In most cases, inheritances are not taxed as income to the person who receives them, and the federal estate tax hits so few estates that it rarely enters the picture at all. But how an inheritance is taxed depends on what you inherit and where you live: money pulled from an inherited traditional IRA is taxed as ordinary income, gains on inherited property you later sell can be taxable, and a handful of states charge their own inheritance or estate taxes at much lower thresholds than the federal one.
Two Different Taxes, Two Different Payers
Before worrying about a bill, it helps to separate what the estate owes from what you owe. Federal estate tax, if any, is paid by the executor out of estate assets before anything reaches beneficiaries. You, as an heir, receive whatever is left after that. The taxes you personally deal with are different: income tax on money you withdraw from inherited retirement accounts, capital gains tax if you sell an inherited asset for more than its stepped-up value, and state inheritance tax in the few states that charge it.
For most families, the federal estate tax is not the concern. Under the One, Big, Beautiful Bill Act signed into law on July 4, 2025, the federal estate tax exemption for 2026 is $15 million per individual, with inflation adjustments starting in 2027.1Internal Revenue Service. What’s New – Estate and Gift Tax A married couple with proper planning can shield up to $30 million combined. Estates below that owe no federal estate tax; estates above it are taxed at a top rate of 40 percent on the excess.2Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax Spouses inheriting from each other pay no federal estate tax at all thanks to the unlimited marital deduction under Section 2056.3Office of the Law Revision Counsel. 26 US Code 2056 – Bequests to Surviving Spouse
Inherited Retirement Accounts: The Tax Most Heirs Actually Feel
This is where inheritance becomes a tax event for ordinary beneficiaries. Traditional IRAs and 401(k) plans hold money that was never taxed on the way in. Under Section 691 of the Internal Revenue Code, these accounts are treated as income in respect of a decedent, meaning withdrawals are taxed to you at your ordinary income tax rate in the year you take them.4Office of the Law Revision Counsel. 26 US Code 691 – Recipients of Income in Respect of Decedents For 2026, the top federal income tax rate remains 37 percent for single filers with taxable income above $640,600.5Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates
The SECURE Act tightened the timeline. Most non-spouse beneficiaries must fully empty an inherited retirement account within ten years of the original owner’s death.6Internal Revenue Service. Retirement Topics – Beneficiary Spread a $500,000 inherited IRA over that decade and you add $50,000 to your taxable income every year, which can be enough to push you into a higher bracket. Skip a required distribution and you face a 25 percent excise tax on the shortfall, reduced to 10 percent if you correct it within a set window.7Office of the Law Revision Counsel. 26 US Code 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans
Roth IRAs work differently. Because contributions were taxed on the way in, most withdrawals from an inherited Roth are tax-free, both the contributions and the earnings. If the Roth is less than five years old at the time of withdrawal, the earnings portion may be taxable.6Internal Revenue Service. Retirement Topics – Beneficiary The ten-year rule still applies, but the timing pressure matters far less when withdrawals aren’t creating a tax bill.
Surviving spouses get treatment nobody else does. A spouse can roll an inherited retirement account into their own IRA and treat it as if it had always been theirs, delaying withdrawals until they reach their own required beginning date. A younger surviving spouse can stretch tax deferral for decades this way.
Stepped-Up Basis: The Rule That Erases Old Gains
Section 1014 gives heirs one of the most valuable breaks in the tax code. When you inherit property, its cost basis resets to fair market value on the date the owner died.8Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent Every dollar of appreciation that built up during the original owner’s lifetime is wiped away for tax purposes.
A house bought for $80,000 that’s worth $500,000 when the owner dies gives the heir a basis of $500,000. Sell it for $510,000 and the taxable capital gain is $10,000, not $430,000. The same principle applies to inherited stocks, mutual funds, and most other appreciated assets. For 2026, long-term capital gains rates are 0 percent for single filers with taxable income up to $49,450, 15 percent up to $545,500, and 20 percent above that.5Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates Higher earners may also owe the 3.8 percent net investment income tax on the gain.
If you hold the inherited property and it appreciates further before you sell, only that later growth is taxable. If you sell soon after inheriting, at or near the stepped-up value, the capital gains tax is often minimal or zero.
State Inheritance and Estate Taxes
State-level death taxes operate independently of the federal system, and they can hit at much lower thresholds. Two types exist. A state estate tax is charged against the total estate, similar to the federal version. A state inheritance tax is charged to the individual who receives the assets, with the rate often depending on how closely related that person was to the deceased.
Five states currently impose an inheritance tax: Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Iowa repealed its inheritance tax effective January 1, 2025.9Tax Foundation. Estate and Inheritance Taxes by State, 2025 In the states that still charge it, a surviving spouse typically pays nothing. A child or parent might owe a small percentage or qualify for a large exemption. A distant relative or unrelated heir could face top rates of 15 to 16 percent. Maryland stands alone in imposing both an estate tax and an inheritance tax, creating two separate obligations on the same death.
Roughly a dozen states and the District of Columbia also charge their own estate taxes, and their exemptions are often far below the federal $15 million. Some start as low as $1 million, so a moderately wealthy family can owe nothing federally and still face a six-figure state bill. State thresholds and rates change often, so checking the current rules where the deceased lived is worth doing before assuming there’s no tax exposure.
Life Insurance Proceeds
Life insurance payouts are generally not subject to income tax when you receive them as a beneficiary. Estate tax is a separate question. Under Section 2042, life insurance proceeds are included in the deceased person’s gross estate if the payout goes to the estate itself or if the deceased held any incidents of ownership over the policy at death.10Office of the Law Revision Counsel. 26 USC 2042 – Proceeds of Life Insurance Incidents of ownership include the right to change beneficiaries, borrow against the cash value, or cancel the policy. A large policy owned by the deceased can push an otherwise exempt estate over the $15 million threshold.
For estates well below the federal exemption, this is rarely a practical concern, and the beneficiary receiving the check does not pay income tax on it.
Estate Income Earned During Administration
Between the date of death and the date assets are distributed, the estate itself can earn income: interest from bank accounts, dividends on stocks, rent from property. If that income isn’t distributed to beneficiaries during the tax year, the estate pays income tax on it. Estates with more than $600 in annual gross income must file Form 1041.11Internal Revenue Service. File an Estate Tax Income Tax Return When the estate distributes that income to beneficiaries, the beneficiaries report it on their own returns through Schedule K-1 and the estate takes a deduction. Because estates reach the top income tax bracket at very low income levels, distributing income to beneficiaries in lower brackets often saves overall tax.
When It Makes Sense to Refuse an Inheritance
You can turn down an inheritance through a qualified disclaimer, which treats the property as if it had never come to you. This can be the right move when accepting would push you into a higher tax bracket, create a state inheritance tax bill, or interfere with means-tested benefits. Section 2518 sets strict requirements: the refusal must be in writing, delivered within nine months of the death (or within nine months of the beneficiary turning 21 if a minor), and you cannot have already accepted the property or any benefit from it.12Office of the Law Revision Counsel. 26 USC 2518 – Disclaimers The disclaimed property passes to whoever is next in line under the will or state law, and you cannot direct where it goes. A disclaimer that fails any of the four requirements is treated as a gift from you, which can trigger its own tax consequences.