Understanding US Tax and Filing Obligations for Gifts and Inheritance from Overseas

As global mobility increases and people travel and settle in different parts of the world in a quest for a better life, confusion often arises on the tax obligations of US citizens who receive gifts or inheritances from family or friends who are foreign nationals. Understanding your obligations in this regard is vital to complying with the regulations properly. Let’s learn how the IRS deals with the issue of foreign gifts and inheritances received by US citizens.

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Foreign gift/inheritance

Considering the connotations of the terms gift and inheritance is essential to understanding the IRS taxation provisions. A gift refers to the transfer of certain financial assets from one individual/organization to another individual, during the lifetime of the donor. An inheritance, on the other hand, refers to the transfer of certain financial assets to an individual after the death of the donor.

The IRS defines a foreign gift/inheritance as any amount received by a US person (US citizen or tax resident) from a foreign person that the US person considers a gift/inheritance and excludes from his/her gross income. Amounts transferred as payment of tuition fees or medical bills by the foreign person on behalf of the US person are not considered foreign gifts.

For the purposes of this definition, the IRS specifies that the term ‘foreign person’ may denote a non-resident alien individual or a foreign partnership, company, estate, or trust. It can also indicate a domestic trust that, for taxation purposes, is regarded as being owned by a foreign person.

The IRS does not tax overseas gifts/inheritances, subject to certain exceptions, but these must be reported if the amounts exceed certain thresholds. Here, it must also be noted that although these sums do not attract federal taxes, certain state tax laws may require you to pay tax on such gifts and inheritances.

Reporting obligations for gifts/inheritances from overseas

Every US person who receives a large gift or inheritance from overseas ( from a foreign person) must comply with the Internal Revenue Code. The IRS has laid down certain reporting obligations for such sums, although these are not taxable.

?????????i.? ? ? ? ? ? Gifts/inheritances from overseas must be reported only if you cross an applicable threshold during the taxable year.

???????ii.? ? ? ? ? ? This threshold is determined by aggregating the gifts and inheritances from overseas for the taxable year.

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Thresholds laid down by the IRS:

?????????i.? ? ? ? ? ? Gifts/inheritance from a non-resident alien/foreign estate

In case you receive a gift or inheritance from a non-resident alien or a foreign estate, your reporting obligations arise only if the total amount received from a particular non-resident alien or foreign estate exceeds $100,000 during a particular taxable year. In such circumstances, you would also need to specify separately each gift amount that exceeds $5,000. The threshold of $100,000 is calculated on the basis of the fair market value of the asset received.

???????ii.? ? ? ? ? ? Gifts from foreign companies/partnerships

If you receive gifts from a foreign company or partnership, these must be reported if they exceed a total of $18,567 for the year 2023 and $19,570 for the year 2024. The difference in threshold amounts is based on inflation considerations. Each such gift must be specified separately along with details of the donor’s identity.?

If you meet the thresholds specified by the IRS, you must file the Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts (Part IV of Form 3520). Form 3520 is a separate filing requirement, distinct from your annual income tax returns.

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When overseas gifts/inheritances are taxable and additional filing requirements

If you receive a gift/inheritance from a person designated as a covered expatriate under IRC 877A, it could be taxed under IRC section 2801. Section 2801 levies a transfer tax on US persons receiving gifts or inheritances from abroad on or after June 17, 2008. Such gifts/inheritances must be from former citizens or lawful permanent residents of the US who are considered covered expatriates by Section 877A. However, the provisions of Section 2801 remain deferred until the final regulations are issued by the IRS.

You should also note that the state you live in may tax your overseas gift/inheritance as per the state tax laws in force.

If you decide not to bring your gift or inheritance to the US and choose to deposit it in a foreign bank account, you are required to file FinCEN Form 114, which is the Foreign Bank and Financial Accounts (FBAR).

Additionally, you may also have to file a Statement of Specified Foreign Financial Assets in Form 8938.

Penalties:

You could be penalised for failing to file Form 3520 on time or providing partial or inaccurate information. A penalty amounting to 5% of the value of the gift or inheritance will be levied for every month of failure to comply unless you can provide a reasonable explanation for this non-compliance. The penalty is capped at 25% of the gift/inheritance value.

The complexity of taxation laws regarding the various aspects of gifts/inheritances received from overseas cannot be denied and requires proper planning and strategising with an experienced advisor. This will ensure you factor in compliance issues while deciding the best mode of investing your windfall.