The Internal Revenue Service has heightened enforcement on reporting foreign gifts and trusts.
Receiving significant gifts from foreign individuals or engaging in specific transactions with foreign trusts may trigger reporting obligations through Form 3520 and/or 3520-A for US individuals.
While these forms primarily disclose the presence of gifts, inheritances, or trusts from foreign entities rather than serving tax purposes, noncompliance has led to IRS penalties.
Here, we outline key details about filing Form 3520 due to the increased scrutiny and consequences of noncompliance.
Please note this article is not formal tax, legal or financial advice and is only here for informational purposes.
The facts might also have changed since we wrote it.
If you want to invest as an expat or high-net-worth individual living outside of the United States, you can email me (advice@adamfayed.com) or use WhatsApp (+44-7393-450-837).
What is the IRS Form 3520?
US individuals utilize Form 3520 when receiving foreign gifts and inheritances or engaging in specific transactions with a foreign trust.
A typical scenario involves a US person receiving a gift from nonresident alien parents, even if it aids in purchasing a home or covering school-related expenses, and such instances must be reported.
Regarding trusts, it’s crucial to highlight that filing Form 3520 may be obligatory for a US person, even if no distributions are received from the trust.
Who Must Submit IRS 3520 Form?
The IRS 3520 Form is obligatory for US individuals, encompassing US citizens, legal permanent residents, and foreign nationals meeting the Substantial Presence Test, categorizing them as US persons for income tax purposes.
When is the Deadline for the IRS 3520 Form?
Typically, the IRS 3520 Form is due by April 15th. If residing outside the US with a tax return deadline in June, filing extends until June for Form 3520.
Extending the tax return does not require an extension for Form 3520, unlike Form 3520-A, which necessitates Form 7004 for an extension.
Where to Submit IRS 3520 Form?
File the IRS 3520 Form in Ogden, UT, at the Internal Revenue Service Center:
P.O. Box 409101
Ogden, UT 84409
Foreign Gift Reporting
The comprehensive information regarding foreign gifts and the Foreign Gift Reporting rules as per the IRS are provided below.
If a US individual receives gifts from foreign person or entity exceeding $100,000 or the total value of gifts from the same person in a year surpasses this threshold, filing Form 3520 is mandatory.
Related Party Rules consolidate gifts from related individuals to prevent splitting large gifts.
Gifts from foreign person entities surpassing $16,649 in value or the cumulative value in a year necessitate filing Form 3520 by the US person.
There is no specific threshold for reporting trust distributions. Any distribution from a foreign trust requires reporting on Form 3520 by the US person.
Related Party Rules
Gifts from related foreign persons follow related party rules. If related individuals collectively give a gift, their values are aggregated to prevent evasion of reporting obligations.
Currency Restrictions and Multiple Contributors
Currency restrictions may prompt multiple parties to contribute to a single gift.
Even if unrelated, the cumulative value from various contributors is reportable on Form 3520 if the gift originates from a single person.
Foreign Gift Reporting Requirements
Reporting foreign gifts or bequests is mandatory only if exceeding specific thresholds. Aggregate gifts from related parties must be considered.
For nonresident alien or foreign estate gifts, reporting is required if the aggregate exceeds $100,000 during the taxable year.
For purported gifts from foreign corporations or partnerships, reporting is necessary if the aggregate exceeds $17,339 for 2022 and $18,567 for 2023.
Each gift and donor’s identity must be separately identified.
File Form 3520 separately from your income tax return, following the instructions.
The general due date is the 15th day of the fourth month following the U.S. person’s tax year.
U.S. citizens living outside the U.S., Puerto Rico, or military/naval service personnel abroad have a due date of the 15th day of the 6th month.
An extension to file the income tax return extends the Form 3520 due date.
Example: For a U.S. person with a December 31 calendar year-end in 2022, Form 3520 is due by April 15, 2023, or June 15, 2023, for U.S. citizens residing abroad. With a Form 4868 extension, the deadline is extended to October 15, 2023.
General Rule: Foreign Gifts and Bequests
Generally, a foreign gift or bequest refers to any amount received from a foreign person, excluding qualified tuition or medical payments made on behalf of the U.S. person.
