When to File Form 3520 – Gift or Inheritance From a Foreign Person
When to File Form 3520 – Gift or Inheritance From a Foreign Person
IRS Form 3520 is the key IRS (Internal Revenue Service) Form for persons who received Gifts from a Foreign Person. The failure to file it timely may lead to excessive Fines and Penalties (detailed below)
Specifically, it refers to individuals who received:
- Gift From a Foreign Person
- Inheritance from a Foreign Person
- Gift From a Foreign Business
- Distribution from a Foreign Trust
IRS Form 3520
The form is technically referred to an Annual Return To Report Transactions With. Foreign Trusts and Receipt of Certain Foreign Gifts is one of the most important international tax forms when it comes to Foreign Money (Foreign Gifts and/or Foreign Trust Distributions).
Why? Because even though Form 3520 is merely a reporting form for foreign gifts or trust distributions received from foreign persons, the IRS has the authority to issue extensive fines and penalties against any individual who fails to properly filed the form.
Why is IRS Form 3520 Necessary?
There are many reasons why a Form 3520 may be necessary. While filing the form is used to report the receipt of a Foreign Gift from either a Foreign Individual or Foreign Business (or Foreign Trust Distribution) the form has a much more far reaching impact than just reporting the information. Moreover, in recent years (and with the enactment and enforcement of FATCA) the IRS has increased enforcement of this form.
The two main issues involving a form 3520 are usually the following:
IRS Form 3520 – Earning Income From the Foreign Gift
At Golding & Golding, we like to use examples. Tax Law can de dense (read: Boring) and we don’t want you to be that bored this early in the article For example, let’s say Michelle received a million-dollar gift from a family member overseas. That gift is in the form of an investment fund that is spread throughout various different accounts and trading firms worldwide.
Thus, Michelle may have $500,000 in Hong Kong, a few hundred thousand dollars in Brazil, and some other investments scattered throughout China, Taiwan, and Portugal.
While the receipt of the gift is not taxable to Michelle (the recipient of the gift does not pay any income tax or gift tax) and the person who transferred the gift is not subject to any U.S. reporting (Michele’s grandma is a non-US person with no US reporting requirements) – what happens to the income generated from the gift?
In other words, while the gift itself is not taxable, the income being generated to Michelle from the Foreign Gift is absolutely taxable. Moreover, many foreign financial institutions (even with FATCA in play) do not issue 1099-INT or 1099-DIV equivalents to report distributions. Therefore, how would the Internal Revenue Service know that Michelle received a $1 million gift that is generating upwards of $70,000 – $100,000 a year in income?
By requiring individuals to file Form 3520, the IRS can track how much money and the type of gift Michelle received.
IRS Form 3520 –Estate Tax Purposes
The Internal Revenue Service also likes to track whether a person who is subject to US tax (and may be subject to estate tax in the future) may have received foreign gifts (which in addition to other worldwide assets the individual owns) may lead to an estate tax issue.
Here’s another example: Scott is a US person who resides in Southern California. Scott has a net worth of $3.5 million. Therefore, if Scott passed away today, his estate would not be taxed. But, recently Scott received a $7 million gift from his grandma, which was an inheritance. Some of the money has been transferred to the United States while some of the funds remain abroad.
For U.S. Estate Tax purpose, it does not matter where Scott keeps the money or the assets. If Scott is the owner of the money/assets and he was to suddenly passed away, then his estate would have to pay estate tax on the value of the gift that exceeds (~$5.47 Million COLA).
But, since only half of the money was transferred to the United States, how would the IRS be aware of the additional $2-$3 million that Scott is the rightful owner of, but is located overseas? That is where Form 3520 comes in.
By requiring Scott to file a Form 3520, the IRS will be updated as to the value of Scott’s current assets.
Therefore, if Scott was to pass away and the estate tax laws have not changed, if the IRS did not know about Scott’s foreign assets, the IRS could be out upwards of $1 million.
Form 3520 – Gift vs. Inheritance
One technical nuance to keep in mind is that while all gifts are not inheritances, all inheritances are gifts. Therefore, if a person who is a U.S. person receives a foreign inheritance, it is considered a gift — and if it meets the threshold requirements required to file a Form 3520, then the person would have to file the Form 3520 to report the gift even though the gift is in the form of an inheritance.
IRS Form 3520 – Threshold requirements
There are various threshold requirements for when a person is required to file a form 3520. The threshold requirements vary depending on whether the persons receiving a gift from a foreign individual, from a foreign business, or a trust distribution.
