Will my kids have to pay taxes on their inheritance? Usually, children do not owe federal income tax simply because they receive money or property as an inheritance. However, estate taxes, state inheritance taxes, taxes on inherited retirement accounts, and capital gains when inherited assets are sold can change the outcome.
For Wisconsin and Minnesota families, the state where a person dies and owns property matters. Neither Wisconsin nor Minnesota imposes a state inheritance tax on children, but Minnesota does have a separate estate tax that can affect estates below the federal estate tax threshold.
Planning an inheritance for your children? Heritage Law Office assists Wisconsin and Minnesota clients with wills, trusts, beneficiary arrangements, and estate planning. Request a phone or video consultation. Call Wisconsin at 414-253-8500 or Minnesota at 612-204-2300. You can also review our trust planning services.
Understanding Estate Taxes vs. Inheritance Taxes
Estate Taxes
An estate tax is assessed in connection with a deceased person's taxable estate, generally before property is distributed to beneficiaries. Estate tax calculations may involve deductions, lifetime taxable gifts, and other adjustments; the gross value of an estate is not necessarily the amount subject to tax.
- Federal estate tax: For deaths in 2026, the federal basic exclusion amount is $15 million per person, subject to the applicable tax rules, prior taxable gifts, and any available spouse-related adjustments. Federal estate tax rates can reach 40%. The threshold is adjusted by law and may change for later years. See the IRS Form 706 instructions.
- State estate taxes: State thresholds can be much lower. For 2026, the Minnesota estate tax filing threshold is $3 million in gross estate value, subject to state-specific rules and calculations. Wisconsin does not impose an estate tax for deaths occurring on or after January 1, 2008.
Inheritance Taxes
An inheritance tax, where applicable, is based on what a beneficiary receives. There is no federal inheritance tax, and neither Wisconsin nor Minnesota currently imposes an inheritance tax on an ordinary inheritance from a recent death.
- Some other states impose inheritance taxes, with exemptions or rates that depend on the beneficiary's relationship to the person who died. The rules can matter when family members or property are in other states.
- Iowa no longer imposes inheritance tax for deaths occurring on or after January 1, 2025. Older lists naming Iowa as a current inheritance-tax state are outdated.
- Inheriting from someone who lived or owned property outside Wisconsin or Minnesota may require a separate state-law review.
Are Inherited Assets Taxable?
The answer depends on the type of asset and what the beneficiary does with it after receiving it.
- Cash inheritances: Generally not subject to federal income tax merely because the cash was inherited. Interest earned after inheritance may be taxable.
- Traditional retirement accounts (IRAs and 401(k)s): Withdrawals may be subject to income tax. The timing rules depend on the beneficiary and the account. Many non-spouse beneficiaries are subject to a 10-year distribution deadline, with exceptions.
- Stocks, investments, and real estate: A later sale may produce a taxable gain or deductible loss based on the asset's applicable tax basis. A basis adjustment at death frequently applies, but not to every asset.
- Life insurance death benefits: Generally excluded from the beneficiary's federal gross income; interest and certain unusual arrangements may be taxable. Separately, proceeds may be included in the insured person's taxable estate depending on ownership rights and other factors.
The Step-Up in Basis Rule
For many assets acquired from someone who died, federal income tax basis is generally adjusted to fair market value on the date of death (or to another permitted valuation amount). This may reduce the capital gain when the asset is sold. However, exceptions apply, and assets such as traditional IRAs generally do not receive the same basis adjustment.
- Illustration: Suppose a parent bought a home for $200,000, its value was $500,000 at death, and the home qualifies for a $500,000 basis. If the heirs later sell it for $510,000, the difference before selling costs and other adjustments may be about $10,000 of gain, not $310,000. Actual tax treatment depends on the facts.
For current IRS guidance, see Gifts and Inheritances. Lifetime gifts and some trust transfers can produce a different basis result, so the cheapest-looking transfer is not always the best estate plan.
