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Last Updated on October 29, 2022 by Estate Planning FAQ

Short Answer: Typically Not. It Depends on the Asset

In most instances, a beneficiary, whether they receive their inheritance through a probate case, beneficiary designation or trust, at the death of the Grantor/Testator will not have to pay income taxes on the assets that are inherited. This is at least true at the federal level. The reader should consult with their local tax professional as to whether there is any income tax that would be owed at the state level. Typically the state follows the rules at the federal level but this should be confirmed by the reader.

General Rule

This is said with a few caveats. To determine whether income tax will have to be paid on the inheritance that is received, it is necessary to determine what type of asset is being received. In the literature the term “stepped-up basis” is used. Stepped-up basis means that at the death of the Testator, the individuals named in the transferring document, whether it be a will, trust or intestate succession will receive the property at the value at date of death of the Testator. By way of example, assume the Testator purchased Walmart stock 50 years ago at $10 per share. At the time of the Testator’s death, for illustration purposes only, let’s assume the value of Walmart stock had an ending price of $110 per share. Had the testator sold the shares immediately before his death, he would have to report capital gains at the rate of $100 per share, the difference between what he purchased it at and what he sold it for ($110 – $10 = $100). However, if the Testator owned it at the time of his death, the person who received the shares now receives it with their starting bases at $110 per share. This is assuming valuing the shares using the average of the highest selling price and the lowest selling price of the stock on the date of death.

The difference between the value as stated above and what the Testator purchased the stock for escapes any form of income taxation in the hands of the beneficiary at the federal level. If the beneficiary however would sell the stock the following day for $115 per share and his stepped-up basis was $110 per share, he would have to report $5 per share as capital gain. Depending on when it was sold this would either be a short-term or long-term gain.

The issue of income taxation on the inheritance is separate and apart from a determination as to whether there would be any estate tax owed on the estate of the Testator. This discussion is beyond the scope of this article but at least deserves a mention.

Exceptions to Stepped-Up Basis

This analysis, and the application of the stepped-up basis applies to essentially every asset owned by a decedent at time of death. However, there are a few exceptions. The first exception is commonly referred to as qualified account. These accounts are accounts in which no income tax has previously been paid on the funds. They fall into the category of 401(k), 403(b), TSA and Individual Retirement Accounts (IRAs). The second category of assets that do not get a stepped up basis are United States Savings Bonds. The beneficiary of the US Savings Bonds will have to report the interest and pay income tax on the interest.

Further Advice

For further discussions on the topic of income tax and its application to your particular situation, the author recommends that the reader discuss specific details with their own professional advisers.