How Is Money From a Will Taxed? (w/Examples) + FAQs

Money you receive from a will is generally not taxed as income to you, the beneficiary, under IRC §102(a), which excludes gifts and inheritances from gross income. However, the estate itself may owe federal estate tax before the money reaches you, and six states still impose a separate inheritance tax on the beneficiary. On top of that, certain inherited assets — like traditional IRAs, 401(k)s, annuities, and unpaid wages — carry income in respect of a decedent (IRD) under IRC §691, which is taxable to you when you receive it.

The federal government taxes transfers of wealth at death, not inheritances received. The governing framework sits in Subtitle B of the Internal Revenue Code, which covers estate, gift, and generation-skipping transfer taxes. For 2026, the unified federal estate and gift tax exemption is approximately $15 million per person after the One Big Beautiful Bill Act (OBBBA) made the higher exemption permanent in 2025.

According to the Tax Policy Center, fewer than 0.1% of U.S. estates owe any federal estate tax — meaning roughly 99.9% of inheritances pass to heirs free of federal death tax.

Here is what you will learn in this guide:

• 💰 The exact difference between estate tax, inheritance tax, and income tax on an inheritance
• 🏠 How the step-up in basis under IRC §1014 can erase decades of capital gains
• 📊 How IRD assets like inherited IRAs trigger income tax and the 10-year payout rule
• 🗺️ Which six states still tax inheritances, and the 12 states + D.C. that tax estates
• ⚖️ Real-world scenarios, common mistakes, and court rulings that shape modern inheritance tax law

The Three Taxes That Can Touch Money From a Will

When money moves from a decedent to a beneficiary, three very different taxes can apply. People often lump them together under the label “death tax,” but that label hides important distinctions. The IRS Estate Tax page describes estate tax as a tax on the right to transfer property at death. Inheritance tax, by contrast, is a tax on the right to receive property, and only six states charge it. Income tax enters the picture when the inherited asset carries deferred income that the decedent never paid tax on.

Each of these taxes has its own rate, its own filer, and its own form. The estate’s executor files Form 706 for federal estate tax and Form 1041 for estate income tax. A beneficiary reports their own taxable items on Form 1040 and receives a Schedule K-1 from the estate. Mixing these up is the single most common mistake heirs make, and it leads to double reporting or missed filings.

Below is the core distinction every beneficiary should keep straight.

Tax Type	Who Pays It
Federal estate tax (Form 706)	The decedent’s estate, before distribution
State inheritance tax	The beneficiary, in six states
Federal income tax on IRD	The beneficiary who receives the IRD asset

Federal Estate Tax

Federal estate tax applies to the gross estate of U.S. citizens and residents who die in 2026 with assets exceeding roughly $15 million, as set by the OBBBA adjustments to IRC §2010. The tax rate climbs to a top marginal rate of 40% on amounts above the exemption, per the IRS estate tax rate schedule. The executor reports the full gross estate on Form 706 within nine months of death.

The consequence of missing the filing deadline is steep. The IRS imposes a failure-to-file penalty under IRC §6651 of 5% per month, up to 25% of the unpaid tax. Interest accrues daily under IRC §6601 from the original due date.

Example: Maria dies in March 2026 with a $20 million estate. Her executor files Form 706 in December 2026, reports $5 million above the $15 million exemption, and pays roughly $2 million in federal estate tax before Maria’s children receive the rest.

A common misconception is that the beneficiary pays federal estate tax. The estate itself pays, and beneficiaries receive what is left after tax.

State Estate and Inheritance Taxes

Twelve states plus the District of Columbia impose their own state estate tax, with exemptions far lower than the federal threshold. Oregon taxes estates above $1 million, and Massachusetts taxes estates above $2 million. Washington State raised its top estate tax rate to 35% in 2025, making it the highest state estate tax in the country.

Six states still charge inheritance tax on the beneficiary directly. These are Iowa (phasing out in 2025), Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Rates depend on the beneficiary’s relationship to the decedent. Spouses pay 0% in every state, children and grandchildren typically pay 0–4.5%, and non-relatives can pay up to 16%.

