Must a Child File a Federal Tax Form for an Inheritance?
The Internal Revenue Service doesn't allow much to go untaxed, but some inheritances are an exception. When a child inherits, an additional rule applies that may exempt him from taxation – he only has to report and pay taxes on unearned income that exceeds $950. As far as the IRS is concerned, unearned income includes taxable interest and some trust distributions. Depending on the nature of his inheritance and the amount, your child may be able to collect tax-free.
Your child can inherit land, real estate, stock or cash without paying income tax, at least on the principal value. These types of inheritances are never taxable, regardless of the age of the beneficiary, so your child does not have to file a tax return or report them. The key word, however, is "principal." This typically means the value of the gift at the time of the inheritance. What you or your child do with the inheritance after he receives it can affect its tax-free status.
An otherwise non-taxable bequest can become taxable if you or your child ultimately sell it. If you realize a profit, capital gains taxes come due. The IRS considers capital gains as part of your child's unearned income, subject to the $950 rule. His basis in the inherited property is its value as of the date of the decedent's death, plus the cost of any improvements you might have made to it. If you sell it for $950 or more over its basis, you must complete Schedule D for your child and submit it with his 1040 tax return.
Income in Respect of a Decedent
Your child might also have to report income in respect of a decedent for certain bequests. These include assets that produced interest before the decedent's death, but the interest was not paid out before her death. A common example is savings bonds. Unless the decedent reported and paid taxes on accrued interest up to the date of her death, the tax liability for the interest transfers to your child. He must effectively report this income on his own tax return and pay the deceased's tax liability as a condition of inheriting. The principal value of the bonds is tax-free, however.
If your child is the beneficiary of a trust, the trustee must issue a Schedule K-1 to him at the end of the year, showing all disbursements of trust income made to him. Trusts are pass-through tax entities – they only pay tax on income they retain. If they pass income on to beneficiaries, the beneficiaries must include it on their own returns. The trust then takes a deduction for all such distributions.
Under some circumstances, you can include your child's unearned income on your return so he doesn't have to file a 1040 of his own. If his unearned income represents either interest or dividends – such as savings bond interest, payments from a trust or capital gains – you have this option. You must claim your child as a dependent to qualify, and his unearned income cannot exceed $9,500. He cannot also have earned income, such as from a part time job. If you meet these rules, you can complete and submit Form 8814 with your tax return. You're limited to filing Form 1040, not 1040A or 1040EZ. Depending on your own income, it might be more beneficial to file a return for your child, however. Your tax rate is probably higher, and including his unearned income with your income can push you into a higher tax bracket.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.