With Christmas having recently been on our doorstep, now is the time to review what tax consequences are in store for gift givers and their lucky recipients. US tax filings might be required of a US individual who receives a gift (whether in cash or property of some kind – you know, a 5 carat sapphire ring, a Mercedes Benz or a penthouse on the French Riviera). Tax filings (and maybe tax payments) may also be required of the giver of the gift — even if he or she is a foreign (non-US) individual. Let’s break it down:
Is it a Gift?
It is often the case that many people receiving a gift (or an inheritance /bequest) get very confused. They mistakenly believe that they have to pay US tax when they receive a gift (or bequest). This is not so. Bona fide gifts or bequests are not subject to income tax in the hands of the recipient because of a special exemption under Section 102 of the US Internal Revenue Code. The exemption applies regardless of whether the person giving the gift is a US person or a foreign person and regardless of the amount of the gift or bequest.
Note, the US Internal Revenue Service (IRS) may look closely to see if the gift is bona fide or whether it might be some kind of disguised compensation or other taxable item. The term “gift” is not defined in the US tax law, but the seminal case of Commissioner v. Duberstein 363 US 278 (1960) tells us that when determining whether something is a gift for US federal income tax purposes (note, the test is different for Gift Tax purposes), the critical consideration is the transferor’s intention.
Ascertaining this intention is a question of fact that must be determined on a case-by-case basis. Generally, the question boils down to whether the transferor’s intention was “disinterested” – meaning the act of giving was as a result of “detached and disinterested generosity” and out of “affection, respect, admiration, charity or like impulses”, or, whether it “involved an intensely interested” act. For example, in Duberstein, the giving of a Cadillac was determined to have been given to compensate for past customer references or to encourage future references, and not of out affection or disinterested generosity. As such, the Cadillac was taxable as income to the recipient.
Who is the Giver of the Gift? A US Person or Foreign Person?
If the recipient is a US citizen or resident and receives gifts (or inheritances) of money or other property from a foreign (non-US) person or entity, the gifts may need to be reported 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. So, while the gift is not taxable, the IRS must be notified of the gift. More below on the reporting obligations.
Gifts are Not Taxable to Recipient – The Exception
There is one exception to this wonderful no-tax rule! Gifts or bequests received from certain former American citizens or long term permanent residents can be subject to a special transfer tax currently equal to 40% of the gift/bequest. Full details about how a gift or inheritance from a former US person can be a Trojan horse are at my blog post here.
Recipient’s 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, the reporting duties imposed on the recipient cannot be ignored. Significant penalties may be assessed for a failure to file IRS 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; in other words, the gifts from the related parties must be aggregated.
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 in excess of $16,076 for 2018. (This is per the Instructions to Form 3520 at page 14). For 2019 the amount is expected to be $16,388 per the IRS 2019 draft Form 3520.
A lower dollar threshold applies when gifts are received from entities (as opposed to individuals or an estate) simply because entities do not really make gifts. The 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. Full details on this issue of “purported” gifts are at my blog post here.
Exactly What is a “Foreign” Gift or Bequest?
Here’s where the tax law can get very 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 a nonresident alien for US 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 since as a green card holder, she is a US resident for income tax purposes. This remains so even though her green card has expired. She is still liable for income tax on her worldwide income even though the green card is no longer valid for immigration law purposes. (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 post.
With respect to estates, the inquiry becomes far more complex. In determining whether an estate is to be treated as a “foreign” estate, the question is answered by examining 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. Professional advice is surely recommended. With respect to the example above, on balance, the estate 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.
Tax May be Imposed on the Giver of the Gift
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 relevant to 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 posts here and here.
Posted January 7, 2020
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