- 1 U.S. Tax on Foreign Gifts
- 2 What is a “Foreign” Gift
- 3 Foreign Person
- 4 Undisclosed Gifts from a Foreign Person
- 5 U.S. Gift – Common Example of Estate Tax
- 6 Estate Tax is different than Inheritance Tax
- 7 Example: U.S. Person or Former U.S. Person Living Abroad
- 8 The IRS disagrees & Wants to Collect Estate Tax
- 9 Examples of Foreign Gifts and Income Tax Liability
- 10 Example: Foreign Person/Foreign Gift with No Income
- 11 Example of a Foreign Gift that Generates Income
- 12 IRS Reporting of Foreign Gifts
- 13 Form 3520
- 14 FBAR
- 15 FATCA Form 8938
- 16 Out of Compliance – IRS Offshore Voluntary Disclosure
U.S. Tax on Foreign Gifts
U.S. Tax on Foreign Gifts usually are the result of two types of situations:
- Gift and/or Estate Tax
- Income Tax on the Income Generated by the Gift or Inheritance
What is a “Foreign” Gift
The rules involving Foreign gifts typically revolve around Gifts from foreign persons, as opposed to a U.S. person is gifting foreign property. That is because a U.S. Person’s Gift and Estate Tax exemption includes both U.S. and foreign property — while a Foreign Person (aka non-U.S. Person) is usually only subject to U.S. Estate Tax on U.S. situs.
In order for the foreign gift to be from a foreign person, the person giving the gift must be foreign. What makes this statement important is that it must be a non-U.S. person. A non-U.S. person who was previously a U.S person, may be considered a U.S. person for U.S. Gift and Tax purposes.
**The analysis of whether a Former Long-Term U.S Resident or Citizen who is no longer a U.S. person but gifting a “foreign Gift” to a U.S. person is a very complex (read: Tiresome) analysis.
The reason why the Internal Revenue Service and U.S. government as a whole is keen on enforcing this rule, is primarily due to the estate tax and Gift Rules (explained below), and ensuring that the U.S. Person is paying the proper income tax on the income generated from abroad — even if it is being generated by a gift outside of the United States.
For example, if a foreign person was to gift a U.S. person $250,000 equivalent of non-U.S. property, the US person’s reporting requirement would be limited to filing a form 3520 (absent other facts). Moreover, the United States has no reach over the foreign person who issued the foreign gift. Why? Because as foreign persons who are not otherwise subject to US tax or US tax laws (aka no U.S. property owned), the Internal Revenue Service and government as a whole have no right to enforce U.S. gift and estate tax “rules” against them.
Undisclosed Gifts from a Foreign Person
The IRS Reporting of International Gifts is a very important piece in the Offshore Compliance puzzle.
Even though there are no U.S. tax ramifications on the initial receipt of a gift from a foreign person (although usually an IRS Form 3520 is required), the lack of reporting of the foreign gift on behalf of the U.S. person recipient may lead to extensive fines and penalties.
In addition, if the gift generates income either in the U.S. or abroad, the recipient may have significantly more reporting tax filing requirements.
U.S. Gift – Common Example of Estate Tax
When a person is a U.S. person residing in the U.S. and tax compliant, it is easier for the IRS to keep tabs on the person, along with his or her assets.
For example, Scott’s grandmother is a U.S. Person. During her lifetime, she amassed a fortune and when she passed away she left Scott and each of his siblings $8 million each. Unfortunately, Scott’s grandma did not trust attorneys and therefore did not contact an attorney to set up any sort of trust scenario — which may have limit the resulting estate tax.
Estate Tax is different than Inheritance Tax
In the United States it is the estate that is taxed. Therefore, with the current exemption at $5.45 million, the estate at issue is going to have to pay 40% estate tax on the $2.55 million that exceeds the $5.45 million exemption.
The takeaway is that since the decedent is a US person, her estate is subject to US estate tax. It does not matter if the property is located in the U.S. or abroad, if the threshold is met, then the entire estate of the U.S. Person is subject to Estate Tax.
Example: U.S. Person or Former U.S. Person Living Abroad
Here’s where it gets tricky: Let’s say Peter’s father was a long-term Legal Permanent Resident (“Green Card Holder”). He was a very successful entrepreneur and also amassed a fortune. He has assets around the world with a value at around $40 million. Moreover, Peter is the sole recipient of the money.
After living in the United States for 25 years, Peter’s father decided to move back to Panama. He gave up his green card, but did not pay any expatriate tax because he posted a bond. His thought was that once he passed on, and his son received the Fortune – Peter would receive it Tax-Free.
