U.S. Tax On Inheritance from Overseas IRS Reporting Rules

U.S. Tax On Inheritance from Overseas IRS Reporting Rules

U.S. Tax on Inheritance from Overseas

U.S. Tax On Inheritance from Overseas: When a U.S. person receives an inheritance from overseas, there is the immediate concern of whether it is taxable.

Generally, the catalyst for U.S. tax is not whether the property is overseas, but rather whether the person who is the decedent is a U.S. person for estate tax purposes.

Stated another way, the estate is what gets taxed, not the individual (Estate Tax vs. Inheritance Tax). Some states have inheritance tax, but from a U.S. tax perspective, the key ingredient in determining the tax.

This is different than the ongoing IRS international reporting requirements for the U.S. person recipient, which is not impacted by the status of the foreign person, but rather the location of accounts, assets, investments and income.

Estate Tax vs. Income Tax vs. Reporting Requirements

When it comes to U.S. tax and IRS International Reporting rules, the topic has three (3) main components to it:

  • U.S. Tax on the Inheritance from Overseas
  • U.S. Tax on the income generated from the Inheritance from Overseas
  • IRS Reporting of the Inheritance from Overseas (FBAR & FATCA)

U.S. Estate Tax is Limited 

For many of our clients, they will be glad to find out that right from the start, unless U.S. situs is involved, a U.S. person who is inheriting a foreign estate from a foreign person who had no ties or residency issues to the United States will not have to pay any tax on the estate.

*The rules are different if a U.S. citizen resides overseas, since they are still considered U.S. person. The rules for a Legal Permanent Resident may vary based on domicile.

Overseas Inheritance Example

Brian comes to our office and tells us that he received an inheritance of $3 million from his grandma.

His grandparents were very wealthy, and they split a $15 million inheritance over five different grandkids.

Luckily for Brian, he stayed in his grandma’s good graces and didn’t do anything during his lifetime to make his grandma revoke the inheritance (good job, Brian).

U.S. Decedent Example

Peter is a U.S. citizen who passed away in 2016 (before the increased exemption amount).

He has never gifted any of his money beyond the annual exclusion amount. When he died, Peter’s estate was worth $10 million. He does not have any charitable trusts, Irrevocable Trusts, a spouse to claim portability…or any other mitigating components to his estate.

Therefore, the estate would be taxed at the amount which is above and beyond the exemption. In the current year, Peter’s estate would be taxed at around $1.8 million (40% of 4.5 million)

Since Peter was a US citizen, the United States has the opportunity to tax the estate on its worldwide assets.

Therefore, since Peter has land in the United States as well as multiple other countries, the total aggregate value will be taxed by the IRS.

Peter may be able to mitigate the double taxation though, since the United States has estate tax treaties with 16 different countries — and therefore,

Peter may be able to minimize some of his U.S. Estate Tax.

Foreign Decedent Example

Brian moved to the United States with his family when he was very young. He obtained his citizenship through his parents as a minor and has been a U.S. citizen for the majority of his life.

As a result, will the United States tax Brian on the estate, since Brian is a U.S. citizen?

No, based on these facts the IRS will not tax Brian on his inheritance.

Estate Tax vs. Inheritance Tax

When a person dies, the first thing the United States will look to see is if the person is a U.S. Person, and what is the value of the decedent’s estate.

If the value of the estate is over the exemption amount, and the decedent is a U.S. Person or has U.S. situes, then the United States may be able to tax the estate that is above the exemption amount.

Since Brian’s Grandma is a non-U.S. Person with no U.S. Situs, she will not be taxed.

Some of the Assets Earn Income

As part of the inheritance, Brian received a stock investment located in the foreign country.  The stock generates significant income for Brian. As a result, Brian will have to report the income to the United States and pay tax on the income as well.

In other words, while Brian’s grandma’s $3 million inheritance to Brian is not taxed as estate tax any future income generated from it would be taxed as income tax to Brian.

IRS Reporting Foreign Inheritance

Continuing from above, since the United States cannot tax the inheritance, they are going to do what they can to force the recipient of the money (Brian) to report the money to the United States government.

Why do they Care?

It is relatively simple and straightforward: Currently, the gift and estate tax exemption is $5.5 million. Let’s say instead that Brian received $10 million from his grandma. Five years later, Brian dies. If Brian was not forced to report the $10 million he received from his foreign person grandma, the IRS would have no way of knowing that Brian had a value of over $10 million.

As a result, the United States would have no way of knowing that Brian estate would be subject to estate taxes of around 2 million.

While you may be wondering (rightfully so) why would Brian report the inheritance if it’s only going to be taxed in the future? The answer simple – if the IRS learns of the inheritance and the lack of reporting, the penalties alone will reduce the value of the estate significantly.

Reporting Rules

The following is a non-exhaustive list of common IRS International Tax Reporting forms.

Form 3520

Since Brian received a foreign gift (albeit an inheritance) from overseas, he has to report the receipt of the gift on the year he received it, on a form 3520. It is a very simple reporting form, but the failure to file a timely can result in significant penalties.   As a result, Brian should file this form timely  at the same time he files his current tax return — either in April or on extension.

FBAR

Since Brian is the owner of foreign mutual funds and other accounts that exceed $10,000 in annual aggregate total, Brian will also have the file an annual FBAR statement.  This statement is not necessarily difficult to complete, although the penalties for failing to file a timely FBAR are severe. And, if the IRS believed Brian was Willful, they can try to come after him the full amount of the accounts.

FATCA Form 8938

FATCA is the Foreign Account Tax compliance Act. Is a relatively new law requiring certain individuals significant amounts of specified foreign financial assets to report the form to the IRS.  Rhe reason why this form is a bit more menacing than other forms is because it is actually included with your tax return.

In addition, unlike some other forms listed above, FATCA Form 8938 requires the individual to itemize the different types of income that was received, as well as:

  • Which accounts generated income
  • Whether the accounts were opened in the current year
  • Whether the accounts were close in the current year
  • If the account of jointly owned

Form 8621

An 8621 is a complicated form involving passive foreign investment companies.   We have written numerous blog posts and articles on this issue and have been invited to speak as presenters to different organizations on this issue.

It is tedious and boring, but the most important take away from this form is that the failure to file it leaves your tax return open. In other words, if you do not file this form and is otherwise required, then the statue limitations for the return does not yet begin to run.As a result, the tax return could be audited many years into the future.

In addition, if a person does not make a mark-to-market election, then in years that they received an excess distribution, the tax liability amounts to a penalty tax which can reach 50 to 75%, if not higher of the value of the PFIC.

What Can You Do?

Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure

Contact our firm today for assistance.


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