Special Rules for Gifts or Bequests from Covered Expatriates
U.S. citizens or residents receiving gifts or bequests from covered expatriates under IRC 877A may face tax under IRC section 2801.
The imposition of section 2801 tax is deferred pending the issuance of final regulations.
Refer to the September 2015 proposed Guidance Regarding the Imposition of Tax on Certain Gifts and Bequests from Covered Expatriates for more information.
Note: Filing FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) and Form 8938 (Statement of Specified Foreign Financial Assets) may also be required. Visit the IRS penalties webpage for more details.
International Tax Gap Series
If you, as a U.S. person, have received a significant foreign gift or bequest, you might need to complete Part IV of Form 3520, as discussed earlier.
Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.
Submit the form by the 15th day of the fourth month following your income tax year’s end (typically April 15th for individuals).
Failure to file on time or provide incomplete or inaccurate information may lead to IRS determination of income tax consequences and potential penalties under section 6039F(c).
Refer to Form 3520 instructions for details.
Foreign Gift Tax in the US
As a baseline, gifts from non-resident foreign persons to US individuals are not inherently taxable.
However, if the non-resident alien transfers/gifts US real property interest, the gift portion may become taxable based on various factors.
Property Transfer to a Foreign Trust
Form 3520 imposes more intricate rules for foreign trusts than for foreign gifts.
Transferring property to a trust, whether it involves cash to a related foreign trust or an individual related to the trust, triggers reporting obligations.
The criteria for related trusts or individuals related to the trust are broad and encompassing.
Beneficiary Receives Trust Distribution
If a US person beneficiary receives a distribution from a foreign trust, reporting on Form 3520 becomes mandatory.
Taxability of Trust Distribution
In a foreign grantor trust, the grantor, not the beneficiary, bears the income tax.
Distributions from grantor trusts to beneficiaries are generally non-taxable to US beneficiaries. Conversely, in a non-grantor trust, distributions to beneficiaries are typically taxable.
Ownership of a Foreign Trust
Individuals with ownership or beneficial interest in a foreign trust must report such details on Form 3520.
Foreign Pension Classification
Foreign pensions are typically regarded as trusts, featuring a Grantor/Owner, Administrator, and Beneficiary.
Reporting All Foreign Pensions on Form 3520
Yes, unless an exception or exclusion applies. While there is no blanket exemption for all foreign pensions on Form 3520, Revenue Procedure 2020-17 excludes certain foreign tax-deferred trusts and tax-deferred retirement trusts from reporting.
However, it’s unclear if common foreign pensions meet the exemption criteria.
Penalties for Form 3520 Non-filing
Certainly, the IRS imposes substantial penalties, often automatically assessed, particularly in international information reporting.
Form 3520 penalties are disproportionately high compared to the violation.
Penalty for Unreported Foreign Gifts
The penalty for unreported foreign gifts is exorbitant, typically 5% of the gift’s value accruing monthly, with a maximum threshold of 25%.
Taxpayers receiving significant gifts may face substantial penalties.
Penalty for Foreign Trusts
Penalties for foreign trusts vary based on distributions and trust values. The IRS levies penalties:
- 35% of the gross value of property transferred to a foreign trust for failing to report its creation or transfer.
- 35% of the gross value of distributions from a foreign trust for failing to report the receipt.
- 5% of the gross value treated as owned by a U.S. person if the foreign trust fails to file a timely Form 3520-A.
Appealing or Abating Penalties
While penalties can be appealed or abated, the process is challenging. It’s advisable to prioritize avoiding penalties over seeking their removal.
Recent changes to Delinquency Procedures emphasize thorough preparation before presenting the case to the IRS.
Filing Tips to Avoid Penalties
If an extension was filed for the income tax return, enter the form number in Form 3520, Box 1K, to prevent late filing treatment.
Targeted Enforcement on Foreign Gifts, Inheritances, and Trusts
The IRS prioritizes enforcing compliance on US persons receiving substantial gifts or engaging in specific transactions with foreign trusts.
Taxpayers must adhere to reporting rules, ensuring compliance or rectifying non-compliance promptly.
Foreign Inheritance Tax
If you have inherited assets from a non-US individual located abroad, you might be curious about whether the IRS mandates payment of foreign inheritance tax.
This guide delves into IRS regulations regarding foreign inheritance tax and guides you on ensuring compliance with all necessary filing obligations.
