: Inheritance Tax vs. Estate Tax

Many people confuse inheritance tax and estate tax, but they're different:

Estate Tax (Federal)

The federal estate tax only applies to estates exceeding $13.61 million in 2024 (or $27.22 million for married couples). This means the vast majority of estates owe no federal estate tax.

Key points about federal estate tax:

• Only about 0.1% of estates owe federal estate tax
• The estate pays this tax before distributing to heirs
• Tax rates range from 18% to 40%
• You don't personally owe this tax as a beneficiary

Inheritance Tax (State)

Only six states impose an inheritance tax:

1. Iowa (being phased out by 2025)
2. Kentucky
3. Maryland (has both estate and inheritance tax)
4. Nebraska
5. New Jersey
6. Pennsylvania

If you live in one of these states or inherit from someone who lived there, you may owe inheritance tax. Rates vary by state and your relationship to the deceased.

Inheritance Tax Exemptions by Relationship

Most states exempt close relatives from inheritance tax:

• Spouses: Exempt in all states
• Children/Grandchildren: Exempt or reduced rates in most states
• Siblings: Partial exemption in some states
• Non-relatives: Usually taxed at higher rates

What About Income Tax on Inherited Assets?

While the inheritance itself isn't taxed as income, there are situations where income tax may apply:

Inherited Retirement Accounts (401k, IRA)

When you inherit a traditional IRA or 401(k):

• Withdrawals are taxed as ordinary income
• Non-spouse beneficiaries must generally withdraw all funds within 10 years (SECURE Act rules)
• Roth IRA withdrawals are typically tax-free

Inherited Stocks or Real Estate

You receive a stepped-up basis for inherited assets, which can significantly reduce capital gains taxes:

Example:

• Deceased bought stock for $10,000
• Stock worth $50,000 at death
• Your new cost basis: $50,000
• If you sell immediately: No capital gains tax

This stepped-up basis is one of the most valuable tax benefits for heirs.

Income Generated by Inherited Assets

Any income generated after you inherit (dividends, rental income, interest) is taxable to you as ordinary income.

State Estate Taxes

In addition to the federal estate tax, 12 states plus Washington D.C. have their own estate taxes with lower exemption thresholds:

Strategies to Minimize Inheritance Taxes

If you're concerned about taxes affecting your inheritance:

1. Understand Your State's Laws

Check whether your state or the deceased's state has inheritance or estate taxes. If so, consult a tax professional.

2. Consider the Timing of Asset Sales

If you're inheriting appreciated assets, you benefit from the stepped-up basis. Selling quickly after inheriting can minimize capital gains.

3. Inherited IRAs: Plan Your Withdrawals

Spread withdrawals over time to manage your income tax bracket, especially with large inherited retirement accounts.

4. Work with Professionals

For large inheritances, consult:

• A tax professional or CPA
• An estate planning attorney
• A financial advisor

Frequently Asked Questions

Do I have to report my inheritance on my tax return?

Generally no, unless it includes income-generating assets or you withdraw from an inherited retirement account.

Is life insurance inheritance taxable?

Life insurance proceeds paid to a named beneficiary are not taxable as income. However, if paid to the estate, they may be subject to estate tax.

What if I inherit property with a mortgage?

Inheriting a mortgaged property isn't a taxable event. You'll owe income tax only on any rental income or capital gains when you sell.

Can I avoid inheritance tax by refusing the inheritance?

Disclaiming an inheritance passes it to the next beneficiary in line. This may or may not reduce taxes depending on who receives it instead.

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This article is for informational purposes only and does not constitute tax advice. Please consult a qualified tax professional for advice specific to your situation.