When someone dies and names you as an heir, the money might pass to you completely tax-free. While the Internal Revenue Service has a 40 percent estate tax, you don't have to pay it as an inheritor. Paying it is the estate's responsibility, but thanks to exclusions built into the tax code, the estate might not owe anything, either.
Inheritance Tax Basics
Before levying an inheritance tax, the IRS lets a portion of a person's estate go without being taxed at all. As of 2014, the exclusion is $5.34 million. This means that if someone dies and leaves you an entire estate worth $5.33 million, the estate will owe exactly nothing in inheritance tax. If she leaves you $5.35 million, the 40 percent tax only hits the $10,000 that is over the limit. The IRS has one small gotcha, though: Gifts that the person gave while they were alive that are above a set limit come off the top, reducing the exclusion when that person dies.
Paying the Inheritance Tax
If you inherit money or property from an estate that is big enough to be taxed, you generally shouldn't have to pay the inheritance tax yourself. Usually, the person that is taking care of the estate files all of the paperwork and sends the taxes into the government. Once you get the money, it should already have all of the taxes paid so that you can keep it and do what you want with it. The exception to this is if you inherit someone's individual retirement account. It isn't subject to tax for that person, but you'll have to pay taxes when you pull money out.
What You Do Pay
You don't pay any taxes on money that you inherit, but once it's yours, it gets treated like any other money you have. If you inherit stock valued at $50 a share and you sell it for $65 a share, that $15 profit will be taxed. A bank account you inherit that pays interest will come to you tax-free, but you'll have to start paying taxes on the interest that you earn once it's yours.
Gifts vs. Inheritance
Gifts while a person is still alive can also be tax-free. For example, any individual may give you as much as $14,000 a year -- as of 2014 -- completely tax-free. Your parents together may give you $28,000 a year without paying a gift tax. An individual making the gift must pay taxes on any amount over $14,000, however, and each reported gift is subtracted from the giver's $5.34 million lifetime exclusion for gift and estate taxes.
- Creatas Images/Creatas/Getty Images