Example: Tom, a Pennsylvania resident, dies and leaves $200,000 to his nephew. Pennsylvania charges a 15% inheritance tax on transfers to nephews, so the nephew owes about $30,000 on Form REV-1500.

Maryland is the only state with both an estate tax and an inheritance tax. Missing the state inheritance tax deadline can trigger interest and penalties that sometimes exceed the tax itself.

Federal Income Tax on Inherited Money

Most cash and property from a will is not subject to federal income tax. IRS Publication 559 confirms that the value of property received as a bequest is excluded from the beneficiary’s gross income. But any income earned by the asset after death is taxable, and any income in respect of a decedent (IRD) is fully taxable when paid out.

IRD includes a traditional IRA balance, a 401(k) balance, a pension, deferred compensation, unpaid wages, accrued interest on savings bonds, and the untaxed portion of installment notes. The beneficiary pays income tax at ordinary rates when the money comes out, per IRC §691(a).

Example: Linda inherits her father’s $500,000 traditional IRA in 2026. Under the SECURE Act 10-year rule, she must empty the account by 2036 and pay ordinary income tax on every dollar withdrawn.

The consequence of ignoring IRD is a surprise tax bill. Linda can, however, claim the IRD deduction under IRC §691(c) for federal estate tax attributable to the IRD, which softens the double-tax hit.

Step-Up in Basis: The Most Valuable Rule in Inheritance Tax

The step-up in basis rule under IRC §1014 is the single most valuable inheritance tax benefit in U.S. law. When you inherit an asset, your cost basis resets to the asset’s fair market value on the date of death (or the alternate valuation date six months later, under IRC §2032). This can wipe out decades of built-up capital gains in one stroke.

The plain-English effect is this: if Grandpa bought Apple stock for $1,000 in 1990 and it is worth $500,000 when he dies, you inherit it with a $500,000 basis. If you sell the next day for $500,000, you owe zero capital gains tax. If you sell two years later for $550,000, you owe tax on only the $50,000 of appreciation after death.

The consequence of not knowing about step-up in basis is that heirs sometimes pay capital gains tax on the entire pre-death appreciation, which is a mistake that can cost six figures. Real estate inherited in coastal California or Manhattan often produces the biggest step-ups because of long-term appreciation.

Example: James inherits his mother’s home in San Francisco. She bought it in 1975 for $60,000, and it is worth $2.4 million at her death in 2026. James’s basis is $2.4 million. If he sells it for $2.45 million in 2027, he reports only $50,000 of gain on Schedule D.

A common misconception is that step-up applies to retirement accounts. It does not. Traditional IRAs and 401(k)s do not receive a step-up because they are IRD assets.

Community Property Double Step-Up

In the nine community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — the surviving spouse receives a full step-up on both halves of community property under IRC §1014(b)(6). This is called the double step-up.

The consequence is powerful. In a common law state, the survivor steps up only the deceased spouse’s half. In a community property state, both halves step up, which can save the survivor hundreds of thousands in capital gains when the property is later sold.

Example: Elena and Diego, California spouses, bought a duplex for $200,000 in 1995. It is worth $2 million when Diego dies in 2026. Elena’s basis becomes $2 million on the entire property. If she sells for $2.1 million later, she owes capital gains tax only on $100,000.

The common misconception is that living in a community property state automatically triggers the double step-up. It does not. The property must actually be held as community property, which often requires a written agreement or proper titling.

Carryover Basis for Gifts vs. Stepped-Up Basis for Bequests

Lifetime gifts do not receive a step-up. Instead, IRC §1015 gives the donee a carryover basis equal to the donor’s basis. This is why tax planners often recommend passing appreciated assets at death rather than during life.

The consequence of gifting an appreciated asset early is that the recipient keeps the low basis and owes capital gains tax on the full appreciation when they later sell. The recipient of a bequest avoids that tax entirely, up to the date-of-death value.

Example: Robert owns stock worth $1 million with a $100,000 basis. If he gifts it to his daughter, she has a $100,000 basis and owes tax on $900,000 when she sells. If she inherits it at his death, her basis is $1 million and the gain disappears.

