What are the steps to handle inheritance taxes?

Inheritance tax is levied on the person receiving an inheritance, while estate tax is assessed on the entire estate before distribution. The federal government imposes an estate tax (not an inheritance tax) on estates above a high exemption amount, currently $12.92 million per individual in 2026. Several states, however, impose a separate inheritance tax that the beneficiary must pay. Understanding which taxes apply and the tax implications of inheritance is critical before taking any steps.

1. Determine if a return is required. Check the federal gross estate value against the exemption. At the state level, verify if the decedent lived in or owned property in a state with an inheritance or estate tax.
2. Gather and value all assets. Include real estate, bank accounts, investments, business interests, and life insurance policies. Use fair market values as of the date of death or the alternate valuation date.
3. Calculate the tax liability. Subtract allowable deductions (debts, funeral expenses, charitable bequests, marital deduction). Apply the relevant tax rate to the taxable estate.
4. File the necessary forms. For federal estate tax, file IRS Form 706 within nine months of death (a six‑month extension is available). State inheritance tax returns have their own forms and deadlines.
5. Pay the tax. The estate executor or the beneficiary must pay the amount owed. Understanding how to pay inheritance tax at the state level is key: most states accept electronic funds transfer or check. The IRS offers installment payment options for closely held business interests if liquidity is an issue.

The tax implications of inheritance vary widely by asset class. Inherited stocks and real estate generally receive a “step‑up” in basis to fair market value as of the date of death, meaning capital gains taxes apply only on appreciation after that date. Retirement accounts (IRAs and 401(k)s) inherited by non‑spouse beneficiaries may trigger mandatory distributions and income tax. Life insurance proceeds are usually income‑tax‑free but can be included in the taxable estate if the decedent owned the policy. Knowing these differences helps beneficiaries plan for annual tax obligations and avoid surprises.

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Are inheritance taxes different by state?
Yes. Only a handful of states impose an inheritance tax (examples include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania). Each sets its own rate, exemption thresholds, and classes of beneficiaries (spouses and children often pay little or nothing). It is essential to identify the decedent’s domicile and state‑specific rules early in the process.

How do I report inherited assets?
Inherited assets are not reported as taxable income on your federal return simply because you received them. However, any income those assets generate (interest, dividends, rental income) must be reported. When you sell an inherited asset, you report the capital gain or loss using the stepped‑up basis. For estate tax reporting, the executor files Form 706 and the state equivalent; beneficiaries generally receive a schedule of assets that may be needed for their own records.

Can I reduce inheritance tax liability?
Yes, proactive planning can reduce liability. Common strategies include making lifetime gifts within annual exclusions, placing assets in irrevocable trusts, using the marital deduction, or taking advantage of state exemption elections. Because the rules are complex and the window for post‑death planning is narrow, work with an estate‑planning attorney to explore options tailored to your situation.