Don’t get tense over the tax on presents and gifts

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.

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