If you are a US citizen or resident and you receive gifts or inheritances of money or other property from a foreign (non-US) person or entity, you may need to report these gifts on Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. Form 3520 is an information return, not a tax return. Many people receiving gifts or bequests get very confused. They mistakenly believe that they have to pay tax when they receive a gift or bequest. This is not the case – bona fide gifts or bequests are not subject to income tax in the hands of the recipient. This remains the case regardless of whether the person giving the gift is a US person or a foreign person. It remains the case regardless of the amount of the gift or bequest.
On the other hand, the giver of the gift (even if he is a non-US person) may have US Gift Tax consequences when he makes a gift; and a decedent’s estate from which the bequest is made may have US Estate Tax consequences, even if the decedent was a non-US person. These are very distinct from the tax issues for the recipient of the gift or bequest. Read more about the US Estate and Gift taxes that may be assessed on non-US persons in my earlier blog postings here and here.
Reporting Duties for Foreign Gifts or Bequests
Even though the recipient of the gift or bequest from the non-US donor, will pay no tax on what he receives, there may be reporting duties imposed on the recipient. Significant penalties may be imposed for failure to file the Form 3520 when it is required. The penalty is 5% of the amount of the foreign gift / bequest for each month for which the failure to report continues; not to exceed a total of 25%. If you have “reasonable cause” for not filing the form, the penalty may be abated. Generally speaking, the IRS has become more strict and exacting with respect to the reasons it will accept as constituting “reasonable cause.”
Gifts or bequests valued at more than $100,000 in any calendar year received from a foreign person, including a foreign estate must be reported on Form 3520 (Part IV). Gifts received from related parties must be aggregated to determine if the dollar threshold has been met. For example, assume your father is a non-US person and he gifts to you $80,000; in the same year, your uncle (your father’s brother), also a non-US person, makes a gift to you of $25,000. You must report the gifts on Form 3520 because the total is more than $100,000.
A lower dollar threshold applies when gifts are received from foreign entities such as a foreign corporation or partnership. Gifts from such entities (including foreign persons related to the foreign corporation or foreign partnership) must be reported when valued, for 2015, at more than $15,601. The threshold amount is adjusted annually for inflation. The amount rises to $15,671 for gifts received from such entities in 2016. The reason that a lower threshold applies to gifts from entities (as opposed to individuals or an estate) is simply because entities do not really make gifts. The Internal Revenue Service (IRS) is concerned that the “gift” (which you will recall is not taxable to the recipient) may in reality be a disguised form of taxable income, such as a dividend or compensation. You can expect that large gifts from entities will be subject to greater IRS scrutiny and questioning. Under Internal Revenue Code Section 672(f)(4) and relevant Treasury Regulations, the IRS has statutory authority to recharacterize so-called “gifts” from a foreign corporation or partnership. The amounts received can actually be income to the recipient and therefore subject to tax. There is an exception in circumstances where the foreign owner of the entity reports the transaction as if they received a distribution from the entity and then made a gift to the recipient, but I doubt this applies too often in the real world.
Exactly What is a “Foreign” Gift or Bequest?
Here’s where the tax law can get really confusing! If your Russian mother-in-law who holds a green card that expired 8 years ago, gives you a $200,000 gift, must you report that gift on Form 3520? Must you report a bequest you receive from your deceased father’s estate on Form 3520 when your father was a US citizen who had lived in Mexico since age 10, was married to a Mexican wife, owned only non-US assets such as real estate in Mexico, stocks in non-US companies, a sole proprietorship in Mexico, and cash in Swiss bank accounts. A Mexican law firm was appointed as executor of his Will and the Will was governed by Mexican law.
The relevant provision of the US tax law provides that a “foreign gift” is “any amount received from a person other than a United States person which the recipient treats as a gift or bequest.” See IRC 6039F. The phrase “A person other than a United States person” is not defined.
With respect to individuals, it seems the IRS interprets this to mean that the gift is from an individual who is nonresident alien for income tax purposes. See page 12 Instructions part IV Line 54. Thus, the gift from your Russian mother-in-law need NOT be reported on Form 3520. This remains so even though her green card has expired; she is still treated as a US person for income tax purposes. And, guess what? She is still liable for income tax on her worldwide income even though the green card is no longer valid! (You might not want to tell her that until after she has made you the gift.) Read more on the topic of expired green cards and continuing US tax liability at my blog posts here and here.
With respect to estates, the inquiry becomes far more complicated, so you may possibly have to reach for the Imigran. In determining whether an estate is a “foreign” estate, the question is whether the estate is comparable to a nonresident alien individual. Thus, it must be decided whether the estate is “alien” and “nonresident” in the United States. In a nutshell, various factors are examined such as location of the estate’s assets, location of its administration, alienage and residence of its executor, alienage and residence of the decedent and the estate beneficiaries and so on. On balance, the estate in the example above of the deceased US citizen who lived in Mexico would likely be treated as a “foreign estate”. Thus, any US beneficiary of the estate would be responsible for filing Form 3520 to report a bequest exceeding $100,000.
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