Late-Filing Penalties Eased And Regulations Finally Clarified On Foreign Gifts

The U.S. Internal Revenue Service is easing severe penalties and clarifying regulations on foreign gifts and inheritances.

Recipients of foreign gifts have received a couple of breaks from the U.S. Internal Revenue Service.

The IRS has ceased assessing automatic penalties – some of which were severe – for late filing Form 3520 (and Form 3520-A for the trust portion of the form) that cover foreign gifts and inheritances and has said it start accepting reasonable cause explanations for late filing.

And after a decade and a half, the IRS has issued final regulations providing guidance on the Section 2801 tax for U.S. citizens and residents who receive gifts or bequests from certain expatriates from the United States.

Gifts, inheritances and automatic penalties

Forms 3520 and 3520-A report large foreign gifts or inheritances, which, under Internal Revenue Code (IRC) Section 6039F, U.S. recipients must report even if such gifts are generally tax-exempt. As a result of the latter fact, many taxpayers haven’t known of the need to report these gifts.

Taxpayers filing Form 3520, “Annual Return To Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts,” late have faced automatic penalties of up to a quarter of the gift’s value even if no tax was due.

According to the IRS, you have to file a 3520 if any one or more of the following apply:

• You’re the responsible party for reporting a reportable event that occurred during the current tax year, or you are a U.S. person who transferred property (including cash) to a related foreign trust (or a person related to the trust).
• You are a U.S. person who, during the current tax year, is treated as the owner of any part of the assets of a foreign trust under IRC rules.?
• You are a U.S. person or an executor of the estate of a U.S. person who received a distribution from a foreign trust during the current tax year; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year you or a U.S. person related to you received a loan of cash or marketable securities from such foreign trust or the uncompensated use of trust property; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year such foreign trust holds an outstanding qualified obligation of yours or a U.S. person related to you.
• You are a U.S. person who, during the current tax year, received either more than $100,000 from a nonresident alien individual or a foreign estate that you treated as gifts or bequests; or more than the section 6039F threshold amount from foreign corporations or foreign partnerships that you treated as gifts.

At the UCLA Tax Controversy Conference last fall, IRS Commissioner Danny Werfel said that the American tax agency will no longer automatically assess penalties for late-filed 3520s and 3520-As and will also review reasonable cause statements attached to these late filings before determining whether to impose penalties.

This change means taxpayers can explain their circumstances. “A person may be with parents living overseas,” Werfel said at the conference, “a parent dies, now you’re dealing with the estate, you’re dealing with grief, you’re dealing with all the moving pieces, and maybe in the middle of all this, you late file your form that you’re required to file.”

Failure to report large gifts and inheritances from foreign persons can carry a penalty of 5% of the unreported transfer for each month the form is late, up to 25% of the gift or inheritance.

Final word, at last and so far, on gifts

Proposed regulations for guidance on the tax imposed by IRC Sec 2801 – aka the 40% “Section 2801 tax” for U.S. citizens and residents who receive gifts or bequests from certain individuals who have expatriated from the U.S. – came out some 15 years ago. At last, the IRS recently released the new final regs. Reporting and paying the Section 2801 tax can also be done with the new Form 708,?“United States Return of Tax for Gifts and Bequests Received from Covered Expatriates.”

The Section 2801 tax is incurred by U.S. citizens and residents who receive any “covered” gift or bequest, meaning property acquired from a covered expatriate or from a foreign trust funded by a covered expatriate. The tax is on the value of whatever portion of the gift or bequest goes over the annual exclusion for gifts, which for this year $19,000.

A?“covered expatriate”?is a U.S. citizen or long-term resident who meets specific criteria when relinquishing their citizenship or residency and who has generally met conditions and incurred U.S. federal tax obligations such as the American exit tax. A covered expatriate can also be a green card holder whose status is revoked or abandoned at a time when the person was a lawful permanent resident of the United States in at least eight of the past 15 years and who at the time of expatriation had a worldwide net worth of $2 million or more, an average annual U.S. federal income tax liability above a certain threshold ($206,000 for 2025), or who failed to certify compliance with U.S. federal tax obligations for the preceding five years.