IRS Form 3520 – Foreign Gift From an Individual
When a person receives a foreign gift from an individual, they must report the receipt of the foreign gift on a form 3520 if the gift (in either one transaction or a series of transactions) exceeds $100,000 in any given tax year.
Therefore, whether or not you received a $150,000 gift from your mom, or received a series of $15,000 gifts from your mom in the same year – you would still have to file Form 3520.
IRS Form 3520 – Foreign Gift From a Business
The threshold requirements for having to file a Form 3520 upon the receipt of a gift from a business are much lower. If you received a foreign gift from a business that exceeds ~$15,000 COLA (Cost of Living Adjustment), then the person is required to file a form 3520 to report the gift.
IRS Form 3520 – Foreign Trust Distributions
With Foreign Trust Distributions, the IRS is very stringent. In fact, a person is required to file a form 3520 when he or she receives any trust distribution at all during the year from a foreign trust. There is no minimum threshold requirement for having to report the receipt of the trust. Therefore, if you are the beneficiary of a foreign trust in you received a trust distribution it is important that you file the form 3520 timely.
IRS Form 3520 Penalties
The penalties for failing to file form 3520 are located in Internal Revenue Code Section 6677, and are as follows:
– A penalty generally applies if Form 3520 is not timely filed or if the information is incomplete or incorrect. Generally, the initial penalty is equal to the greater of $10,000 or:
– 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust or
– 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution or
– 5% of the gross value of the portion of the trust’s assets treated as owned by a U.S. person for failure by the U.S. person to report the U.S. owner information.
Additional penalties will be imposed if the noncompliance continues after the IRS mails a notice of failure to comply with the required reporting. For more information, see section 6677.
FBAR (Report of Foreign Bank Accounts)
If the gift is money or investment accounts which are being held in your name overseas, you may be subject to FBAR filing requirements.
An FBAR is a “Report of Foreign Bank and Financial Accounts” form. It is a form that is filed online directly with the Department of Treasury when a person, trust or business owner has more than an annual aggregate amount of $10,000 in foreign and overseas accounts.
The penalties for failing to file the FBAR can reach 100% value of the foreign accounts, so it is important that if you have not filed FBAR forms (or IRS Form 8938) that you get into compliance quickly.
Should I Submit to IRS Offshore Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
4 Types of IRS Offshore Voluntary Disclosure Programs
There are typically four types of IRS Offshore Voluntary Disclosure programs, and they include:
- Offshore Voluntary Disclosure Program (OVDP)
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)
IRS Voluntary Disclosure of Offshore Accounts
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that for one or more years, you were required to file a U.S. tax return, FBAR or other International Informational Return and you did not do so timely, then you are out of compliance.
Common Un-filed IRS International Tax Forms
Common un-filed international tax forms, include:
- 1040 (Tax Returns)
- Schedule B (Ownership or Signature Authority over Foreign Accounts)
- FBAR (FinCEN 114)
- FATCA (Form 8938)
- Form 3520 (Gift from Foreign Person)
- Form 5471 (Foreign Corporations)
- Form 8621 (Foreign Investments, aka PFIC)
- Form 8865 (Foreign Partnership)
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to IRS Offshore Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.”
It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
5 IRS Methods for Offshore Compliance
- Streamlined Domestic Offshore Procedures
- Streamlined Foreign Offshore Procedures
- Reasonable Cause
- Quiet Disclosure (Illegal)
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.
The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.
The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.
Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.
An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.
What is Included in the Full OVDP Submission?
The full OVDP application includes:
- Eight (8) years of Amended Tax Return filings;
- Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
- Penalty Computation Worksheet; and
- Various OVDP specific documents in support of the application.
Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.
Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).
The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.
Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).
For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.
Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!
2. Streamlined Domestic Offshore Disclosure
The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.
What am I supposed to Report?
There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.
In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.
Reporting Specified Foreign Assets – FATCA Form 8938
Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.
The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.
The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.
Other Forms – Foreign Business
While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:
- If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
- If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
- If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
- And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.
Reporting Foreign Income
If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.
It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.
In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.
3. Streamlined Foreign Offshore Disclosure
What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?
If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.
Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)
*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.
4. Reasonable Cause
Reasonable Cause is different than the above referenced programs. Reasonable Cause is not a “program.” Rather, it is an alternative to traditional Offshore Voluntary Disclosure, which should be considered on a case by case basis, taking the specific facts and circumstances into consideration.
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