I received an inheritance: How is this money taxed?

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The amount of federal estate tax typically is determined by the amount of assets within the estate and the relationship of the beneficiaries to the deceased.

Spouses and nonspouses

Spouses typically may inherit an unlimited amount of assets free of federal estate taxes. Estates bequeathed to nonspouses, in contrast, may be subject to federal estate taxes and state inheritance taxes depending on the level of assets within the estate.
For nonspousal heirs, in 2019, the federal estate tax is levied at a maximum rate of 40% after approximately $11.4 million exclusion. For estate tax purposes, heirs typically value assets at the fair market value on the date of the deceased's death.
Note that some states impose inheritance tax thresholds and tax rates that differ from those at the federal level. An estate planning attorney can advise you on taxation issues in your area.

Special rules for retirement accounts

In most instances, spouses who inherit individual retirement accounts (IRAs) may treat the IRA as their own and must begin required minimum distributions (RMDs) after age 70½. RMDs, which are taken annually thereafter, are taxed as ordinary income.
Nonspouses, in contrast, may not delay RMDs until they reach age 70½. Nonspouses may transfer the IRA assets into an inherited IRA titled specifically for an heir. When taking distributions, which are taxed as ordinary income, a nonspouse has two options. As one option, the nonspouse may empty the account over a five-year period. A second option available to a nonspouse is to take annual distributions, with the amount determined by the account balance and the heir's life expectancy (or the life expectancy of the plan owner if longer and if RMDs have already begun). The latter strategy may permit a larger portion of the account to remain invested and subsequently provide the potential to grow tax deferred.
Similar rules apply to employer-sponsored retirement plans, such as 401(k) plans or 403(b) plans. If you inherit assets that are within an employer-sponsored plan, you may want to contact the sponsoring employer to determine rules affecting beneficiaries.
Inheritance taxes are a complicated issue. When determining how they apply to your situation, an experienced estate planning lawyer could be your most valuable asset.

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