Is Foreign Inheritance Taxable and How to Report it to the IRS

Do I pay US Taxes on Foreign Inheritance or Report it to the IRS?

Foreign Inheritance Taxation and Reporting to IRS

When a U.S. person receives an inheritance from a non-resident alien (aka non-U.S. Person), the U.S. tax rules are different than when a person receives an inheritance from a U.S. person. That is because when the decedent/estate is a U.S. person, they are required to report the inheritance (when the threshold requirements are met) on Form 706. However, since non-resident alien decedents/estates are not required to report an inheritance to the IRS, instead the U.S. Government requires the U.S. person recipient to report the foreign inheritance to the U.S. government. When it comes to taxation of a foreign inheritance from a non-resident alien, generally they are not taxable — but there are also potential tax implications in some situations such as transferring U.S. situs from a non-resident alien and when U.S. property is held in a foreign trust. Let’s take an introductory look at how foreign inheritance may be taxed or reported to the US government.

Reporting Foreign Inheritance to the IRS

When a U.S. person receives a foreign inheritance from a non-resident alien, the U.S. person is required to report it to the U.S. government. For these types of reporting purposes, the IRS considers the foreign inheritance as a ‘gift’, and therefore the US person is required to file Form 3520.  The Form 3520 is used for several different scenarios and can sometimes get complicated, such as when it is used to report foreign trusts. However, when Form 3520 is used to report a foreign inheritance, it is relatively straightforward in terms of what needs to be reported, which includes:

• • • the date the inheritance was received,

    • the type of property that was received, and

    • the value of the property received.

The Form 3520 due date to report a foreign inheritance is April, but it goes on extension if the taxpayer files an extension for their tax return. The big issue with Form 3520 is usually the penalties associated with late filing. Unfortunately, the IRS can and does regularly assess penalties against taxpayers who do not report their foreign inheritance timely.

U.S. Taxes on Foreign Inheritance

Generally, there is no inheritance tax on foreign property. For example, if a U.S. person receives a $20M foreign inheritance from a non-resident alien and that property consists of foreign property, then the estate is not taxed by the U.S. government — and neither is the beneficiary. But, there are some exceptions in situations in which the non-resident alien owns US property and/or the decedent owned a foreign trust that contained U.S. situs in it.

Estate Tax vs. Income Tax

It is also important to distinguish between estate tax and income tax. The foreign inheritance/estate may not generate any estate tax for the U.S. beneficiary, but if the foreign inheritance that is now owned by the U.S. beneficiary generates income, then the U.S. beneficiary is required to report the income (and pay taxes) on the foreign income.

Does Farhy Apply to Foreign Inheritance Reporting on Form 3520

The Farhy Case is a Tax Court case in which the U.S. Tax Court ruled against the IRS and in favor of the Taxpayer. The Court held that the IRS does not have the authority to assess Form 5471 penalties short of filing a lawsuit against the Taxpayer. The case does not refer specifically to Form 3520 but the same enforcement protocol that was missing from the statute that authorizes Form 5471 penalties is also missing from the statute that authorizes Form 3520 penalties.

Noting, that the IRS did file a Notice of Appeal and appears intent on appealing the Farhy ruling.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their 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.

Current Year vs. Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting 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. 

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.