When You Inherit Money From an Aunt, Do You Need to Pay Federal Income Tax?

Inheriting money can be wonderful; paying taxes on your inheritance is a lot less enjoyable. If your aunt leaves you money, you may have to pay inheritance tax and possibly income taxes, depending on the nature of your inheritance. You're more likely to pay taxes on an inheritance from an aunt or uncle than if it came from a parent or spouse.

There are multiple ways your aunt or other relatives can leave you money. Your aunt could name you the beneficiary of an IRA, 401k or a living trust; she could leave you the contents of a bank account; or your inheritance could be the proceeds of your aunt's life insurance or a saving bond. Federal tax law treats different inheritances differently; so do state tax laws, which vary among the 50 state governments.

Most heirs don't have to worry about paying income tax on inherited money, financial writer Dorothy Rosen states on the Bankrate website: Your aunt would have paid taxes on her income when she earned it, so it doesn't get taxed again. Money in a 401k or IRA is an exception because it's deposited free of income tax (pretax). You'll have to pay income tax on any money you withdraw from your aunt's account, unless you roll it over into another retirement account.

If your aunt's estate is subject to federal estate tax, that could put a 45 percent bite on your inheritance, the Nolo legal website states. Starting in 2011, however, only estates worth $1 million and up will be subject to the tax, though Congress has changed the cut-off amount several times in the past. Some forms of inheritance are safe from the estate tax, such as money you receive from your aunt's life insurance. The estate will pay the tax during probate, before you receive your inheritance.

A number of states impose estate tax on deceased residents; some of them set it at levels which may hit smaller estates than the federal government and take out more money, Bankrate's Kay Bell states online. A small number of states also impose an inheritance tax in addition to an estate tax. If your aunt lived in Pennsylvania, for example, you'd be taxed 15 percent on your inheritance; unlike estate taxes, you, not the estate, have to pay the bill.