Inherited stock is a nice windfall, but the taxman may or may not cometh. Whether you must pay taxes on inherited stock depends on the amount inherited, the state in which the deceased person or you live, and your relationship to that individual. The good news is that most people do not have to pay taxes on inherited stock until they sell their shares.
States With Inheritance Tax
As of 2017, the following states had inheritance taxes with these percentages taxed:
- Kentucky – up to 16 percent
- Iowa – up to 15 percent
- Nebraska – up to 18 percent
- New Jersey – up to 16 percent
- Maryland – up to 10 percent
- Pennsylvania – up to 15 percent
Spouses are exempt from inheritance taxes in all states, and many states exempt lineal heirs. States may offer a tax exemption on certain amounts inherited.
If you are a spouse or lineal heir of the decedent, you probably do not have to pay inheritance taxes on stock even if you or the decedent lived in a state with an inheritance tax. A lineal heir is a direct descendant, such as a child or grandchild. If the decedent was not related to you or you had some other type of familial relationship such as cousin, aunt or uncle, you are not a lineal heir and any inheritance tax applies.
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Even if you don’t have to pay any inheritance tax and haven’t sold your shares, if you receive dividend income from the stocks, you have to pay taxes to the IRS on that income. At the beginning of each year, you receive a 1099-DIV form from the brokerage with your dividend payments from the previous year.
When you sell stock shares, you are subject to capital gains tax. When it comes to inherited stock, you have an advantage. If you sell stock shares you bought yourself, you must use the basis price to calculate the difference between what the stock cost at the time of purchase and when you sold it to determine your profit. That may involve a lot of record keeping and going through old files on your part.
When you sell inherited stock, the basis is what it was worth on the day the person you inherited it from died. Not only is that amount much easier to determine, but it could prove a real windfall. If the original owner held the stock for 50 years and the price skyrocketed, you’re not paying taxes on that giant increase. If you sell your shares soon after inheriting them, you may end up with no capital gains increase at all.
Alternate Valuation Date
There is a small fly in this ointment. The executor of the estate may choose to go with an alternate valuation date when filing the estate’s tax return, which is six months from the decedent’s death date. It’s not hard to find the fair market value of the shares on that date, and the brokerage can give you that information. However, six months is a long time in investment terms, and the value of the shares may have risen or dropped significantly in that period.
Automatic Dividend Reinvestment Plans
If the inherited stock shares were enrolled in an automatic dividend reinvestment plan at the brokerage, additional shares may be added after the date you inherited the stock. That cost basis differs from the basis for the actual inherited stock, so you must keep accurate records when selling the shares.