I’m Inheriting Money, What Now?

Generally, when someone passes, a final tax return will need to be filed for the decedent.  Often a 1041 Estate and Trust Income Tax Return will also be needed, depending on a variety of circumstances.  There may also be a need for a Federal 706 Estate Tax Return and/or a State Inheritance Tax Return.

First, I encourage anyone who is dealing with assets (and liabilities) of a loved one who has passed to seek legal counsel.  This is not an area you want to stumble through.  Each state has it’s own specific probate rules and Inheritance Tax requirements.  In my experience the Attorney will generally handle the State Inheritance Tax Return as well as the 706 if one is required.

Ok, legal advice disclaimer out of the way, let’s talk about Surviving Spouses.  Generally, estate planning is set up in such a way that the surviving spouse inherits everything.  (This may not be the case if there is not a Will or the Will was not properly executed, again, please speak to an Estate Planning Attorney about this.  Your tax professional can likely recommend several if you do not have one).  If you are a surviving spouse you have the option to file a joint tax return with your deceased spouse for the year he/she passed.  Your tax return will be prepared as it normally has and you will sign as the Surviving Spouse.  You will want to take this opportunity to do some tax planning as the following year you will generally file Single (or possibly Qualifying Widower).

As a surviving spouse, you likely already hold an interest in most, if not all, of the property as a joint owner.  So as far as what is taxable to you and what is not, it will not change much.  Of course, there are always exceptions to this rule.

If you are not the surviving spouse, there will be some changes to your tax return.  Most of this depends on the what you are inheriting and how it is titled.

Some Examples:

Life Insurance – Life Insurance paid directly to an individual beneficiary is not taxable.

Jointly Held Accounts – As a surviving spouse, you should have already been reporting any income these accounts generated and no additional taxable income because of the death should be created. (i.e. Interest Income, Dividend Income, Sales of Stocks and/or Bonds, etc.).

If you held these accounts jointly with a parent (or anyone else), it’s likely that the parent reported this income on their tax return.  The proper way to report this is to attribute all income from January first through the date of death on the final tax return for the decedent. The rest of the income will be reported on the beneficiaries tax return.

Retirement Benefits – This is an area you should work with your Attorney and Tax Professional together.  There are a lot of planning opportunities here.  (Joe can certainly speak to these in much more detail).  Depending on how you choose to inherit these accounts, some options may be taxable to you and others may not be.  Regardless of what you choose, you will be exempt from the early withdraw penalty of 10%.

Rental Property – Depending on how the property is titled, you will typically report the income and expenses as normal.  If the title is held jointly, you may be entitled to step up a portion of the basis in the property for depreciation purposes.  If the title was held in a sole name and you are the named beneficiary you maybe able to step up all of the basis in the property for depreciation purposes.  Again, you will need to work with your Attorney and Tax professional in this area.

Small Businesses – There are so many variables with how these can be handled I will encourage you to talk to your tax professional about these assets.

This is a basic introduction to what happens in the tax world when a loved one passed away.  It can easily become more complicated and have many more levels depending on what is involved.  I cannot stress enough to be sure to seek advice of your Tax Professional and your Attorney.

So the short story, generally inheritance is not taxable as a lump sum (with some exception of course) but you should always verify this information with your Attorney and/or Tax Professional.  Do not hesitate to seek help from an Attorney and/or Tax Professional to make sure you have your Estate Planning Documents in order and once a loved one has passed.