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Common Foreign Gift Traps for the Unwary, IRS Tax Forms
Common Foreign Gift Traps for the Unwary
It is not uncommon for foreign persons to want to provide gifts and other support to children, especially those living in the US — or may who have otherwise become US Persons. Whether it is because the child is living in the United States for school or employment — or has reached a major milestone such as graduating from University, getting married, or welcoming their first child– gifts are common. And, depending on the wealth of the family, those gifts can have a very substantial value. While the foreigner non-US person generally does not have any requirements from a US tax perspective –– unless they meet the Substantial Presence Test or are Covered Expatriates – there may be additional reporting and tax for the US Person gift recipient.
Worldwide Income and Reporting
First, from a baseline perspective, the United States taxes US persons on their worldwide income. That means that if a child of a foreigner resides in the United States and earns significant income from overseas sources — they are taxed on their worldwide income if they are considered a US Person. This generally includes US Citizens, Lawful Permanent Residents, and foreign nationals who meet the Substantial Presence Test.
*There are certain exemptions and exceptions for US-Person statuses, such as the Closer Connection Exception to Substantial Presence or F-1 Students in their first 5-years of status.
Form 3520 Foreign Gift
One of the most common ways that US person children get stuck in the US tax and reporting matrix is when they receive a gift from a foreign person. When a person receives a gift from a foreign person — and that gift exceeds the threshold for being from an entity or from an individual — they must file an IRS Form 3520 or risk upwards of a 25% penalty on the value of the unreported gift. Likewise, if a person receives a trust distribution from a foreign trust they are also required to report this information on Form 3520, and there is no threshold – – which means even a very minimal or de minimus foreign trust distribution to a US beneficiary will generally warrant the filing of Form 3520.
Covered Expatriate
If the foreign person is actually a covered expatriate, then there are additional gift and tax rules. Currently, the regulations are proposed, but once the IRS publishes Form 708 it will require the filing of a gift tax return form as well. In this type of scenario, it is actually the US person who must pay the gift tax upon receipt of the gift. The idea behind this rule is to prevent covered expatriates from moving money freely back into the United States (foreign tax credits for gift taxes paid may apply).
Form 3520-A Foreign Trust
If a US Person child is the owner of the foreign trust, in part or in whole, then they’re considered a US owner of a foreign trust, and then they may have significant reporting requirements on Form 3520-A. When it comes to the taxation of foreign trusts, it is very complicated and involves issues such as grantor vs non-grantor trust rules, the throwback rule, DNI versus UNI – and whether the proper beneficiary/trustee statements were issued.
It is not uncommon for family members overseas to gift a portion of a family foreign business to a child that has become a US person. This may lead to significant reporting requirements, especially in the year that the person becomes a US person — and may require the filing of Form 5471—which is no small feat, especially for taxpayers who may not have a background in tax or accounting. Likewise, if it turns out the US person owns more than 50%, it may be considered a Controlled Foreign Corporation (CFC) – which can lead to issues such as GILTI.
Out of IRS Tax or Reporting Compliance?
If you are out of compliance, there are various international tax amnesty programs the taxpayers can use to see if we get into compliance. And you should speak with a Board-Certified Tax Law Specialist who specializes in a specific area of offshore tax law to get a good understanding of what your options are.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure and Form 8938.
Contact our firm today for assistance with getting compliant.