The beady eyes of the Internal Revenue Service are looking out for any US taxpayer who fails to report any offshore earnings or gains – but what about money from gifts or inheritances?
Anyone who has tussled with an IRS examination will know they have to explain when and where every cent came from – even family gifts like cash for a birthday present.
The Foreign Account Tax Compliance Act (FATCA) will make offshore transactions less secretive – but will probably lead to more questions for some from the taxman.
US residents must pay tax on income from overseas – the IRS demands they declare their worldwide income and gains on a tax return.
Most believe that tax on a gift or inheritance is the responsibility of the person or estate giving away the money or property, but that’s OK once you have proved the cash or asset was a gift.
Avoiding an IRS examination
A gift, according to the IRS, is any transfer to an individual, either directly or indirectly, where no money or money’s worth is received in return.
Not all gifts need reporting – the exclusions are:
- Gifts that are not more than the annual exclusion for the calendar year
- Tuition or medical expenses paid for someone else
- Gifts to a spouse
- Gifts to a political organisation
One way to avoid an IRS examination is to get in first and file an IRS form 3520 to notify that you have received a gift or inheritance.
The two circumstances when this form is useful are:
- When receiving $100,000 or more as a gift or bequest from someone living outside the US
- If a foreign business makes a gift of $14,375 or more
The form should be filed in the tax year the gift or bequest was received – or when it was available to spend or use, whichever comes first.
Reporting a gift is not an option
Not telling the IRS about a sizeable gift is not an option – Penalties are $10,000 or 35% of the gross reportable amount, whichever is the greater. For returns reporting gifts, the penalty is 5% of the gift per month, up to a maximum penalty of 25% of the gift.
Gifts or bequests in trusts owned by a US taxpayer also need reporting on an IRS Form 3520A. Failing to report will mean penalties of the greater of $10,000 or 5% of the gross value of trust assets owned by the taxpayer.
The IRS suggests sending some paperwork with the Form 3520 is a good idea – consider adding:
- Copies of appraisals
- Copies of relevant documents regarding the transfer.
- Documentation of any partially-gifted assets or other items relevant to the transfer shown on the tax return
If a taxpayer sells the gift or bequest, tax is paid on the gain on the same basis as if they were sold by the donor – for instance if the donor bought shares at $10 each and gave them to a relative who sold them for $100 each, the relative would pay tax on the gain of $90.
