Are you wondering to yourself, “Do I have to pay taxes on inherited money?” Unfortunately, you may have to. Generally, the IRS does not impose federal income tax on inherited money - at least not on the inheritance itself. However, there are always exceptions to every rule.
You can receive a money market account free of charge, but even if you empty the account immediately and stash the cash in your freezer, taxes might eventually take a bite. When the taxation begins depends on when you receive the account. With that in mind, you should carefully analyze your options in order to ensure that you don't incur unnecessary income tax on inherited money.
Read More: What Happens if You Don't File Taxes?
Taxes on Interest Income
Under some circumstances, you may have to pay taxes on inherited brokerage account. Depending on whether you inherit a money market account or a money market fund, it’s going to generate either interest or dividends. Both are income to you, and you must report them on your tax return, but this doesn’t necessarily begin with the date of the deceased’s death.
Unless you receive the money market as a payable-on-death account, the fund or account will most likely pass through the probate process before it gets to you. If the asset goes through probate, you generally don’t have to report any interest or dividends earned until the executor of the estate actually transfers the account into your name when he closes the estate.
With that in mind, taxes on beneficiary money won't begin until you have officially received ownership of the account.
Taxes on the Estate’s Income
A gray area sometimes exists regarding when the interest or dividends actually accrued. If they accrued but didn’t pay out before the date of the deceased’s death, the executor of the estate will report them on the estate's income tax return. This is income in respect of a descendent. The same principle applies to payable-on-death accounts.
If the asset doesn’t have to go through probate because it’s already assigned to you by contract with the banking institution or the financial institution, any interest or dividends earned before the date of death are the responsibility of the deceased’s estate, regardless of when they pay out. They are also income in respect of a decedent.
Using Investment Tools
Money market funds, although very low-risk, receive no insurance coverage from the FDIC and you'll find these accounts offered by brokerage firms and mutual fund companies.
Money market funds invest your money into treasury securities and other low-risk instruments. Accordingly, money market funds generate dividends rather than interest. Report dividends on lines 3a or 3b of Form 1040, depending on whether they are qualified dividends or not.
Reporting Your Taxes
Money market accounts typically reside at banks and work as depository accounts that generate interest, like a regular bank account. These accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to the maximum legal limit.
If you inherit a money market account with a bank as part of inheritance programming, report the interest on Line 2a or 2b of Form 1040, depending on whether it is taxable or not.
Although the federal government does not impose an inheritance tax on the value of the money market you receive, states have their own tax laws. Nebraska, Iowa, Maryland, New Jersey, Pennsylvania and Kentucky levy inheritance taxes. Depending on your degree of kinship with the deceased, you may have to pay a percentage of the value of the money market if you inherit it in one of these states.
Read More: Deducting State & Local Tax on Your Federal Taxes
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.