Americans Receiving Foreign Inheritance, Tax, and Reporting
Americans Receiving Foreign Inheritance, Tax, and Reporting
When a U.S. person for tax purposes (including residents) receives an inheritance from a foreign person, they must meet various requirements to remain in IRS compliance. The most notable requirement is that the taxpayer must file Form 3520 if they meet the reporting threshold. The threshold requirements for reporting a foreign inheritance will vary depending on whether the inheritance came from an individual or if it was distributed from a trust. It is important to know the distinction between reporting a foreign inheritance and the U.S. taxation on the foreign inheritance. Presuming that the foreign inheritance is from a foreign person and all of the assets are foreign, then generally there is no U.S. tax implication because the estate is a foreign estate — and the U.S. has no tax authority over a foreign non-resident alien’s foreign property. This can become infinitely more complicated if there are U.S. assets that are being inherited and/or if there is a domestic trust that contains both U.S. and foreign assets. Here are four e important facts for Americans receiving foreign inheritance.
Form 3520 (Requirements and Due Date)
The complexity involved in filing a Form 3520 will vary based on the type of matter being reported. When the taxpayer receives a foreign inheritance, and they have to file Form 3520, the filing of the form is not too complicated. In this circumstance, a U.S. person is typically limited to having to report just the date of the inheritance, what the inheritance was, and the value of the inheritance. If the taxpayer received multiple inheritances or foreign gifts in the same year, then they may have to identify each entry separately, and if there are more than a few entries, they may have to create an attachment.
Reporting a Foreign Inheritance on a Form 1040
In general, the receipt of a foreign inheritance is not a taxable event, so a U.S. person is not required to report the inheritance on the Form 1040 directly. In other words, the 1040 is used to report income, expenses, etc., but since the receipt of a foreign inheritance is not income per se, there is typically no income implication.
Is Income Generated After Ownership Takes Place, Taxable?
One important factor that taxpayers should keep in mind is that while the foreign inheritance itself may not be taxable, income generated from the foreign inheritance can become taxable in future years.
Here is a common example:
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John is a U.S. person who received a $1,000,000 foreign inheritance that was placed into some foreign bank accounts, which generates 10% interest a year. While the receipt of the inheritance was not taxable, John is required to report the annual income generated from the foreign assets going forward. This is because he owns the foreign assets and they generate income.
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In addition, John will be required to file other international information reporting forms, such as the FBAR and Form 8938, to report the foreign account.
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Late Filing
The IRS has the right to penalize taxpayers upwards of 25% value of the unreported inheritance if it’s more than five months late. In late 2024, the IRS intended to minimize these types of penalties and possibly eliminate the automatic penalty assessment, but unfortunately, no formalized procedures were issued by the government. While there is a lower chance of taxpayers being penalized for late Form 3520, the penalty still exists, and many taxpayers unfortunately become subject to the penalty. Typically, taxpayers can challenge the penalty showed is important that if they’re filing a late Form 3520, they develop and execute a strategy from the outset.
Late Filing Penalties May be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.
Late-Filing Disclosure Options
If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.
*Below please find separate links to each program with extensive details about the reporting requirements and examples.
Streamlined Filing Compliance Procedures (SFCP, Non-Willful)
The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.
Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)
Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.
Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)
Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.
Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)
Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.
Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)
Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.
IRS Voluntary Disclosure Procedures (VDP, Willful)
For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).
Quiet Disclosure
Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.
Current Year vs. Prior Year Non-Compliance
Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
Need Help Finding an Experienced Offshore Tax Attorney?
When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. *This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. Contact our firm today for assistance.