Estates and Trusts

Maybe, but maybe not.

It depends on what the 1041 (K-1) shows. When someone dies, an estate is born to handle distribution of the person's property. If income is earned on an asset before it is passed on to the new owner, for example, someone has to pay tax on that income.

The estate can pay the tax or, if it passes that income on to a beneficiary, the beneficiary pays the tax. That's the kind of income that's reported on a 1041 (K-1) form. The form is also used to report other kinds of income, deductions and credits that are passed through to a beneficiary -- to help you report the correct amounts on your tax return. To make your task easier, TurboTax asks for these items in its interview. You do not include the 1041 (K-1) with your tax return when you file.

No, the cash your father left you in his will is tax-free.

You don't owe tax when you inherit the stock. You only owe tax when you sell the stock.

.And you might not owe any tax then, either. When you inherit stock, your "tax basis" in the securities -- that is, the value from which you will determine your gain or loss -- is the value of the stock on the date of your uncle's death. So you would owe capital gains tax only on the amount of any appreciation after your uncle's death. If the stock falls in value before you sell it, in fact, you'd get to deduct a tax-saving capital loss.

No. While cash, stock or real estate are not taxed as income when you inherit them, other assets come with a tax string attached -- you're taxed on part or all of the value, just like the original owner would have been if he or she had lived. This rule comes into play for what's called "income in respect of a decedent."

Common examples of inheritances of this type are savings bonds, annuities, IRAs and other retirement plans such as 401(k)s. If you inherit savings bonds, for example, you'll owe tax on all interest that accrued during the life of the previous owner; if you inherit an annuity, the same portion of each payment will be tax-free and the same portion taxable as if the original owner were receiving the payments. This same rule applies if you are the beneficiary of a traditional IRA, as discussed later.

The principal on the bonds is tax-free, but you will owe tax on some or all of the accrued interest.

If your mother was like most taxpayers and did not pay tax on the interest as it accrued each year, the executor of her estate can elect to have the estate pay income tax on the interest earned before your mother's death. If so, that wipes out your tax liability for that interest when you cash in the bonds.

On interest that accrues after her death, you have a choice of paying tax each year on the interest or postponing the tax bill until the bonds are cashed. If your mother's estate doesn't pay income tax on the interest, you have the same choice for all of the accrued interest on the bonds: Pay tax now or postpone the bill until you cash in the bonds.

If your mother paid tax each year as the interest accrued on the bonds, you only need to report the interest earned after her death.

It depends. If it's a Roth IRA, the inheritance is tax-free. If it's a traditional IRA, however, you will owe income tax as you withdraw money from the account. You have two choices on how to do that:

You have the same two withdrawal choices we just noted, plus one significant one that's only available to a beneficiary who is the spouse of the IRA owner.

You can elect to treat the IRA as your own IRA, rolling the money over to an IRA in your name. By doing so, you can delay taking distributions from the IRA until you reach age 70½.

Actually, there's an easily-overlooked deduction when you inherit an IRA.

If the estate was large enough to be subject to federal estate tax, you can deduct the portion of the federal estate tax attributable to the IRA. For 2008, estate taxes kick in when an estate has assets of more than $2,000,000 that go to persons other than the surviving spouse.

Say you inherited a $50,000 IRA, which, because it was included in your mother's taxable estate, boosted the estate tax bill by $22,500. Although you have to pay tax as you pull the money out of the IRA, you also get an income tax deduction for that $22,500.

If you pulled the full $50,000 out in 2008, you get the full deduction on your 2008 return. If you withdrew just $5,000 (one-tenth of the account), you deduct 10% of the estate tax bill attributable to the IRA: $2,250 in this example.

You must file a tax return for the trust if it is not required to distribute all of its income to your son each year, or if its gross income is $600 or more.

If you are the beneficiary of a trust, you are responsible for paying tax on your share of the trust income that's distributed to you. The Schedule K-1 you receive details your share of the trust's income, deductions and credits, which you report on your tax return. The K-1 tells you where to report each item. TurboTax does this for you automatically.

Trusts have their own income tax rate schedule. To prevent trusts from being used to shelter large amounts of income, higher tax rates kick in far sooner than for individuals.

For example, if a trust has undistributed taxable income of more than $2,200, it is in the 25% tax bracket in 2008. Joint filers don't reach that bracket until they have more than $65,100 of taxable income, and singles need more than $32,250 of income to be in the 25% bracket. Trusts reach the 35% tax bracket with undistributed taxable income of more than $10,700, while individuals need to have more than $357,700 of taxable income to be taxed at the highest rate.

TurboTax Deluxe helps you find all the money-saving tax deductions related to your estate and trust income.

Updated for tax year 2008