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 your relationship 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 2022, the federal estate tax is levied at a maximum rate of 40% after $12.06 million exemption (less any amount of the exemption used during the deceased's lifetime). 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 estate and/or 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, for traditional IRAs must begin required minimum distributions (RMDs) after age 72. RMDs from a traditional IRA must be taken annually thereafter and are taxed as ordinary income for federal income tax purposes (state and local income tax can vary). For Roth IRAs treated as the spouse's own Roth IRA, no RMDs would be required for the spouse's lifetime (but RMDs would be required for a nonspouse beneficiary who inherits the spouse's Roth IRA as described below).
In contrast, nonspouses who inherit IRAs may not delay RMDs until they reach age 72. Nonspouses may transfer the IRA assets into an IRA held in the nonspouse's name (an "inherited IRA"). In general, an inherited IRA must be completely distributed within 10 years following the year of the original account owner's death (and RMDs must be taken annually if the original account owner died after age 72Footnote 1). In some cases, eligible beneficiaries may take annual distributions, with the amount determined by the account balance and the beneficiary's life expectancy. The latter strategy may permit a larger portion of the account to remain invested and subsequently provide the potential to grow tax deferred. The tax treatment of distributions from an inherited IRA depend on the type of assets in the inherited IRA; if the inherited IRA has traditional assets, the distributions are taxed as ordinary income for federal income tax purposes, whereas if the inherited IRA has Roth IRA assets, distributions are federally income tax-free. State and local income tax treatment may vary.
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 retirement plan, you may want to contact the sponsoring employer to determine rules affecting beneficiaries.
Estate and 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.

Footnote 1 If you delay your first RMD to the year after you turn age 72, you will be required to take two RMDs in that calendar year. The requirement to take the RMDs each year during the 10-year period if the original account owner died after age 72 (the required beginning date) is from an interpretation of Code Section 401(a)(9) as applied in Proposed Treasury Regulation Section 1.401(a)(9)-5(d)(1). While the Proposed Regulation can be relied on by a taxpayer at this time, the Treasury Department may choose to rescind or revise the Proposed Regulation before the Proposed Regulation is finalized. Contact your legal and/or tax advisor for more information.

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