What Is a K-1 Tax Form in Relation to Inheritance?

by Beverly Bird
Only rarely can beneficiaries take tax deductions that rightfully belong to the estate.

K-1 tax forms can reflect different types of income. The schedule identifies money that passes through one tax entity – the one that actually earns it – to beneficiaries, who pay taxes on it. Most – but not all – inheritance money reported on a K-1 is taxable. It depends on whether the inheritance represents income or principal from the decedent's estate or trust.

Initial Inheritance

Property or cash owned by the decedent and passed to you through his will or a trust is tax-free, at least at the federal level. A handful of states impose inheritance taxes, but the Internal Revenue Service doesn't take a bite of any cash, real estate or stock you receive by bequest. In some cases, such as in jurisdictions where inheritance taxes are applicable, you may receive a Schedule K-1 reporting your inheritance, but you do not have to pay federal income taxes on these amounts or claim them on your tax return. The source of this type of inheritance is the decedent's remaining estate after it has paid all its own taxes.

Interest Income

If a probate estate remains open for several months – and most do because it takes the executor some time to marshal assets and pay the decedent's debts and taxes – some assets might generate interest or other passive income. This is subject to income tax, either payable by the estate or by the beneficiary. Typically, it's passed on to beneficiaries and reported on a K-1. For example, if the decedent's estate earns $15,000 in interest while the probate estate is open, and if the executor then distributes the entire estate to three beneficiaries according to the terms of the decedent's will, each beneficiary might receive a K-1 for $5,000. The K-1 wouldn't reflect any of the estate's principal. If the entire distributed estate is $315,000 and if each beneficiary receives $105,000, only the $5,000 appears on each beneficiary's Schedule K-1. The tax form is also submitted to the IRS, and each beneficiary is responsible for including the K-1 sum on Schedule E and filing this schedule with his tax return.

Trust Distributions

Distributions from trusts also result in beneficiaries receiving K-1 tax forms. The rules are similar to those that apply to probate estates when the decedent leaves a will, with one major distinction. Some trusts can retain income earned by the decedent's estate, holding it rather than distributing it to beneficiaries. If the income is held, the trust pays income taxes on these amounts. If the trustee distributes the income to the trust's beneficiaries instead, he issues a Schedule K-1 to each, showing the amount. The estate can take a tax deduction for these distributions. This is only the case, however, if the trust documents direct the trustee to make such disbursements. Some trusts grant their trustees the freedom and discretion to decide when to make distributions and, if so, how much they disburse. If the trustee has this authority, you won't receive a K-1 and you don’t have to report these amounts on your tax return. The trust must pay income taxes on this income.

Income in Respect of a Decedent

The IRS also taxes "income in respect of a decedent," sometimes referred to as IRD. This is money earned by the decedent before his death. If he did not actually receive it before he died, it can't be included on his final tax return. The estate, the trust, or the beneficiary must report it instead and pay taxes on it. If the estate or trust doesn't do so, the executor or trustee must issue the beneficiary of the money a K-1 tax form. You might get a bit of a tax break, however, if the estate paid any federal estate taxes. You can itemize deductions on your personal return, claiming a miscellaneous deduction for the portion of the estate taxes attributable to the IRD you inherited.

About the Author

Beverly Bird has been writing professionally since 1983. She is the author of several novels including the bestselling "Comes the Rain" and "With Every Breath." Bird also has extensive experience as a paralegal, primarily in the areas of divorce and family law, bankruptcy and estate law. She covers many legal topics in her articles.

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