A common misconception is that gifting is always more tax-efficient than bequeathing. For appreciated assets, the opposite is usually true.

How Specific Inherited Assets Are Taxed

Different assets follow different rules. Cash and personal property are the simplest; retirement accounts, life insurance, annuities, and business interests are the most complex. The IRS Publication 559 walks through the basics, but the nuances often require a CPA or estate attorney.

The governing structure combines IRC §102 (gift exclusion), IRC §691 (IRD), IRC §101 (life insurance), and IRC §1014 (basis).

Cash Bequests

Cash from a will is not taxable income to the beneficiary under IRC §102(a). Whether the check is $5,000 or $5 million, the beneficiary does not report it on Form 1040. Any interest the cash earns after the beneficiary receives it is taxable in the normal way.

The consequence of treating cash bequests as income is overpayment and a painful amended return. The beneficiary should still keep the executor’s distribution letter and the Schedule K-1 showing that the distribution was a non-taxable principal distribution.

Example: Aisha inherits $250,000 in cash from her aunt’s will in 2026. She reports nothing on her Form 1040 for the bequest itself. When she invests the cash and earns $8,000 in interest, she reports the $8,000 — not the $250,000.

A common misconception is that large cash bequests must be reported like lottery winnings. They do not.

Inherited Real Estate

Inherited real estate gets a stepped-up basis to fair market value at death, per IRC §1014. The beneficiary owes no tax on the inheritance itself, but will owe capital gains tax on any appreciation after the date of death when the property is sold. Rental income received after death is ordinary income to the beneficiary.

The consequence of not ordering a date-of-death appraisal is losing the step-up evidence. Without an appraisal, the IRS can challenge the basis, and the beneficiary may have to rely on less reliable comparables.

Example: Priya inherits her father’s rental duplex worth $900,000 at his death in 2026. She collects $36,000 in rent that year, which she reports on Schedule E. When she sells the duplex for $950,000 in 2028, she owes capital gains tax only on the $50,000 appreciation.

A common misconception is that the beneficiary inherits the decedent’s depreciation recapture liability. They do not — depreciation recapture resets with the step-up.

Inherited Retirement Accounts

Traditional IRAs, 401(k)s, and other pretax retirement accounts are the most complex inherited assets. They are IRD assets under IRC §691, so every dollar withdrawn is taxed as ordinary income. They do not receive a step-up in basis.

Under the SECURE Act and SECURE 2.0, most non-spouse beneficiaries must empty the account within 10 years of the original owner’s death. The final IRS regulations published in 2024 confirm that beneficiaries of owners who died after their required beginning date must also take annual RMDs during the 10-year window.

Example: Marcus, age 45, inherits his mother’s $600,000 traditional IRA in 2026. He must withdraw the entire balance by 2036 and pay ordinary income tax on every withdrawal. If he is in the 32% bracket, his total federal tax could approach $192,000.

A common misconception is that a non-spouse beneficiary can roll the inherited IRA into their own IRA. They cannot — only a surviving spouse can do that under IRC §408(d)(3).

Roth IRAs and Roth 401(k)s

Inherited Roth accounts are generally tax-free on withdrawal, provided the account is at least five years old at the original owner’s death. The 10-year distribution rule still applies to most non-spouse beneficiaries, but the distributions themselves carry no income tax.

The consequence of missing the five-year seasoning is that earnings (not contributions) become taxable. The consequence of missing the 10-year deadline is a 25% excise tax under IRC §4974, reduced to 10% if corrected within the correction window.

Example: Kenji inherits a $300,000 Roth IRA from his father in 2026. The account was opened in 2010, so it easily meets the five-year rule. He can withdraw the full $300,000 tax-free at any point before 2036.

A common misconception is that Roth inheritances escape all rules. They escape income tax, not the 10-year payout rule.

