Do I pay federal income tax on an inherited sum and its gain?

We lost our mother last year and she left us some money invested in mutual funds. State estate taxes were paid. The funds were transfered within the brokerage and invested in the same and similar funds under our individual names. They have appreciated about 4% this year. What do we pay taxes on; the original amount AND the gains, or just the gains?

1. Any thing (money and property) you receive as gift or inheritance, you (the receiver) don't pay any federal tax. Exception: If you inherit a traditional IRA (or tax-deferred retirement account), you are called a beneficiary. Beneficiaries of a traditional IRA must include in their gross income any taxable distributions they receive.

2. So the funds that were transferred to your account are not taxable. Any you don't pay tax on the appreciation unless the gain is realized that is you pay tax on interest, dividend, or gains when you sell the stocks.

just the gains, thankfully.

You pay tax just on the gains since your mom died, assuming these funds were not in a tax-deferred retirement account of some sort.

any interest or income you earn on the inheritance will be taxed. The principal will will probably fall under unearned income unless she made special provisions such as a trust fund. How much will also depend on the type of fund and whether or not she had taxes taken out over the years.

Best find an tax accountant to check into this.

The rules are complicated enough, especially if the estate has not been settled, that you should see a CPA. The rules are that the securities are marked to market at death, to the extent she was an owner. Further, the estate tax laws actually grant two possible dates for the marking to market, and you can use whatever creates the lower estate tax. You have to have actually filed an estate return to claim the better of the two dates. If there is no estate tax due, then you really want the higher of the two dates since it would be marked to market at that date instead. If it was higher than today, you could actually have a loss. You pay taxes, not on the appreciation, but rather on the gains the fund made. It is possible to lose money in a fund AND owe taxes. You need a CPA.