Taxes on Inheritances Frequently Asked Questions

For the most part, the answer is no. A direct inheritance that is received in the form of life insurance proceeds or through the terms of a will would not be looked upon as taxable income by the IRS or state tax authorities. If you inherit an individual retirement account, the tax situation will depend on the nature of the account. If it is a Roth account, you would not pay taxes on distributions, but distributions from a traditional individual retirement account would be taxable income. Distributions of the principal in a living trust are not taxable, but you would have to report distributions of the trust’s earnings.

The assets would get a stepped-up basis, so the value for capital gains purposes would be reset to the value at the time of acquisition. You would not be responsible for gains that accumulated during the life of the decedent.

No, because there is an unlimited marital estate tax deduction. You can transfer unlimited resources to your spouse free of taxation as long as your spouse is an American citizen.

The estate tax exclusion has been portable since 2011. If you predecease your spouse, they would be able to use their exclusion and your exclusion. Since two people contributed to the accumulation of a couple’s wealth, logic would tell you that a surviving spouse should be able to use two exclusions.

This was possible in the early days shortly after the estate tax was enacted back in 1918. Pro-tax lawmakers were able to get a gift tax enacted in 1924, but the other side pushed back, and it was repealed in 1926. In 1932, it was reenacted, and it has been in place continuously since that time. The gift tax and the estate tax are unified under the tax code, so the multimillion-dollar exclusion applies to your estate and large lifetime gifts that you give. However, there is an additional annual gift tax exemption. You can give up to $15,000 to an unlimited number of people in a given calendar year free of transfer taxes. There is no limit to the amount you can give as long as no one person receives more than $15,000 in a particular year. If you are married, you and your spouse could combine your annual exclusions to give as much as $30,000 to any number of people each year tax-free. There is also an educational exemption that can be used to pay school tuition for others in a tax-free manner. You can use the medical exemption to cover medical bills for others without incurring any tax liability, and this includes health care insurance.

There are a dozen states in the union that have their own state-level estate taxes, but California is not on the list. If you own property in a state that has an estate tax, it would apply to your estate if the value of the property exceeds the exclusion in that state.