You cannot deduct state inheritance taxes paid on your federal income tax return. The prohibition also applies to deducting state estate taxes. The Internal Revenue Service only permits income tax deductions for state and local income taxes, real estate taxes, personal property taxes and sales taxes.
Estate Tax Return
You can deduct the amount of state inheritance taxes from the federal estate tax return for the decedent. The tax code authorizes a deduction for estate, inheritance, legacy or succession taxes charged by any state or the District of Columbia. For example, if you pay $50,000 in inheritance taxes to Nebraska, you can deduct $50,000 from the decedent's federal estate tax return.
Inheritance Not Taxable Income
On the flip side, you generally don't have to include money that you receive as part of your inheritance as taxable income. For example, if your grandfather leaves you $25,000, you don't have to pay income taxes on that money. Qualified retirement plans, such as traditional 401(k)s and individual retirement accounts, are one notable exception to this rule, however. You won't pay income taxes on the value of the account when you inherit it, but when you take distributions, those withdrawals will count as taxable income.
