With families increasingly spread around the world, it’s become common to receive gifts from friends and relatives living abroad. However, the IRS can tax you on these gifts and mandate strict reporting of the same. Understanding how foreign gift tax works, what items fall under it, and when to report them is necessary to ensure compliance with tax laws. In this guide, we will lay them out for you.
Understanding Foreign Gift Tax
The idea of the foreign gift tax is to track the movement of wealth into the United States from foreign sources. It is geared to prevent tax evasion and to ensure greater transparency in cross-border transactions. This tracking can also help prevent money laundering and other illegal activities.
What Is Considered a Foreign Gift?
A foreign gift is any money or bequest received from a foreign person, and the recipient does not include it in the gross total income. It can include cash transfers, foreign bank deposits, real estate properties, or any other assets received without any repayment or exchange. Some examples of foreign gifts are:
- A parent living in a different country is transferring money to his or her child living in the U.S.
- A relative or friend gifting shares of a company.
- Inheriting property that is located outside the U.S.
Note that business transactions or payments in any form for services rendered are not considered foreign gifts.
Who Is a “Foreign Person” Under IRS Rules?
The IRS also lays down which entities constitute a “foreign person” for the purpose of this foreign gift tax. The individual sending the gift must not be a U.S. citizen or resident. In case of non-individual entities, the company must not have been incorporated in the U.S. to constitute a foreign person.
The following entities are considered foreign persons:
- Nonresident alien individual.
- Foreign corporations, partnerships, and estates.
- A domestic trust that is treated as owned by a foreign person
- Foreign trusts.
- Any other non-U.S. entities.
Key Differences Between Domestic and Foreign Gifts
There can be a lot of confusion about what a domestic gift is versus a foreign gift. This difference can decide who must report the same to the IRS. In case of domestic gifts that exceed the annual exclusion limit, the responsibility is on the donor or giver. In other words, the giver of a gift must file a gift tax return if the amount exceeds the limit set for that taxable year.
On the other hand, the receiver is responsible for filing the required IRS informational form (Form 3520) if the foreign gift meets the IRS reporting thresholds. Note that the reporting must be done even if the gift itself is not taxable.
Reporting Requirements for U.S. Taxpayers
U.S citizens and residents must report foreign gifts using Form 3520, also called “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.” The purpose of this form is to track incoming wealth and avoid any illegal transfers.
When Does Form 3520 Need to Be Filed?
Form 3520 must be filed by U.S. citizens and residents when they receive:
- More than $100,000 from nonresident aliens and foreign trusts. If the cumulative value of all gifts exceeds $100,000, then the taxpayer must separately identify each gift that is more than $5,000.
- Gifts from foreign corporations and partnerships that exceed $18,567 for 2023 and $19,570 for 2024. If the cumulative amount from multiple gifts exceeds this amount, each gift must be separately identified.
Form 3520 must be filed with the IRS before the 15th day of the fourth month following the end of the taxpayer’s tax year. In general, this comes to around the 15th of April each year.
How to Fill Form 3520?
Form 3520 is detailed and requires extensive information from you. Besides providing your personal details, you must fill out Part III of the form, which is for distributions to a U.S. person from a foreign trust during the current tax year. Schedule A within Part III lists the default calculation of trust distributions, while Schedule B is the actual calculation of trust distributions, and Schedule C is for the calculation of interest charges.
Part IV of this form is where you list the gifts or bequests received from foreign entities during the current taxable year.
In all these sections, you must provide detailed information about each gift, including:
- Donor’s name and country of residence.
- Description and fair market value of the gift.
- Date and manner of receipt.
- Relationship to the donor.
You must also mention if the gift came from an individual or a foreign entity, as the IRS uses this information to detect indirect transfers from foreign trusts or corporations that may be taxable. Most taxpayers reporting foreign gifts will complete Part IV, which lists gifts or inheritances from foreign persons, but the specific part to complete may vary case by case depending on the type of transfer or entity involved.
Thresholds for Reporting Foreign Gifts
The IRS sets clear thresholds for reporting foreign gifts through Form 3520. You must report only if the aggregate amount exceeds $100,000 per year from foreigners or $19,570 from foreign corporations and partnerships.
Penalties for Failing to Report Correctly
The IRS imposes severe penalties for failing to report income correctly or not reporting at all. The penalties include a fine of 5% of the gift’s value for each month the filing is late, up to a maximum of 25% of the total gift amount.
In addition to the above, the IRS may conduct a detailed audit to understand if any income was not reported with the intent to conceal. Based on the findings, it may impose further penalties.
Tax Implications of Receiving a Foreign Gift
Many taxpayers assume that gifts received from family and friends outside the country are not taxable. However, this is not true, and the taxability depends on the nature of the transfer and who the donor is.
Is the Recipient Taxed on the Gift?
Genuine gifts from foreign persons are not taxed. However, the earnings that accrue from this gift are taxed. For example, if you receive $200,000 as a gift, this money is not taxed. But when you invest this money in stocks and earn dividends, the earnings are taxed.