How to Minimize or Avoid Taxes on Your Children's Inheritance
The appropriate strategy depends on family circumstances, the assets involved, and whether the concern is estate tax, income tax, probate, long-term care costs, or simply a smooth transfer to beneficiaries. Not every family needs complex tax planning.
1. Gifting Assets During Your Lifetime
Lifetime gifts may be part of an estate plan, but they should be reviewed before transferring valuable property. In 2026, the federal gift-tax annual exclusion is $19,000 per recipient per donor for qualifying gifts. Two spouses may, subject to the applicable rules, make qualifying gifts totaling up to $38,000 per recipient under their individual exclusions.
- Example: Two spouses making qualifying gifts of $19,000 each to three children could transfer a combined $114,000 in 2026 using their annual exclusions.
- A gift above the annual exclusion does not automatically mean gift tax is owed. It may require a gift-tax return and use of part of a lifetime exclusion.
- Gifts of appreciated assets can sacrifice a potentially valuable basis adjustment at death. State estate tax rules and Medicaid transfer rules may also affect the decision.
See the IRS gift tax FAQs before relying on any year's gift limit.
2. Using Trusts to Shield Inheritance from Taxes
Trusts can help manage assets, provide instructions for beneficiaries, and sometimes address tax or long-term care planning objectives. A trust does not automatically eliminate taxes or protect assets from every creditor or care expense.
- Revocable Living Trusts (Learn more): Can help assets pass outside probate when properly funded, but generally do not remove those assets from the creator's taxable estate.
- Irrevocable Trusts (Learn more): May serve particular tax, beneficiary, or asset planning purposes depending on retained rights, trust design, and timing.
- Charitable Trusts (Learn more): May suit some charitable giving and tax-planning goals, but involve distinct legal and administrative requirements.
- Medicaid Asset Protection Trusts (Learn more): Can be evaluated for advance long-term care planning; Medicaid eligibility, look-back periods, transfer penalties, and estate-recovery rules must be considered.
Not sure whether a trust would help? Review your objectives with an attorney before gifting or retitling assets. Request an estate planning consultation with Heritage Law Office.
3. Naming Beneficiaries Wisely
Beneficiary designations on retirement plans, insurance policies, and certain financial accounts can determine who receives the assets, often outside probate. Designations should be coordinated with your will or trust rather than reviewed in isolation.
- Retirement accounts: A surviving spouse may have options that differ from those of a child. Many non-spouse beneficiaries must empty inherited accounts within 10 years, although exceptions apply; the tax impact depends on the distributions.
- Life insurance: Death benefits are generally not taxable income to recipients, but the proceeds may still count for federal or state estate-tax purposes if the insured held certain rights. An irrevocable life insurance trust is a specialized tool, not an automatic tax exemption.
4. Converting Traditional IRAs to Roth IRAs
A Roth conversion during the account owner's lifetime may make sense for some families, but the amount converted is generally taxable in the year of conversion. Whether the conversion helps children depends on the owner's tax rate, available cash to pay taxes, and future distribution rules.
- Potential benefit: Qualified Roth IRA distributions can be free of federal income tax, but inherited Roth accounts still have distribution requirements and qualification rules, including applicable five-year rules.
5. Utilizing the Marital Deduction and Portability
For qualifying transfers between spouses, the federal marital deduction may defer federal estate tax. Federal portability may allow a surviving spouse to use a deceased spouse's unused federal estate-tax exclusion if the proper election is made, generally through a timely estate tax return or an available relief procedure.
- 2026 federal example: Each individual has a $15 million basic exclusion amount, subject to applicable adjustments. A married couple may potentially preserve more combined federal exclusion through careful planning and a valid portability election; it is not automatic.
- Important Minnesota distinction: Federal portability and Minnesota's separate estate-tax planning rules are not interchangeable. Minnesota families should review the state estate-tax effects of a first spouse's death, rather than assume a federal election resolves everything.
