Inheritance flow
Two parallel systems
- Probate / non-probate transfer — who receives legal title (will, trust, beneficiary designation, joint tenancy, TOD).
- Tax reporting — income tax (final 1040, 1041, K-1), estate tax (706), gift tax (709), state inheritance/estate tax where applicable.
A fully funded revocable trust avoids probate for trust assets but does not eliminate fiduciary income tax or potential estate tax.
Probate vs trust administration
| Path | What happens | Typical timeline |
|---|---|---|
| Probate estate | Court-supervised; executor appointed; creditors noticed | Months to years (state-dependent) |
| Revocable trust at death | Successor trustee administers without probate for trust assets | Often faster if trust is funded |
| Non-probate transfers | IRA/401(k), life insurance, TOD accounts pass by contract | Weeks to months |
Unfunded RLT (assets still in individual name) flows through pour-over will into probate, then to trust — common planning failure.
Step-up in basis
General rule (Pub. 559): inherited property basis is usually FMV at date of death (or alternate valuation date if elected on Form 706). Surviving joint owners get partial step-up on decedent's share. Community property states may get full step-up on entire community property.
Exceptions and reductions:
- Income in respect of a decedent (IRD) — no basis step-up; IRAs, unpaid compensation, installment notes.
- Retirement accounts — basis is not the planning lever; distribution rules control income tax.
- Assets gifted during life — carryover basis to donee; no step-up on pre-death gifts.
- Certain trusts (grantor retained annuity trusts, incomplete gifts) may not remove assets from estate.
Estate tax vs income tax
| Tax | Trigger | Return | Who pays |
|---|---|---|---|
| Federal estate tax | Gross estate + adjusted taxable gifts over basic exclusion | Form 706 | Estate |
| GST tax | Transfers to skip persons or trusts | Form 706 / 709 schedules | Estate or donor |
| Federal gift tax | Taxable gifts over annual exclusion | Form 709 | Donor |
| Income tax — decedent | Income before death | Final Form 1040 | Estate / beneficiaries per will |
| Income tax — estate/trust | Income after death | Form 1041, K-1 | Estate, trust, or beneficiaries |
| State estate/inheritance | Varies (Illinois has estate tax with lower threshold than federal) | State forms | Estate or beneficiaries |
2025 federal basic exclusion: $13,990,000 (per Form 706 instructions). 2026 basic exclusion: $15,000,000 (per IR-2025-103 / notebook irs-2026-inflation-adjustments-summary).
Portability: timely Form 706 may elect to transfer deceased spousal unused exclusion (DSUE) to surviving spouse.
Typical sequence after death
- Secure assets; locate will, trust, and account statements.
- Obtain death certificates; notify SSA, employers, custodians.
- File decedent's final Form 1040 (income through date of death).
- Open estate or trust administration; obtain EIN for estate/trust.
- Inventory assets; value for estate tax (706) if required or elected for portability.
- Pay debts, expenses, taxes; make distributions per trust or will.
- File Form 1041 annually until estate/trust terminates; issue K-1s.
- File Form 706 within 9 months if required or to elect portability / QTIP.
- Beneficiaries report K-1 income and inherited asset basis on their returns.
Consistent basis reporting
Estates may file Form 8971 to report basis to beneficiaries (coordination with step-up). See Pub. 559 discussion of consistent basis reporting.
Sources
- p559-survivors-executors-administrators-summary
- i706-estate-tax-instructions-summary