Future inherited Royalties included in estate taxes - Non-taxable?

[JPM0622]

In 2018 our father passed away.   He wrote text books and received royalties from them.   These royalties going forward will be directed to the siblings for a number of years after he passed.   Because we live in the not-so-great state of Illinois, we had to pay significant Illinois Estate taxes.    Because the royalties were inherited, we had to have a firm do a present value calculation to come up with a number to be reported with the Illinois estate taxes.   (He did NOT have to file for Federal Estate taxes although you still need to prepare the federal form to get the numbers required for the IL form.)  The siblings are now receiving these royalties.   Each will soon be receiving 1099's from the publisher.

The accountant we had hired to do his final taxes told us that the amount included in the estate is not taxable because it was inherited and taxes paid (at least IL estate taxes).    The amount excluded (he said), would be up to the amount of the determined present value included in the estate taxes.    

Bottom line he is saying this:

Assume the present value of the book royalties included in the estate was $100k

Assume I receive $20k per year in inherited royalties.

The accountant says that the $20k/year is NOT taxable because it was already accounted for.

Bottom line:

1.  I am going to receive a 1099.   I can't just not report it on my tax return!

2.  If this accountant is correct, is there an IRS form and/or document that might discuss this?

3.  Is this really true what he says.

Basically, he said to report the 1099 but put a zero for the amount.   Then, create my own schedule with a note explaining what I did.   IE:  The tax return would be manually reviewed and then someone would look at it and say "oh.... that's why they didn't report it".    Seems like an automatic audit to me!

Thanks for anyone who may have a comment.  

[Carl]

While I do not have a full and complete understanding of your situation due to your state imposed inheritance tax, I can only pharaphrase to you how the IRS sees things at the federal level when it comes to dealing with an inheritance at the federal level.  What effect your state's treatment would have on the laws at the federal level as I understand those laws, I don't know and really can't say. But basically, the IRS says this:

An inheritance is not taxable or reportable on any tax return (with exceptions, such as an inherited 401(k)). Period. What is not taxable is the FMV of the inheritance on the day the original owner passes away. However, all accumulated earnings on that inheritance that occur after the passing of the deceased, are taxable income to the beneficiary recipient.

So as I see it, if what you inherited was worth $500 on the day of the owner's passing, it's value today is irrelevant. For example, take stocks. The stock may have been worth $500 on the day of their passing. But today, it's worth $1000. You will not pay *any* taxes on that value. However, if there was a dividend payout in 2018 for that stock of say, $1 per share, then that $1 per share would be taxable income to you.

Now if you sell the stock for $1000, then your costs basis of that stock is the FMV on the day the deceased passed, which would be $500. So in the tax year you sell it, you would only pay taxes on the $500 gain realized from the sale.

So the "value" of the royalty today doesn't matter. But the "payout" from that royalty to you, would be taxable income. So until you sell your rights to that royalty income, the "present value" of those rights really doesn't matter.

[Carl]

Something else I just realized too. If the estate will be receiving the royalty income in future years, then if the estate pays taxes on that income first, then the estate can distribute what's left to the beneficiary recipients with no tax consequences to those recipients. Of course, that would have a lot to do with how the estate was set up in the first place.

[JPM0622]

Thanks for your reply.

Basically what the other accountant was saying is that since (as in my example) $100k was the FMV as determined from the outside firm and that amount was included in the TOTAL estate that any amounts earned after death up to $100k should not be taxable.   IE:  The future royalties were already estimated and accounted for in the estate tax.   In this way, we were in theory already paying for future earnings in the estate taxes.  

Thanks so much for your info.....    Seems like it's a complicated issue.   

[Carl]

I think I understand a bit more now.

Basically, in order for the estate of a deceased person to be dissolved, the estate has to show the disposition of all assets first. Generally, this is shown on a K-1. In situations I'm familiar with, that portion that the estate has already paid taxes on and then distributed to the beneficiary recipients is reported to the beneficiary recipient on a K-1. That is for the sole purpose of showing the disposition of he asset in the estate dissolution process. The recipient of that K-1 does not report that K-1 on their tax return at all.

Then, for those things that the beneficiary recipient pays taxes on, those are reported separately using other tax reporting documents, which are also sent to the IRS and to the beneficiary recipient. But in your case, I have no clue how you're going to handle this on your tax return, and I question if you can do what's required (whatever that may be) with TurboTax.