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U.S. Tax On Inheritance from Overseas – IRS International Reporting

U.S. Tax On Inheritance from Overseas – IRS International Reporting (Certified Tax Specialist)

U.S. Tax On Inheritance from Overseas – IRS International Reporting (Certified Tax Specialist)

U.S. Tax on Inheritance from Overseas and the IRS International Reporting Rules are two of the most common inquiries we receive at Golding & Golding.

When it comes to US tax and IRS International Reporting rules, the topics needs needs to be broken down into three different parts

  • 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 US situs is involved, a US 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.

U.S. Tax

Typical 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 gift (good job, Brian).

Brian is a U.S. Citizen

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 US 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, then the United States may be able to tax the estate that is above the exemption amount — at the alarming rate of 40% per dollar.

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

Peter – U. S. Citizen

Another Example with a Different Outcome: Peter is a US citizen who passed away in 2016. 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.

Brian’s Grandma – Foreign Person

Brian’s grandma resides in a foreign country. She is, and has always been a non-US person, with no ties to the United States other than the fact that her daughter married a U.S. citizen and they reside in the United States.

**There are very complicated estate tax rules that apply to U.S. Persons or Long-Term Permanent Residents who renounce citizenship or relinquish their Green-Card, relocate overseas, an leave an estate (or gifts) in excess of the exemption amount.

Aside from not being subject to U.S. Tax as a U.S. Person, Brian’s grandma also never invested in the United States and therefore, she does not have any U.S. situs.   As such, and despite the fact that her Estate has net worth of $25 million, with many of the beneficiaries qualifying as U.S. Persons, none of the estate is subject to any taxation by the United States. Why? Because as a non-US person with no U.S. investments, the United States does not have any reach over Brian’s grandma.

Stated another way, it is not as if the United States government gets the opportunity to tax non-US persons with non-US investments solely because the recipient of the estate/inheritance is a US person. Remember, it is the estate that is taxed.

What if Brian’s Grandma did Have U.S. Situs

Currently, the gift and estate tax exemption is around $5.5 million. Therefore, a U.S. person could feasibly pass away with $5 million of U.S. assets, foreign assets, or a mix of the two – but as long as it is under $5.5 million (subject to any gifting that occurred during life) there would be no tax.

Conversely, when a non-US person owns US property and then passes away, the exemption amount is closer to $60,000. Therefore, using this example if Brian’s grandma had US situs that was above $60,000 then that US situs only (not the foreign assets) would be taxed at 40%.

If Brian’s Grandma was considered a U.S. person, she would have to had employed various Gifting, Family Business (minority discounts) and Irrevocable Trust strategies during life in order to try to reduce the value of the estate during life.

Some of the Assets Earn Income

As part of the inheritance, Brian received a mutual fund located in the foreign country.  The mutual fund 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.

Examples of areas of tax we handle

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.

Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)

Our Managing Partner, Sean M. Golding, JD, LLM, EA  earned an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

Mr. Golding and his team have successfully handled several hundred IRS Offshore/Voluntary Disclosure Procedure cases. Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

Less than 1% of Tax Attorneys Nationwide are Board Certified Tax Law Specialists 

The Board Certified Tax Law Specialist exam is offered in many states, and is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. Certification also requires the completion of significant ethics and experience requirements.

In California alone, out of more than 200,000 practicing attorneys (with thousands of attorneys practicing in some area of tax law), less than 350 attorneys are Board Certified Tax Law Specialists.

Beware of Copycat Law Firms

Unlike other attorneys who call themselves specialists or experts in Voluntary Disclosure but are not “Board Certified,” handle 5-10 different areas of tax law, purchase multiple keyword specific domain names, and even practice outside of tax, we are absolutely dedicated to Offshore Voluntary Disclosure.

*Click here to learn the benefits of retaining a Board Certified Tax Law Specialist with advanced tax credentials.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

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.

A Penalty for failing to file Form 8938

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.

A Penalty for failing to file Form 3520

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 Penalty for failing to file Form 3520-A

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 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

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.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, 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.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, 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, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

Contact Us Today; Let us Help You.