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By: Nathan Hannah
DeConcini McDonald Yetwin & Lacy, P.C.
Tucson, Arizona

I have addressed in previous reports the tax consequences of gifts and inheritances, but the subject is worth revisiting because I get asked about it frequently.

There is a common misconception that inheritances are automatically taxable. Although the reasoning behind that misconception is usually not clearly articulated, or is unexpressed, I think it originates with the notion that an inheritance is income, and is therefore subject to the income tax, like wages. People don’t, however, seem to have the same notion about gifts. In other words, people don’t generally assume that gifts are taxable.

Why am I talking about gifts and inheritances as if they are the same thing? I am doing it because, for this purpose, they are the same thing. When you receive something from someone’s estate, it’s a gift.

To illustrate the distinction between gifts and income, think about this example. If you get a check for $100 from your grandmother for Christmas, you don’t include it on your income tax return, do you?

When you put it that way, the distinction seems fairly obvious. The gift is not taxable income.

But when it’s an inheritance from grandma rather than a check from her at Christmas, I guess it’s not so obvious. It’s a question I get asked fairly regularly, or rather an assumption that is expressed something along the lines of: I don’t want my children or grandchildren to have to pay tax on the money I leave them in my will.

Maybe the assumption that an inheritance will be taxed is actually founded on the fact that inheritances are taxable in some states (but not in Arizona), and estates and gifts are subject to the federal estate and gift taxes if they are large enough. Those taxes are different from the income tax, however. Inheritance, estate, and gift taxes are taxes on the transfer of property (usually payable by the transferor), not on the receipt of income (payable by the recipient).

The Internal Revenue Code is pretty clear on the question of whether or not a gift is taxable income. Section 102(a) says:

(a)      General rule. Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.

The regulation that explains that code section is also pretty direct:

Reg. §1.102-1 (a) General rule. Property received as a gift, or received under a will or under statutes of descent and distribution, is not includible in gross income, although the income from such property is includible in gross income.

So your inheritance is no different from the $100 check from your grandmother, for tax purposes. It’s a gift, not income.

When I was a kid, my Aunt Jerry (her real name was Geraldine, and she was born in 1900) always gave me and my siblings each a card with a crisp, new $5 bill in it for Christmas. They were the kind of cards that had a pocket for a bill, with an opening that showed the face of the president on the bill. I think you have to be over 50 to remember them. I’m sure she made a special trip to the bank to get those cards and the $5 bills.

I still think that was a very generous gift. I never worried about whether to include it on my tax return, though, probably because I didn’t have any income.

The main concepts I’m trying to get across here are these: (1) inheritances and gifts are not income; and (2) federal estate and gift taxes are taxes on the transfer of money or property, paid by the giver. Some states have inheritance taxes that may be at odds with these concepts, but I’m ignoring those because there is no inheritance tax in Arizona. Just remember that in general, if an inheritance is taxable, it’s taxable because the transfer triggers the tax, not because the transfer is income to the recipient.


Do You Really Want To Make Your Children’s And
Grandchildren’s Inheritance Conditional On Them Doing Thing Your Way?

In thirty years as a lawyer, I have not talked with very many people about planning their estates who said they wanted to make gifts to their progeny conditional on the progeny’s future actions. The only exception is educational achievements, which are actually a pretty common condition for releasing control of a gift (but not the making of the gift itself). I can’t recall anyone I have talked with ever even suggesting that a gift should be conditioned on marrying within the family’s faith, for example. I think those kinds of conditional gifts can have detrimental unintended effects.

When someone does suggest that their gifts should be conditioned on specific future events or activities, I typically simply point out that it’s impossible to predict the future, and equally impossible to even know what circumstances might exist at the future time when those conditions will have to be applied. Usually, the person will agree that they don’t want to put the people who will administer their estate or trust, and who therefore would have to enforce those conditions, in what could be, at best, an uncomfortable position.

My motto, in estate planning and just about everything else, is: keep it simple.