Whether giving or receiving, gifts and December go together. The good news is gifts are generally tax-free to the recipient. However, if you receive a gift (or inheritance) from a foreign person, you may be required to report it to the IRS to avoid a penalty, and there may be tax implications.
A foreign person includes a non-citizen individual who has a domicile (or intent to live) outside the U.S. A foreign person can also include a foreign corporation, foreign trust, foreign estate or foreign partnership.
The IRS defines a gift as “money or other property received by a U.S. person from a foreign person that the recipient treats as a gift or bequest and excludes from gross income.” A gift does not include most tuition or medical payments made by foreign non-citizens.
The IRS requires reporting on Form 3520 if you receive a gift or bequest from a non-U.S. citizen or foreign estate valued at more than $100,000 in a calendar year. The filing threshold is lowered to $15,358 for the 2014 year if the gift is received from a foreign corporation or foreign partnership. A U.S. person who receives a distribution from a foreign trust is required to file Form 3520 regardless of the amount received.
Form 3520 is due at the same time as an individual’s income tax return (Form 1040), including extension. The penalty for failure to timely report a gift or inheritance from a foreign person is equal to 5% of the value received per month, up to a maximum 25% penalty. The penalty associated with foreign trusts is up to 35% of the value of the trust property received. A penalty can be abated based on facts and circumstances that support the reason for failure to file was not willful or intentional. The IRS currently has several offshore voluntary disclosure programs that can help a U.S. person disclose issed gifts from foreign persons.
If you are expecting a gift or inheritance from a foreign person, here are some planning considerations:
- Avoid gifts from foreign partnerships and foreign corporations. Corporations and partnerships usually do not make personal gifts, so the IRS has the ability to challenge a gift and change the character from a tax-free event to taxable income for the recipient. When possible, gifts should be made from foreign individuals directly.
- Transfer currency outside of the United States. A transfer of currency done within the United States may result in a gift tax to the foreign person making the gift if more than $14,000. Thus, it is better to transfer currency outside the U.S. by using transfers between foreign financial institutions and then having the U.S. recipient transfer the funds to a U.S. account at a future point in time.
- Review transfers from foreign trusts. A loan or distribution from a foreign trust can result in a taxable event to a U.S. beneficiary (recipient). If possible, the trust transfer should be analyzed before being made to determine how best to minimize the U.S. tax exposure. Certain distributions will be considered 100% taxable if the U.S. beneficiary is not provided with adequate accounting details from the foreign trust.
- Avoid a direct gift of U.S. real estate. A direct gift of U.S. real estate will result in a gift tax owed by the foreign person making the gift. The gift rate is 40% on the amount transferred above $14,000. Consider, if possible, having an entity own the real estate before making the gift. A gift of shares of a company or membership units in a limited liability company are not taxable. Certain trusts can also be used to help facilitate the transfer.
- Use caution with gifts of foreign corporation shares. A gift of shares of a foreign corporation may bring along annual information returns and tax exposure. A tax burden is likely if the foreign corporation primarily owns passive assets that produce passive income. To discourage the use of foreign companies to own passive assets, there are several anti-deferral tax regimes that tax U.S. persons on the foreign company’s income even before it is actually received. Certain tax elections may be helpful at the time of the gift to avoid double taxation and to benefit from lower tax rates on qualified dividends and long-term capital gains.
If your spouse is a not a U.S. citizen, then gift tax implications arise upon making a gift to the non-citizen spouse in excess of $145,000 in 2014 (indexed for inflation each year). The U.S. spouse would be required to file a gift tax return (Form 709) to disclose the gift to the non-citizen spouse, and gift tax could be due if the spouse has exhausted his or her lifetime gift exemption of $5.34 million. The U.S. citizen spouse who receives a gift from a non-citizen spouse can receive an unlimited amount tax-free.