Parents often leave children a sizeble inheritance so that the children can build a financial future after their parents' death. In addition to bequeathing cash, parents can bequeath investment instruments and funds such as stocks, bonds and retirement accounts. The Internal Revenue Service has different tax rules for each type of inheritance.
You don't have to pay inheritance taxes on cash inheritances. When the executor of your parents' estate settles the estate, he pays estate taxes on the estate's total value as well as paying all of the estate's debts before he distributes inheritances. Thus, when you receive a cash inheritance, any taxes owed on it have already been paid and you don't have to report it as income or pay taxes on it.
If your parents leave you stocks, you don't pay any tax on them at the time you receive the stocks. However, if you sell the asset later, you have to pay capital gains tax on the sale. Use the stock's value on the date the original owner died as the tax basis. You have to pay taxes if the stock goes up in value, but if it goes down, you can claim a capital loss.
If your parents leave you savings bonds, you don't pay any taxes on the principal -- the bond's original value. However, like stocks, these investment instruments are not tax-free. You usually don't have to pay taxes on interest the bonds accrued while your parents were alive; the executor of the estate takes care of that. However, if interest accrues after you receive the bonds, or the estate doesn't pay the tax your parents owed on the interest, you are liable for it. You can pay the tax yearly or pay it all when you cash in the bond.
Retirement accounts are considered "income in respect of the decedent." This means that in general, you must pay the same taxes on this income that your parents would if they were alive. For example, if your parents leave you a 401k plan, you must pay the same taxes on your distributions that they would pay if they were alive. However, you can deduct a portion of the taxes the estate paid on an individual retirement account relative to the distributions you took. For example, if you withdrew 10 percent of the IRA funds, you can deduct 10 percent of the estate's taxes on the IRA. This offsets the taxes you pay on the distributions.