How Are Stocks Inherited?

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If someone dies and names you as a beneficiary of her stock, you become the new legal owner. The Internal Revenue Service has structured the tax provisions of inherited stock to make things simpler for heirs. These provisions can also result in a huge tax break. As an heir, you won't face any immediate tax consequences, although you may face a tax bill down the road.

Process

Stocks are transferred after death in one of two ways. If the decedent has an estate-planning document, such as a trust or a will, that document will specify who should receive the assets of the estate. If a person dies intestate, or without any such documentation, the state in which the decedent lived will conduct a probate case to determine who should receive any property. Once you receive inherited stock, it is yours to do with as you please. You can sell the shares, gift them to someone else, or simply hold them, the same as if you bought the shares yourself.

Tip

  • If you are a named beneficiary of an estate, the executor of the estate will contact you regarding your inheritance and how to proceed in getting it to you.

Income Tax

As an heir, you won't face any federal income tax on any distributions you receive, including shares of stock. You might owe a small state tax if you're a nonspousal, close relative of the decedent in a handful of states. One instance in which you might face an income tax bill is if the decedent's estate generates any income from its assets before they are distributed. For example, if the decedent's stocks pay out a dividend before they are distributed, you'll have to pay tax on that income, which will be itemized on a tax form you'll receive from the executor of the estate. However, you won't owe tax on the distribution of the stock shares themselves.

Warning

  • You may want to consult a tax adviser if you receive an inheritance of any kind to make sure you don't overlook any taxes that are due. The IRS doesn't consider ignorance of the law an excuse when it comes to paying your taxes.

Capital Gains Tax

One of the most important benefits of inheritance tax law applies to capital gains. Capital gains are generated when you sell a stock for a higher price than you paid for it, which is known as your cost basis. Since you didn't buy stock that you inherit, your cost basis becomes the price of the stock on the day of the decedent's death. In many cases, this so-called "step-up" in basis generates a tax windfall. Say that the decedent bought IBM stock 10 years ago at $84 per share. If the current stock price is $168, the decedent would have to pay tax on that 100 percent gain if he or she sold the shares while still alive. However, as an heir, your cost basis becomes $168 per share. From a tax perspective, the $84-per-share gain essentially vanishes. The only capital gains tax you'll pay is if you keep the shares and later sell them at a price above $168.

Estate Tax

Before you can inherit stock, the decedent may have to pay estate tax. While the estate tax typically only affects a small number of taxpayers every year, those who are liable for the tax can face rates as high as 40 percent. As of 2015, if a decedent had an estate valued at more than $5.43 million per person, he would incur estate tax. This number is adjusted annually for inflation. However, as an heir you don't have to worry about paying the estate tax, since the decedent is the one responsible.

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