Things to Remember
Estate tax is based on the assets owned by a deceased individual, while inheritance tax applies to the taxation of an individual receiving the assets of a deceased person.
Generally, US federal estate taxes are applicable when the deceased person’s assets exceed $12 million.
There is no federal inheritance tax, but specific states and the District of Columbia impose inheritance taxes.
Inheritance tax on foreign income is not in effect as per the federal taxes; however, reporting to the IRS is required, and foreign or state inheritance taxes may apply.
The US imposes taxes on the estate tax on foreign income or properties is only for assets with a “US situs,” meaning tangible properties within the United States.
For instance, if a non-US individual bequeaths a house in California to a US citizen, it qualifies as a US situs asset and may be subject to estate tax.
Understanding eligible deductions and credits can result in significant savings.
Reporting a Foreign Inheritance to the IRS
Foreign Trusts
If a foreign inheritance is placed in a trust, and any part of the trust has a US owner, Form 3520-A must be filed by the trust by March 15.
If the trust fails to file, the US owner must file a substitute Form 3520-A, subject to fines for inaccuracies or delays.
Foreign Bank Accounts (Exceeding $10,000)
If funds from the inheritance are kept in foreign bank accounts totaling over $10,000, filing a Report of Foreign Bank and Financial Accounts (FBAR) using FinCEN Form 114 is necessary.
FBAR is an informational return and must be filed electronically by April 15, with an automatic extension to October 15 if needed.
Offshore Assets (Exceeding $200,000)
If the inheritance raises the value of offshore assets beyond specific thresholds, filing Form 8938 is mandatory.
Form 8938 is due with individual income tax returns and incurs fines for inaccuracies or delays.
Transferring Money to US Bank Accounts
Transferring inheritance to a US bank account doesn’t require additional filings.
If bringing cash into the US, FinCEN Form 105 is necessary to declare it, ensuring compliance with anti-money laundering regulations.
Being prepared and adhering to these reporting requirements is crucial for avoiding fines and ensuring compliance with IRS regulations.
Must Expatriates Settle Taxes on Inheritances Received Overseas?
No, the majority of expatriates are not required to pay US taxes on inheritances acquired from foreign sources.
Interestingly, the IRS regulations governing foreign inheritances are identical for expatriates as they are for US residents residing within the country.
While you may be obligated to submit one or more of the informational forms mentioned earlier, the likelihood of incurring expatriate tax liability is low.
It’s worth noting that, similar for both expatriates and residents in the US, if you generate income from your inheritance, such as through investments, tax obligations may arise as a consequence.
For further details on IRS guidelines concerning foreign inheritances, please refer to the official IRS website.
US Reporting Requirements for Inheritances
The U.S. reporting requirements for inheritances vary based on the circumstances surrounding the inheritance, such as whether the deceased person was a foreign national or a U.S. citizen, and the location of the estate.
Capital gains tax may apply upon selling inherited foreign property if its value at the time of receipt surpasses the sale price.
In the case of an inheritance from a U.S. citizen or Green Card holder, whether situated in the U.S. or abroad, there are typically no filing obligations.
While federal tax is not applicable, state inheritance tax may be levied in specific states.
If the entire estate’s value exceeds $5.45 million, the estate executor bears the federal estate tax, impacting the distribution of individual shares.
For inheritances left in the United States by foreign nationals, the tax consequences depend on the location of death.
If the person died in the U.S., reporting Form 3520 is required for inheritances over $100,000, without incurring tax liabilities.
In cases where the foreign person died abroad, the first $60,000 of the estate’s total value is tax-free, with amounts beyond subject to estate tax paid by the executor, potentially mitigated by U.S. and resident country tax treaties.
Regarding pensions as part of an inheritance, their taxability differs from other inherited assets. Since pensions consist of pre-tax funds, they become taxable upon distribution.
Any remaining amount in an IRA or 401K is taxed to the beneficiary, with varying tax consequences based on the beneficiary’s relationship and age.
In essence, pensions are taxable to the beneficiary in contrast to other inherited assets.
Financial planning services aid in navigating US Reporting Rules on Foreign Gifts and Inheritances, ensuring adherence to IRS regulations, and optimizing tax strategies.
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