The IRS disagrees & Wants to Collect Estate Tax
The IRS will want to collect as much Estate Tax as possible.
Scenario 1: Limited U.S. Estate Tax
If Peter’s father was considered a foreign person for estate tax purposes, the IRS would not be able to tax the money/estate because Peter’s father is a non-US person. There may be some tax liability regarding properties Peter’s father owned in the United States (very small exemption amount), but less than 5% of Peter’s father’s wealth is in the United States, so the tax hit is minimal.
As a result, Peter inherits nearly $39 million without any tax liability.
Scenario 2: Full Taxation Aside from the Exemption Amount
Peter can receive the first $5.45 million dollars tax-free but then would have to pay tax at a rate of 40% on the remaining $33 million. And, 40% tax on more than $33 million is over $13 million tax – which the IRS is not going to want to lose out on. From the IRS’ perspective the assets increased in value during the time Peter’s father was living in the United States, and therefore the IRS should get a piece of pie.
If you fall into one of the above referenced scenarios, you should speak with an experienced international tax lawyer.
Examples of Foreign Gifts and Income Tax Liability
There are three main issues involving the gift when it comes to the majority of cases we handle:
- Was the person providing the gift a US person or not (see above)?
- Is the gift income-producing or or non-income producing?
- Have all the proper forms been filed on the money?
Example: Foreign Person/Foreign Gift with No Income
Example 1: David’s Parent From China
David’s parents are citizens of China. They are non-US persons and neither of them have ever had any US citizenship, Legal Permanent Resident status or otherwise filed a US tax return (or subject to US tax). David’s parents gifted him $1 million to purchase a home for him and his new wife.
Unless other facts impacted the scenario, David’s parents would be considered foreign persons and David’s reporting would be limited to filing a Form 3520.
Example of a Foreign Gift that Generates Income
Example 2: Neil From India
Neil came to the United States to study on F-1 visa and then transitioned over to an H1B visa. Neil’s parents were very proud of him, so they gifted him $100,000 worth of fixed deposits (FDs). The fixed deposits are under Neil’s name even though his parents are responsible for depositing withdrawn the money from different institutions — both to get the best tax rate, as well as to reduce any immediate taxation under Indian tax law.
IRS Reporting of Foreign Gifts
The biggest concern for individuals with receiving a foreign gift is the reporting requirements. Presuming for the moment that the person providing the gift is actually a foreign person, there are many forms that the recipient may need to file based on the specific facts and circumstances of his or her case (although the Form 3520 is the most common).
The following is a brief summary of some of the more common forms a person may need to file and the penalties for failing to do so:
A Form 3520 is filed in three types of situations:
The most common situation is when a person receives a gift from a foreign person in which the value of the gift exceeds $100,000 in a year. It is important to note that it does not matter whether it was one transaction, or a series of transactions from the same person (Read: transfers from Taiwan split amongst 20 different people to circumvent currency restrictions). If a person receives more than $100,000 in a gift from a foreign person (even if the person is using conduits), then he or she will have to file a form 3520.
The second common situation is when a person receives a gift from a foreign business. If the amount of the gift from the foreign business exceeds $15,671 in any given tax year, then the same form must be filed.
The third, situation involves trust reporting. It should be noted that the IRS is not a huge fan of foreign trusts for many different reasons. Most notably, as a true foreign trust, the IRS does not have much stronghold over the trust itself. In order to amplify the reporting rules, the Internal Revenue Service requires the recipient of any amount of a trust distribution to be reported on form 3520.
Penalties for non-filing of Form 3520
A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
A FBAR is a Report of Foreign Bank and Financial Account form. It is required to be filed by any individual who has more than $10,000 in annual aggregate total on any given day of the year in foreign accounts. It is not matter if the money is in one account with $3 million in it, or spread over 15 accounts with $1000 in each.
Therefore, if a family member opened up a bank account or bank accounts for you abroad and the aggregate total of all of your foreign accounts exceeds $10,000 on any day of the year – you will probably have to file this form.
Penalties for non-filing of a FBAR
A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
FATCA Form 8938
The FATCA Form 8938 is similar to the FBAR, etc. except that it is filed directly with your tax return. Moreover, the threshold requirements are different for reporting. It is not merely a one size fits all $10,000 threshold. The thresholds will vary based on whether you reside in the United States or abroad, and whether you file your taxes married filing jointly or single/married filing separate.
Penalties for non-filing of Form 8938
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
Out of Compliance – IRS Offshore Voluntary Disclosure
If you are out of compliance and worried about IRS penalties, one of the fastest ways to get back into compliance (or compliance for the first time) is through the approved IRS offshore voluntary disclosure programs.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
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