The final regulations generally follow the long-ago proposed regs, with modifications that include, among other points:

• elimination of a “timely paid” requirement?of taxes owed before a gift is excluded;
• avoidance of duplicate liability?of the same property under Sec. 2801;
• relief of individual annual filing for electing foreign trusts?(each electing foreign trust must file a timely Form 708 annually); and
• confirmation of a U.S. recipient’s ability to file a protective claim for refund of the Section 2801 tax.

Also, taxpayers’ filing of a 708 is independent of any requirement to file a Form 3520.

Observers note that although the final regulations apply to covered gifts and bequests received this year, they say nothing so far about such gifts and bequests over the years since the proposed regs were introduced. At one time, the IRS did say that 2801 reporting and tax obligations for covered gifts or bequests received after mid-2008 would be deferred until the final IRS guidance.

Until additional final guidance is issued concerning gifts and bequests from 2008 to Dec. 31, 2024, taxpayers don’t need to address U.S. federal reporting and tax obligations from this timeframe but should watch for any revised final regs that change this reprieve.

Your tax specialist needs to stay on top of this and many other issues of wealth, foreign income and tax enforcement. If we can help, please let us know.

About the Author?

Alicea Castellanos is the CEO and Founder of Global Taxes LLC. Alicea provides personalized U.S. tax advisory and compliance services to high-net-worth families and their advisors.

Alicea has more than 20 years of experience. Prior to forming Global Taxes, Alicea founded and oversaw operations at a boutique tax firm, worked at a prestigious global law firm and CPA firm.

Alicea specializes in U.S. tax planning and compliance for non-U.S. families with global wealth and asset protection structures which include non-U.S. trusts, estates and foundations that have a U.S. connection.

Alicea also specializes in foreign investment in U.S. real estate property, and other U.S. assets, pre-immigration tax planning, U.S. expatriation matters, U.S. persons in receipt of foreign gifts and inheritances, foreign accounts and assets compliance, offshore voluntary disclosures/tax amnesties, FATCA registration, and foreign companies wanting to do business in the U.S.

Alicea is fluent in Spanish and has a working knowledge of Portuguese.

Alicea is an active member of the Society of Trusts & Estates Practitioners (STEP), the New York State Society of Certified Public Accountants (NYSSCPAs), the American Institute of Certified Public Accountants (AICPA), the International Fiscal Association (IFA), a member of Clarkson Hyde Global, a world-wide association of accountants, auditors, tax specialists and business advisors and the Global Referral Network (GRN).

Distinctly, in 2020, Alicea was awarded with a prestigious NYSSCPA?Forty?Under 40 Award.?She was selected as someone that has notable skills and is visibly making a difference in the accounting profession.

In 2021 and 2022, Alicea was the Gold and Silver Winner, respectively, of Citywealth's Powerwomen Awards in the category USA - Woman of the Year - Business Growth (Boutique). In 2023, she continued her winning streak by receiving the Gold award for Company of the Year Female Leadership (Boutique) and the Silver award for Accountancy Firm of the Year at the Magic Circle Awards. Furthermore, Alicea has consistently secured her position in the Global Elite Directory for four consecutive years, being recognized as a Private Client Global Elite Advisor and is currently listed for 2024 as a Non-Legal Adviser. This exclusive directory annually highlights the world's elite lawyers and outstanding wealth advisors serving ultra-high net-worth clients.

Please note: This content is intended for informational purposes only and is not a replacement for professional accounting or tax preparatory services. Consult your own accounting, tax, and legal professionals for advice related to your individual situation. Any copy or reproduction of our presentation is expressly prohibited. Any names or situations have been made up for illustrative purposes — any similarities found in real life are purely coincidental.?