My article copied below, first appeared on Forbes June 3, 2024 – link here.
Follow me on Forbes – it’s free and your gateway for easy to understand US international tax coverage. I’ve got 40 years of tax experience and am very careful with my blog posts to ensure accurate information is being provided.
Just below, some important tax tips for Americans who receive an inheritance from a foreign person….Maybe it is from a foreign spouse, or foreign parent. Is that taxable? Maybe! Must it be reported to IRS? What else must the American recipient need to know?
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While an American may feel a mix of joy and sorrow when receiving a foreign inheritance—happy about the financial windfall but grieving the loss of a loved one—they must also navigate the complexities of U.S. tax obligations. In today’s global economy it is increasingly common for Americans whether living abroad or stateside, to receive an inheritance from a non-U.S. person.
Here’s 4 important takeaways from understanding what can be taxed, to IRS reporting requirements and beyond:
1. In the usual case, the inheritance is a true windfall and is not taxed by the U.S. An inheritance is not always easy money, however. If the decedent was a former U.S. person and met certain requirements as a “covered expatriate” (CE), the American recipient must pay 40% of the value of the inheritance to the IRS. Planning can often avoid this problem.
2. Even if the inheritance is not taxed, the American recipient must report its receipt to the IRS, or risk losing 25% of its value as a penalty.
3. Depending on the type of asset inherited, other reporting obligations can arise.
4. The basis of the asset inherited can get tricky but is critical to know for a future sale or other transaction involving the asset.
Receiving An Inheritance From a Covered Expatriate
Under the general U.S. tax rules, when an American receives a gift or inheritance, these are received tax-free. However, the rules change if one receives a gift or inheritance from a CE.
A CE is a U.S. citizen or long-term resident who renounced citizenship or long-term residency and met certain criteria related to income, net worth, or tax compliance, resulting in onerous “expatriation” tax consequences. The expatriation tax regime impacts not only the CE, but U.S. persons within his or her close circle. Gifts or bequests from CE’s are not received tax-free; they can be taxed to the U.S. recipient at the highest gift or estate tax rate in effect at the time of receipt, currently, 40%.
Prior to expatriating, steps can often be taken to avoid CE status altogether, protecting American recipients from a 40% take by the IRS. Nonetheless, the burden of proving to the IRS that something was not received from a CE, falls on the American recipient. While planning can and must be done in advance to meet this burden, most people are simply unaware and fail to take precuationary action. Having certain of the former U.S. person’s tax returns and IRS filings, for example, is critical to proving non-CE status.
Reporting Requirements
IRS Form 3520: If a U.S. person receives a foreign inheritance exceeding $100,000 from a non-U.S. person, they must file IRS Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts”. This form reports the receipt of the inheritance to the IRS and is typically due on the same date as the individual’s income tax return, including extensions. Failure to file the form can result in a hefty penalty of 25% of the inheritance. The IRS has indicated in proposed Treasury Regulations, that the $100,000 amount will become indexed for inflation.
If amounts are received from a foreign trust, reporting is required by the beneficiary on any and all distributions, regardless how small the amount. Taxpayers must be very aware of the source of payments being made to them and must pay careful attention to where the money is coming from and not merely how much was received.
Virginia - US TAX TALK 
Virginia: excellent advice as usual. One quibble. You might want to point out that the $100,000 threshold for reporting gifts or inheritances on Form 3520 applies to amounts received directly from an individual. But any amount received from a foreign trust must be reported. That puts recipients on notice that they have to pay attention to where the money came from and not merely on how much they got. Still, tremendously helpful as is all your writing.
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thank you Richard! yes, even if they get $1 from a foreign trust, it must be reported …. scary stuff. Thank you for pointing this out. Article was UPDATED to reflect your comment 🙂
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