Section 2801: Gifts from Expatriates
Section 2801 applies to any property that was transferred to a U.S. citizen or resident, provided it qualifies as a foreign gift or bequest. A key aspect of this section is that it must be from a covered expatriate, who is a former U.S. citizen who has relinquished citizenship or a long-term green card holder who has ceased to be a lawful permanent resident. In these scenarios, U.S. recipients must file Form 708 for reporting them.
Situations That May Trigger U.S. Tax Liability
There are some scenarios that can trigger tax liability, and this is where the IRS looks at the intent of the transfer. For example, gifts that are disguised as compensation for services and anything that is structured in such a way to avoid taxes can trigger the IRS audits.
Common Scenarios and Examples for Foreign Gift Tax
Foreign gift taxes can be confusing, and this is why we will look at some common scenarios and examples.
Cash Gifts from Foreign Relatives
As a first example, let’s say you receive $150,000 from your parents who are living abroad. You must file Form 3520 to inform the IRS of the gift, as it exceeds $100,000. However, you do not have to pay taxes on this amount.
Gifts from Foreign Corporations or Partnerships
A family-owned business that operates overseas sends you $25,000 as a gift. Even if this is a family-owned company, it is treated as a foreign corporation. Since the amount exceeds the threshold limits, you must report it on Form 3520.
Receiving Property or Inheritance from Abroad
If you receive a property worth $300,000 as an inheritance from your grandparents living in a different country, it is considered a bequest. Again, it exceeds the $100,000 value, so you must report it to the IRS, though no tax is payable. But if you later sell this property, you must pay U.S. capital gains tax.
Compliance and Best Practices
Complying with the IRS tax rules reduces unnecessary tax audits and the resulting penalties and fines. Here are some best practices to follow.
Documentation You Should Keep
Make sure to maintain detailed records to prove the source and value of each gift. Gather and safely store the following items related to your gifts:
- Bank statements reflecting the transfer.
- Letters or documents from the donors.
- Gift deeds or notarized declarations made by the donors, even if they were registered in a foreign country.
- Property documents.
- Records of foreign taxes paid, as this avoids double taxation with countries that have tax treaties with the U.S.
Working with Tax Professionals
As foreign gift taxes are complicated with multiple rules, it’s best that you work with experienced tax professionals like the Manay CPA team. This helps to interpret the IRS rules correctly and file the correct forms. Moreover, you’ll have help in filing the right sections, all of which can save you from penalties.
Avoiding Costly Mistakes
Foreign gifting has many pitfalls, so make sure to avoid the following common mistakes:
- Assuming gifts under $100,000 doesn’t matter. Genuine gifts below the threshold don’t need reporting, but transfers that are actually payments or income are still taxable. Check with tax professionals if you are unsure.
- Misclassifying business payments as gifts.
- Failing to aggregate multiple gifts from the same donor.
- Not converting foreign exchange according to the rules laid down by the IRS.
All these mistakes can attract further audits and it’s best to avoid them.
How Manay CPA Can Assist with the Foreign Gift Taxes?
Given the complexity of the foreign gift tax, professional guidance from an experienced company like Manay CPA can ensure compliance with the IRS regulations.
Filing Accurately to Optimize Taxes
Manay CPA’s experienced team works with you to understand your gifts better. Specifically, these experts view the gifts from the perspective of the IRS and analyze the intent and the donor. Accordingly, they advise on the reporting process.
They also help fill out Form 3520 in the sections that are relevant for you. This precise approach saves time and effort while enabling you to be compliant with the IRS laws.
Schedule a Free Consultation
If you have received any gift from a foreign donor or have questions on how to report your bequests, schedule a free consultation with Manay CPA today. Its experts will guide you through the entire process, so you can proceed with confidence.
FAQs
Do I have to pay tax on money gifted from overseas?
Generally, you don’t have to pay tax on money gifted from overseas if it is a genuine gift. However, you must report this gift to the IRS through Form 3520.
What happens if I don’t file Form 3520?
If you don’t report the gift through Form 3520, you can incur a penalty, which will be 5% of the gift value for every month, with a maximum penalty of 25%. Depending on the situation, the IRS may also levy additional penalties on top of the tax value of the gift.
How much money can I receive from abroad without reporting?
You can receive up to $100,000 from a foreign individual or estate, and up to $19,570 from foreign corporations, as a gift without reporting them to the IRS. Note that these limits can change each year, as the IRS computes the limits based on inflation. It’s best to check the limits for every taxable year.
Are inheritances from foreign estates treated the same as gifts?
Yes, inheritances from foreign estates are treated the same as gifts for the IRS reporting purposes. Hence, you must file Form 3520 for qualifying gifts. However, you may not have to pay taxes on them immediately, only when you generate income from these inheritances.
Can tax treaties reduce reporting requirements?
No, tax treaties between the U.S. and the country of donor do not reduce reporting requirements. Regardless of the origin country, you must report the foreign gifts that exceed the said thresholds through Form 3520. Failure to report can attract penalties and fines.