Life Insurance Proceeds

Life insurance death benefits paid to a named beneficiary are income-tax-free under IRC §101(a). However, any interest paid with a delayed lump sum or installment option is taxable. Life insurance proceeds are included in the decedent’s gross estate for estate tax purposes if the decedent owned the policy or held “incidents of ownership” under IRC §2042.

The consequence of naming the estate rather than a person as beneficiary is a double problem: the proceeds enter probate, and they are fully includable in the estate for estate tax. Naming an individual or an irrevocable life insurance trust (ILIT) can sidestep both issues.

Example: Sarah receives a $1 million life insurance payout from her husband’s policy in 2026. She pays no federal income tax on the $1 million. She does owe tax on the $12,000 of interest the insurer adds while processing the claim.

A common misconception is that life insurance is always estate-tax-free. It is not — it is income-tax-free, but estate-tax-includable if the decedent owned the policy.

Annuities

Inherited annuities mix IRD with after-tax basis. The earnings portion is taxable as ordinary income; the contribution portion (if non-qualified) returns tax-free. Non-spouse beneficiaries generally must follow either a five-year payout rule or the 10-year rule, depending on whether the annuity is qualified.

Example: Rosa inherits a $400,000 non-qualified annuity with $150,000 in after-tax contributions. The $250,000 of growth is taxable income when paid out; the $150,000 of basis returns tax-free.

The consequence of lump-summing a large annuity is a spike into the top income tax bracket. Stretching withdrawals often saves thousands.

Three Popular Inheritance Tax Scenarios

Below are the three most common fact patterns I see beneficiaries navigate, drawn from IRS guidance, state revenue department publications, and common estate planning practice.

Scenario 1: Spouse Inheriting Everything

Transfer	Tax Outcome
Unlimited marital deduction under IRC §2056	Zero federal estate tax on transfers to a U.S.-citizen spouse
Portability election on Form 706	Surviving spouse inherits unused exemption (DSUE)
Spousal IRA rollover	Spouse can treat inherited IRA as their own

Scenario 2: Adult Child Inheriting a House and IRA

Transfer	Tax Outcome
House with stepped-up basis	No income tax on inheritance; capital gains only on post-death appreciation
Traditional IRA under 10-year rule	Ordinary income tax on each withdrawal within 10 years
State inheritance tax (if applicable)	0–4.5% in PA, NJ, KY, NE, MD; zero elsewhere

Scenario 3: Non-Relative Beneficiary in a Death-Tax State

Transfer	Tax Outcome
Cash bequest to friend in Pennsylvania	15% PA inheritance tax on Form REV-1500
Cash bequest to friend in Nebraska	15% Nebraska inheritance tax on amounts over $25,000
Cash bequest to friend in California	No inheritance tax — California does not impose one

Three Named-Person Examples

Example 1: Jenna Inherits $3 Million From Her Mother in Texas

Jenna’s mother dies in 2026 with a $3 million estate consisting of a paid-off home, a brokerage account, and cash. The estate is well under the $15 million federal exemption, so no federal estate tax applies. Texas has no state estate tax or inheritance tax, so Jenna pays zero on the inheritance itself. She receives a stepped-up basis on the home and brokerage assets under IRC §1014.

Example 2: Marcus Inherits an IRA in Oregon

Marcus’s father dies in 2026 leaving a $2.5 million estate that includes a $900,000 traditional IRA. Because Oregon taxes estates above $1 million under ORS 118, the estate owes Oregon estate tax on $1.5 million at rates up to 16%. Marcus also owes federal income tax on every IRA withdrawal under the SECURE Act 10-year rule.

Example 3: Priya Inherits From an Uncle in New Jersey

Priya receives $500,000 from her uncle’s will in New Jersey. Nieces and nephews are Class D beneficiaries under New Jersey inheritance tax law, which means she owes 15% on the first $700,000 and 16% above that. Priya’s bill is about $75,000, filed on New Jersey Form IT-R.

