An inheritance generally is not reported as income on a beneficiary’s federal income tax return.  The value of property inherited, in most cases, is not subject to federal income tax.  Generally speaking, the value of the inheritance for tax purposes, or the tax basis, is reset at current values.  For example, P.W. Herman’s distribution is a money market account previously owned by his mother with a value of $50,000 on the date of the distribution.  For P.W., the tax basis in that asset is $50,000, and the distribution is not subject to federal income tax.  Of course, if that money market pays interest after the date of distribution, Mr. Herman must report that interest as income on his next income tax return.

Exceptions to this rule include traditional individual retirement accounts (traditional IRAs) and 401(k)/employer savings plans.  In most cases distributions of these assets are subject to federal income tax; the beneficiary will be responsible for any income tax that may be due, even if that income was earned during the decedent’s lifetime.

U.S. savings bonds are an example of yet another exception to this rule.  If the decedent didn’t report the interest income from the savings bonds on a federal tax return prior to their death, the IRS provides two options: the individual handling the estate—the Personal Representative or the Trustee—can report that previously unreported income on the decedent’s final income tax return, or, if that income isn’t included in the decedent’s final income tax return, the beneficiary, as the new owner of the savings bonds, will need to report the previously unreported income, as well as any interest income that has accrued following the distribution, on their personal return.

Tax issues can be quite complex and are always subject to change.  I advise all of my clients to hire a CPA with estate tax experience.  Additionally, clear, routine communication with beneficiaries is paramount to litigation free probate or trust administration.

-          Hire a CPA with estate tax experience.  DON’T try to figure it out on your own.

-          Clear, routine communication with beneficiaries is paramount.

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 Roby DeGraw ©