State-Specific Tax Considerations
Wisconsin: Wisconsin does not impose an estate tax for deaths on or after January 1, 2008, or an inheritance tax for deaths on or after January 1, 1992. Federal estate tax and income tax rules may still apply. See the Wisconsin Department of Revenue.
Minnesota: Minnesota has no state inheritance tax, but does have a separate estate tax. Its $3 million gross estate filing threshold for 2026 can make state-level planning relevant even when an estate is far below the $15 million federal exclusion. Tax calculation, filing, deductions, and property held outside the state require case-specific review. See the Minnesota Department of Revenue filing requirements.
Other states: Property or family circumstances connected to another state may raise other taxes and filing obligations. Moving or retitling assets solely to avoid taxes should not be done without reviewing legal, income tax, and practical consequences.
Key Takeaways for Protecting Your Children's Inheritance
- Most inheritances are not federal taxable income simply when children receive them, but inherited retirement distributions and later investment income or gains may be taxable.
- Federal estate tax: The 2026 basic exclusion is $15 million per individual, subject to relevant rules and adjustments.
- Minnesota matters: Minnesota's separate $3 million estate-tax filing threshold means state planning may be relevant to a broader range of families. Wisconsin has no current estate or inheritance tax for recent deaths.
- Annual gifts: The 2026 federal annual exclusion is $19,000 per donee per donor for qualifying gifts; larger gifts do not necessarily create an immediate tax bill.
- Inherited assets: Basis rules, retirement account withdrawal requirements, insurance ownership, and correctly coordinated beneficiary designations can have significant consequences.
Contact an Estate Planning Attorney to Secure Your Family's Future
If your goal is to pass assets to your children with fewer complications and appropriate tax planning, a carefully coordinated will, trust, beneficiary plan, and asset-ownership strategy can help. Not every family needs an irrevocable trust or complex tax strategy.
Heritage Law Office provides estate planning services for matters it accepts in Wisconsin and Minnesota, with consultations generally conducted by phone or video. Explore our trust planning services or Minnesota estate planning services.
REQUEST AN ESTATE PLANNING CONSULTATION
Wisconsin: 414-253-8500 Minnesota: 612-204-2300
Frequently Asked Questions (FAQs)
1. Do children have to pay federal taxes on inherited money?
Generally, children do not owe federal income tax just for receiving inherited cash or property. They may owe income tax on distributions from inherited traditional retirement accounts, certain estate or trust income, interest, or capital gains after selling inherited assets. An estate may separately have estate-tax obligations.
2. What is the difference between estate tax and inheritance tax?
- Estate tax: Calculated in connection with a deceased person's estate under federal or applicable state law, generally before final distribution.
- Inheritance tax: Imposed by certain states on some beneficiaries receiving inheritances. Neither Wisconsin nor Minnesota currently imposes one for recent deaths.
3. How can I avoid estate taxes for my heirs?
First determine whether estate tax is likely to apply. For many Wisconsin families, federal estate tax is not a concern; Minnesota's lower state threshold deserves separate attention. Depending on the circumstances, lifetime gifts, certain trust arrangements, marital deductions, and available elections may help, but none should be assumed to eliminate tax automatically.
4. Do beneficiaries pay capital gains tax on inherited property?
Not merely by inheriting it. A taxable gain can arise when the beneficiary later sells the property for more than its applicable adjusted basis. Many inherited assets receive a basis adjustment at death, but there are exceptions, so the original purchase price is not always the correct basis.
5. Can life insurance proceeds be taxed as part of an inheritance?
Life insurance death benefits are generally not federal taxable income to the recipient. However, interest may be taxable, and proceeds may be included in the insured's estate for estate-tax purposes depending on policy ownership and retained rights. Specialized life insurance trusts require careful planning to achieve intended results.
This article is general educational information, not individualized legal, financial, or tax advice. The 2026 thresholds apply to that year and may change. Results depend on the circumstances and applicable law. Contacting Heritage Law Office does not establish an attorney-client relationship.