Mistakes to Avoid

• Forgetting the date-of-death appraisal — without it, the IRS can deny your step-up in basis and recompute capital gains from the decedent’s original cost.
• Missing the nine-month Form 706 deadline — triggers penalties under IRC §6651 of up to 25% of unpaid tax.
• Rolling an inherited IRA into your own IRA as a non-spouse — an impermissible transaction that makes the full account immediately taxable.
• Naming your estate as life insurance beneficiary — forces the proceeds into probate and makes them fully estate-taxable under IRC §2042.
• Ignoring state inheritance tax filings — each of the six inheritance-tax states has its own form, its own deadline, and its own penalty schedule.
• Skipping the portability election on Form 706 — forfeits the deceased spouse’s unused exemption (DSUE), which can mean millions in lost shelter.
• Treating cash bequests as taxable income — leads to overpayment and an amended return on Form 1040-X.
• Failing to claim the IRD deduction under IRC §691(c) — leaves money on the table when estate tax has already been paid on IRD assets.
• Holding appreciated stock too long after death and losing the alternate valuation election under IRC §2032, which must be made on the first Form 706 filed.

Do’s and Don’ts

• Do get a qualified appraisal on every non-cash asset as of the date of death.
• Do file Form 706 even if no tax is due, to preserve portability of the deceased spouse’s unused exemption.
• Do keep every Schedule K-1 and estate distribution letter for at least seven years.
• Do separate IRD assets mentally and on paper, because they carry income tax while the rest of the estate usually does not.
• Do consult a CPA familiar with both federal and state death taxes, especially in Maryland, Washington, Oregon, and the six inheritance-tax states.
• Don’t assume “no federal estate tax” means “no state tax.” Oregon, Massachusetts, and Washington all have much lower thresholds.
• Don’t cash out an inherited IRA in one lump sum without modeling the bracket impact.
• Don’t commingle inherited funds with marital funds if you want to keep them as separate property.
• Don’t gift appreciated assets during life that you could instead bequeath at death, because carryover basis costs your heirs the step-up.
• Don’t ignore generation-skipping transfer (GST) tax under IRC §2601 when leaving significant assets to grandchildren.

Pros and Cons of Receiving Money Through a Will

• Pro — The bequest itself is almost always free of federal income tax under IRC §102.
• Pro — Capital assets receive a stepped-up basis, which can erase decades of gain.
• Pro — Community property spouses get a full double step-up under IRC §1014(b)(6).
• Pro — Life insurance proceeds to a named beneficiary are income-tax-free under IRC §101.
• Pro — The federal exemption of roughly $15 million in 2026 shelters 99.9% of estates from federal estate tax.
• Con — IRD assets like traditional IRAs and annuities are fully taxable as ordinary income.
• Con — Six states still charge inheritance tax directly against the beneficiary.
• Con — Twelve states + D.C. have lower estate tax thresholds that trap middle-class estates.
• Con — The probate process can delay access to funds for months or years.
• Con — Naming the wrong beneficiary (e.g., your estate instead of a person) can turn tax-free proceeds into taxable, probatable assets.

Key Forms and Filings

Every inheritance involves paperwork. The executor handles most of it, but beneficiaries should know what to expect and what to keep.

Form 706 is the federal estate tax return. It is due nine months after death, with a six-month extension available on Form 4768. Form 1041 is the estate’s income tax return, required if the estate earns more than $600 of income during administration. Beneficiaries receive Schedule K-1 (Form 1041) showing their share of taxable income passed through.

State forms vary widely. Pennsylvania uses REV-1500, New Jersey uses IT-R and IT-NR, and Maryland uses both estate and inheritance tax forms from the Register of Wills.

Key Court Rulings Every Beneficiary Should Know

Several U.S. Supreme Court and Tax Court decisions shape how inheritances are taxed today. Understanding them helps explain why certain rules look the way they do.

In Connelly v. United States (2024), the Supreme Court held that life insurance proceeds a closely held corporation receives on a deceased shareholder are included in the fair market value of the corporation for federal estate tax, without an offsetting redemption obligation. The ruling reshaped buy-sell agreement planning nationwide.

In Estate of Clack (1996), the Tax Court clarified QTIP trust rules under IRC §2056(b)(7) and allowed a contingent power of appointment without disqualifying the marital deduction.

