Last week’s blog post covered the US gift tax basics for foreign nonresidents wishing to make gifts to persons in the US. As discussed in that post, foreign nonresidents are generally subject to US gift tax only on tangible assets located, or deemed to be located, within the US at the time of the gift transfer. Intangibles are exempt from gift tax. When a “nonresident” makes a gift of cash, checks, or bank wire transfer directly to a US recipient, depending on the amount of the gift, the donor could unknowingly become liable for US gift tax since cash has been viewed by the Internal Revenue Service (IRS) as tangible property.
Today’s post examines some methods for the foreign nonresident to avoid the US gift tax. Care must be taken in such gifting transactions since if the IRS cannot collect the gift tax from the foreign donor, it might attempt to collect it from the US recipient.
Transfers from US Bank Account or Foreign Bank Account
Many nonresidents have US bank accounts, and if making gifts to persons living in the US, it would seem most practical to simply transfer the funds from the foreigner’s US bank account to the recipient’s US account. This should not be done since this transfer can be treated as a taxable gift if it exceeds the annual $17,000 per recipient exclusion. The IRS would view the funds as tangible property situated within the US, and the transfer as occurring within the US, since both accounts (donor’s and recipient’s) are with a US financial institution that is physically located in the US.
A much safer method would be for the nonresident to transfer the funds from his or her personal foreign financial account located in a foreign country, to the US recipient’s US account. An even safer approach would be to transfer the funds to a foreign financial account owned by the US recipient, if possible. In this way, the gift transfer is clearly being made offshore the US since both accounts (donor’s and recipient’s) are with financial institutions physically located outside the US. It may not be practical in many instances to make the gift in this manner since it is often difficult for US persons to have a foreign bank account.
Do Not Transfer from Foreign Entity Account!
In general, money or other property received by a US person as a gift is not taxed to the recipient. Under Section 102(a) of the US Internal Revenue Code, gifts (or bequests) are excluded from the recipient’s gross income. (A major exception exists for gifts or bequests received by a US person from a so-called “covered expatriate”). Even though the recipient will pay no tax on what he receives, there may be reporting duties imposed on the recipient if the giver of the gift was a foreign person. Further detail on these rules and reporting requirements can be found at my blog posts here and here.
There is a nasty surprise for the US recipient if the gift is made from a foreign corporation or partnership. When there is a direct or indirect transfer from a foreign corporation or partnership which the US recipient treats as a gift, the tax rules allow the IRS to re-characterize the “purported gift”, as income to the US recipient on which he or she must pay US income tax. Information on this topic is available at my blog posts here and here. In a nutshell, foreign persons should never make gifts from such foreign entity accounts. All gifts should be made from the donor’s personal foreign account.
Gift Intangibles Instead
As discussed, money is considered a tangible asset by the IRS and if transferred within the US, will trigger the gift tax. Instead, the foreign donor can consider using the cash to buy intangibles such as US stocks or bonds. Since these are intangible assets, gifting them will not result in gift tax to the foreign nonresident donor. After a prudent amount of time has elapsed, the donor can gift the stocks or bonds to the US recipients who can later sell these assets. Careful planning is needed in this type of case to prevent the IRS arguing that the purchase and sale of the stock/bonds is part of a so-called “step-transaction”. Using the step transaction theory, the IRS can collapse the steps to result in a gift tax to the donor (who would be viewed as transferring cash to the recipients). Of course, this type of transaction carries a market risk that the intangible, such as stock, may drop in value.
Pay the Educational Institution or Health Care Provider Directly
There are certain types of gifts that are exempt from the gift tax altogether, and one such exemption is when tuition is paid directly to an educational institution or payments are made to a healthcare service provider. More detail at Treas. Reg. § 25.2503-6(b)(3).
If a person pays tuition directly to an educational institution on behalf of another individual, such as a grandchild or a friend, the payment is not considered a gift for tax purposes. Similarly, if a person pays for someone else’s medical expenses, such as a hospital bill or doctor’s fees, the payment is also exempt from gift tax. In both cases, the payment must be made directly to the institution or service provider and not to the individual receiving the services.
The gift tax exception for tuition and healthcare expenses can also potentially cover travel expenses related to those services. For example, if a person pays for their grandchild’s tuition and also pays for their travel expenses to attend school, the travel expenses may be considered a part of the tuition payment and thus exempt from gift tax.
Similarly, if a person pays for someone else’s medical treatment and also pays for their travel and lodging expenses related to that treatment, the travel and lodging expenses may be exempt from gift tax. However, it’s important to note that the expenses must be directly related to the healthcare services being provided. To qualify for the gift tax exception, the payment for travel expenses must be made for the purpose of receiving healthcare services. Additionally, the payment must be made directly to the travel or accommodation provider, such as an airline or hotel, and not to the individual receiving the services.
The gift tax exception for tuition and healthcare expenses may also potentially cover certain payments made to a nursing home, but only under certain circumstances. For example, the payment must be made for the purpose of providing healthcare services, such as long-term care for a chronic medical condition or recovery from an illness or injury.
These gift tax exceptions can be a valuable tool for families who want to provide financial support to their loved ones without incurring gift tax liabilities. Professional guidance should be taken when dealing with these various exceptions to make sure no unwanted surprises arise later from the IRS.
Posted May 4, 2023
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