I Received an Inheritance. How Is This Money Taxed?

How your inheritance is taxed will depend on your relationship to the deceased and other factors.


The amount of federal estate tax typically is determined by the amount of assets within the estate and your relationship to the deceased.


Spouses typically may inherit an unlimited amount of assets free of federal estate taxes. Estates bequeathed to non-spouses, in contrast, may be subject to federal estate taxes and state inheritance taxes depending on the level of assets within the estate.


For non-spousal heirs, in 2014, the federal estate tax is levied at a maximum rate of 40% after a $5.34 million exclusion. For estate tax purposes, heirs typically value assets at the fair market value on the date of the deceased's death.


Note that many states impose inheritance tax thresholds and tax rates that differ from those at the federal level. An estate planning attorney can advise you on taxation issues in your area.


In most instances, spouses who inherit IRAs may treat the IRA as their own and must begin required minimum distributions (RMDs) after age 70½. RMDs, which are taken annually, are taxed as ordinary income.


Non-spouses, in contrast, may not delay RMDs until they reach age 70½. Non-spouses may transfer the IRA assets into an inherited IRA titled specifically for an heir. When taking distributions, which are taxed as ordinary income, a non-spouse has two options. As one option, the non-spouse may empty the account over a five-year period. A second option available to a non-spouse is to take annual distributions, with the amount determined by the account balance and the heir's life expectancy (or the life expectancy of the plan owner if longer and if RMDs have already begun). The latter strategy may permit a larger portion of the account to remain invested and subsequently grow tax-deferred.


Similar rules apply to employer-sponsored retirement plans, such as 401(k) plans or 403(b) plans. If you inherit assets that are within an employer-sponsored plan, you may want to contact the sponsoring employer to determine rules affecting beneficiaries.


Inheritance taxes are a complicated issue. When determining how they apply to your situation, an experienced estate planning lawyer could be your most valuable asset. 


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Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.


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