In Commissioner v. Estate of Bosch (1967), the Supreme Court held that federal courts are not bound by lower state court decisions when determining property rights for federal estate tax purposes. Executors still often need a state court ruling, but the IRS can look past it.

Generation-Skipping Transfer Tax

The generation-skipping transfer (GST) tax under IRC §2601 adds a second 40% layer of tax on transfers to grandchildren or more remote descendants. The GST exemption for 2026 mirrors the estate tax exemption at roughly $15 million per person.

The consequence of skipping generations without allocating GST exemption is brutal. A $10 million bequest to a grandchild with no exemption allocation can trigger an extra $4 million of GST tax on top of estate tax, for a combined effective rate exceeding 60%.

Example: Helen leaves $5 million directly to her granddaughter in 2026. Helen’s executor allocates $5 million of GST exemption on Schedule R of Form 706. No GST tax is due because the exemption absorbs the full transfer.

A common misconception is that GST applies only to trusts. It also applies to direct bequests to “skip persons.”

How State Residency Affects Inheritance Taxation

The decedent’s domicile at death — not the beneficiary’s residence — usually determines which state’s death tax applies. Real estate is taxed where it sits, regardless of the decedent’s domicile. This creates planning opportunities and traps.

The consequence of a sloppy domicile change is double taxation. States like New York aggressively challenge domicile changes to Florida, and losing that challenge can cost millions. Keeping a domicile file with voter registration, driver’s license, homestead exemption, and physical presence records is essential.

Example: Walter moves from New York to Florida in 2024 and dies in 2026 with a $10 million estate. New York challenges his domicile, pointing to his Manhattan apartment he kept. If New York wins, Walter’s estate faces New York estate tax above the $6.94 million NY exemption.

FAQs

Is money inherited from a will taxable as income?

No. Cash and property received as a bequest are excluded from gross income under IRC §102(a), so the beneficiary does not owe federal income tax on the inheritance itself.

Do I have to report an inheritance on my tax return?

No. A pure cash or property bequest is not reported on Form 1040, but IRD items like inherited IRA withdrawals and post-death interest must be reported.

Does the federal government tax inheritances directly?

No. The federal government taxes the estate through Form 706 before distribution. Beneficiaries receive whatever remains after federal estate tax is paid by the executor.

Are life insurance proceeds from a will taxed?

No. Death benefits paid to a named beneficiary are income-tax-free under IRC §101, though they can be included in the decedent’s gross estate if the decedent owned the policy.

Is an inherited IRA taxable?

Yes. Traditional IRA withdrawals are taxable as ordinary income under IRC §691, and most non-spouse beneficiaries must empty the account within 10 years under the SECURE Act.

Do I owe capital gains tax on an inherited house?

No, not on the inheritance itself. You get a stepped-up basis equal to fair market value at death under IRC §1014, and only post-death appreciation is taxable when you sell.

Does my state charge inheritance tax?

Yes, if you live in Kentucky, Maryland, Nebraska, New Jersey, or Pennsylvania. Iowa is phasing out its inheritance tax, and no other state charges one.

Is the federal estate tax exemption really $15 million in 2026?

Yes. The One Big Beautiful Bill Act made the elevated exemption permanent and indexed for inflation, putting the 2026 figure near $15 million per individual.

Can a surviving spouse avoid federal estate tax entirely?

Yes. The unlimited marital deduction under IRC §2056 eliminates federal estate tax on transfers to a U.S.-citizen spouse, and portability preserves the deceased spouse’s unused exemption.

Do I have to pay tax if I disclaim an inheritance?

No. A qualified disclaimer under IRC §2518 treats the property as never received, so no income or transfer tax falls on the disclaiming beneficiary, provided it is made within nine months.

Are Roth IRA inheritances tax-free?

Yes, generally. Qualified distributions from an inherited Roth IRA are income-tax-free, though most non-spouse beneficiaries still must empty the account within 10 years.

Does California tax inheritances?

No. California has neither an estate tax nor an inheritance tax, making it one of the most tax-friendly states in the country for passing wealth at death.