Avoiding the Tax Traps of Gifts from Foreign Sources by Lewis Kevelson, CPA
A common planning challenge faced by multinational families is the U.S. taxation of gifts from foreign, non-U.S. family members to their relatives who are U.S. citizens and U.S. tax residents. For example, if a husband is a non-U.S. citizen who lives and works in foreign country X, what is the best way for him to transfer money to his wife and family living in the U.S.? What does U.S. tax law require the wife to report to the IRS on an annual basis to prevent those cash gifts from becoming subject to U.S. income tax and/or penalties? What are the reporting requirements and how can a U.S. family member avoid penalties when he or she receives a large inheritance from a relative who was a non-U.S. person at the time of passing?
The IRS requires U.S. taxpayers to file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, to report receipts of large gifts and inheritances that meet the following thresholds:
Gifts or bequests valued at more than $100,000 received from non-US individuals or foreign estates, including non-US persons related to the non-US individual or foreign estate,
- Gifts valued at more than $16,111 in 2018 from foreign corporations or foreign partnerships, including foreign persons related to those foreign entities,
- Gifts in the form of distributions of loans from a foreign trust, regardless of the amount.
The $100,000 threshold is based on the aggregate value of all gifts a U.S. taxpayer receives in a given year from a foreign estate or from a non-U.S. person and his or her family members. Therefore, if a U.S. citizen receives $50,000 from her non-U.S. mother and $60,000 from her non-U.S. father, she will have a requirement to file Form 3520 and report to the IRS the aggregate value ($110,000) of both gifts.
Form 3520 is due by April 15th following the year of the gift and can be extended to October 15th if additional time is needed. Failure to timely file and report a gift or inheritance from a foreign person will result in a penalty as high as 25 percent of the amount of the foreign gift or bequest. This penalty may also apply when the information contained on a taxpayer’s Form 3520 is inaccurate or incomplete. The IRS will waive penalties for late filing if there is reasonable cause.
Avoiding Penalties and Tax Traps
U.S. citizens who expect to receive gifts from foreign sources have an opportunity to minimize their U.S. tax liabilities when they take the time to plan under the guidance of experienced tax accountants and advisors. With some advance planning preparation, it is possible for U.S. persons to receive gifts or inheritance free of U.S. taxes.
For example, foreign family members should not make “gifts” to their U.S. family members from a foreign corporation, since the IRS will consider such transfers to be taxable corporate dividends that cannot qualify as tax-free gifts. There is a similar concern with distributions received from foreign partnerships, which the IRS would also presume to be taxable distributions.
Another potential tax trap can occur when U.S. persons receive as “gifts” shares in a foreign corporation that owns assets that produce passive income. This may include an offshore company that owns a portfolio of stocks and bonds or passively managed rental real estate. The primary tax concern is that these gifts of corporate shares could ultimately trigger a U.S. tax liability to the new U.S. owner, even if no actual cash was distributed. U.S. persons are also susceptible to taxation in connection with distributions or loans they receive from certain foreign trusts. For example, a U.S. beneficiary who receives a distribution from a foreign non-grantor trust could be subject to U.S. income tax and an interest charge on the distribution amount. While beneficiaries of foreign trust distributions and loans cannot avoid the IRS’s reporting requirement (also on Form 3520) they may be able to minimize their income tax exposure on these transfers when they plan ahead and properly structure the trust and the distributions.
In each of these situations, multinational families have the opportunity, with advance planning, to restructure their holdings and/or develop appropriate gifting strategies to maximize tax efficiency for U.S. family members.
Similarly, U.S. persons should be careful of their susceptible to taxation in connection with distributions or loans they receive from certain foreign trusts. For example, a U.S. beneficiary of a foreign non-grantor trust who receives a distribution or loan from the trust could be subject to income tax and an interest charge on the distributed amount. While the U.S. beneficiary cannot avoid his or her IRS reporting requirement on Form 3520, he or she may minimize his or her income tax exposure on these transfers when the trust and distributions are properly structured far in advance.
Some Tax Relief for Married Couples
Under U.S. tax laws, special rules apply to gifts between U.S. citizens and their non-U.S. spouses. In general, married couples who are both U.S. citizens may make unlimited tax-free gifts to each other during life and at death. This is known as the marital deduction. Similarly, a U.S. citizen may receive from a non-U.S. spouse an unlimited amount of tax-free gifts.
However, the unlimited marital deduction does not apply when the spouse receiving a gift is not a U.S. citizen. Under these circumstances, a U.S. tax citizen spouse must report to the IRS any gift exceed $152,000 in 2018 that he or she makes to a nonresident alien spouse.
The advisors and accountants with Berkowitz Pollack Brant work with multinational families to comply with complex international tax laws and maximize tax efficiency across borders.
About the Author: Lewis Kevelson, CPA, is a director with Berkowitz Pollack Brant’s International Tax practice, where he assists cross-border families and their advisors with personal financial planning and wealth management decisions. He can be reached at the firm’s West Palm Beach, Fla., office at (561) 361-2050 or via email at firstname.lastname@example.org.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.