Does Inheritance Count As Income? Transferring Wealth to the Next Generation

Understanding the tax implications of inheritance is a critical topic for families with significant assets. We offer guidance on the key issues facing individuals and families in this situation.

Answering a key question - does inheritance count as income - requires an understanding of tax laws and their implications on inherited wealth. There are also considerations other than just income tax when planning for an inheritance. At the core is the distinction between the various types of tax that may apply when wealth is transferred. These categories include income tax, estate tax, inheritance tax, as well as gift tax*.

Income Tax

Federal tax laws do not consider most inherited assets to be taxable income. This means that when an individual inherits assets, whether in the form of cash, stocks, real estate, or other valuable properties, the assets are not subject to federal income taxes at the time of transfer.

Certain assets and untaxed income are considered “income in respect of a decedent” (IRD). These are assets and income sources that would have been taxed as ordinary income if the decedent had not passed away. A few of the potential IRD assets are: uncollected salaries, bonuses, deferred compensation, pension income, 401k, SEP, Keogh, and the deductible portion of IRAs. These assets are taxed as ordinary income at the time the income is received or distributed by the beneficiary. The beneficiary in some situations can receive an income tax deduction for any estate taxes paid by the decedent’s estate that was attributable to the IRD assets.

The income that inherited assets generate after they are inherited, such as dividends from stocks, rent from properties, or interest from cash accounts, is considered taxable income under Federal law.

Estate Tax

Federal estate taxes are assessed on the entire value of the decedent's estate before the distribution of any assets to heirs. The estate tax ranges from rates of 18% to 40% and generally only results in taxes due on assets over $13.61 million in 2024. One caveat to be aware of is that the current estate tax exemption is temporary and only applies through the end of 2025. Unless Congress makes these changes permanent, after 2025 the exemption will revert to $5 million adjusted for inflation which is estimated to be about $7 million.

This federal tax can significantly reduce the estate's value, affecting the inheritance passed on to the heirs. Some states impose additional estate taxes. In most, but not all, cases, these taxes are progressive meaning the tax rate increases with the value of the estate.

Federal and state estate tax rates make it imperative for individuals with significant assets to engage in estate planning strategies that minimize this tax's impact. Techniques such as establishing trusts, gifting strategies, making charitable donations, and utilizing life insurance policies can be effective in reducing a taxable estate and preserving more wealth for heirs.

For answers to commonly asked questions, see IRS Guidance on Estate Taxes.

Inheritance Tax

Inheritance taxes are taxes levied by states and are not very common. Only six states collect inheritance taxes: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. This tax is assessed on the value of the assets received by a beneficiary, and its impact can vary depending on the relationship between the decedent and the beneficiary, with closer relatives often enjoying lower tax rates or exemptions. Also, the tax is paid by the beneficiary and not the estate.

In recent years, there has been a trend of states moving away from estate or inheritance taxes or raising their exemption levels. For details, see Does Your State Have a State Estate or Inheritance Tax?

Gift Tax

Gift taxes are imposed on the transfer of assets from one individual to another without receiving anything, or less than full value, in return. The IRS allows individuals to give a certain amount to others each year without triggering the gift tax, known as the annual gift tax exclusion. For 2024, the exclusion amount is $18,000 per person. This strategy can be used to transfer wealth to heirs gradually during the lifetime of the donor, which reduces the size of the estate and potentially lowers the estate tax burden upon the donor's death.

Moreover, there is also a lifetime gift tax exemption, which is a cumulative limit on the amount that an individual can give over their lifetime without incurring gift taxes. Strategic use of both the annual exclusion and the exemption may allow for significant estate tax-savings opportunities. High net worth individuals may leverage these rules to transfer assets to their heirs tax-efficiently, such as funding educational expenses or contributing to a family member's home purchase, further reducing the taxable estate. Prior to gifting assets you should always consult your tax advisor.

Does inheritance count as income: the importance of high net worth financial planning^*

Financial planning is crucial for high net worth families looking to navigate the complexities of generational wealth transfer and faced with questions like the one we focus on here – does inheritance count as income. Legal, tax, and financial guidance can help wealthy families develop a cohesive estate plan and lead to a more efficient and tax-effective transfer of wealth. Regular reviews and adjustments to the estate plan are necessary to respond to changes in tax laws, family circumstances, and financial goals.

Read more of our guidance in a recent Insights blog, The Ultimate Guide to High Net Worth Financial Planning.

Understanding the interplay between income, gift, and estate taxes is one cornerstone of estate planning. By strategically managing assets during their lifetime and at death, affluent individuals can reduce the tax burden on heirs so that a larger portion of their wealth is preserved and passed on according to their wishes. The strategic use of wills, trusts, and other legal structures can help ensure efficient wealth transfer. This process can determine which assets will be passed on, how this process will be structured to minimize tax liability, and the timing of these transfers to benefit from various tax thresholds and exemptions.

Beyond the question with which we started - does inheritance count as income – wealthy families may have other questions we can help answer. For more information on transferring wealth, read our recent blog series on How to Prepare for the Great Generational Wealth Transfer.

Dedicated, specialist expertise

In a landscape where regulations are constantly evolving, the guidance of financial experts can be crucial. “Does inheritance count as income?” may be only one of many questions a family may be asking related to their wealth transfer. A family’s specific circumstances related to estate planning and inheritance include factors like the size and composition of an estate, future financial goals, and the needs of heirs. Wealthy families often face more complex financial questions - dealing with assets in multiple jurisdictions, understanding the financial implications of various investment vehicles, or planning charitable contributions – that require more sophisticated guidance.

The relationship with experts in this field requires a continuous advisory partnership. As your financial situation evolves - whether through the acquisition of new assets, changes in family structure, or shifts in regulations and legislation – we are here to provide ongoing support. This continuous engagement ensures that estate planning remains aligned with your objectives and responsive to external changes, securing your legacy and the financial well-being of future generations.

Let us help with your wealth planning needs

This article started with one key question that many people ask – does inheritance count as income. Beyond answering that specific question, we outline the more complex estate planning needs of high net worth individuals and families that should be considered. So whatever your question may be around transferring wealth, capitalizing on the opportunities that exist for high net worth individuals and addressing the challenges faced requires guidance from the right wealth manager and a trusted team of experts.

Your Hancock Whitney Wealth Management team has deep experience working with the complex planning needs of high net worth investors and is here to answer questions, provide insights and guide you on the path to financial freedom.

*Please consult your tax professional.

Source:

H&R Block. "Is Your Inheritance Considered Taxable Income?" https://www.hrblock.com/tax-center/income/other-income/is-your-inheritance-considered-taxable-income/

The information, views, opinions, and positions expressed by the author(s), presenter(s), and/or presented in the article are those of the author or individual who made the statement and do not necessarily reflect the policies, views, opinions, and positions of Hancock Whitney Bank. Hancock Whitney makes no representations as to the accuracy, completeness, timeliness, suitability, or validity of any information presented.

This information is general in nature and is provided for educational purposes only. Information provided and statements made should not be relied on or interpreted as accounting, financial planning, investment, legal, or tax advice. Hancock Whitney Bank encourages you to consult a professional for advice applicable to your specific situation.

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