Unraveling Tax Implications: Receiving Inheritances from Overseas Relatives

Foreign Inheritances Taxation

The taxation of inheritances received from non-US citizens residing abroad is a nuanced subject. In most scenarios, such inheritances are not subject to US taxation. Nonetheless, adherence to IRS reporting regulations is crucial, and in some cases, a foreign inheritance tax might apply to inheritances originating from overseas.

The Core Principle

When a non-US person passes on assets to a US individual—whether a US citizen or a resident alien—standard IRS protocol does not impose taxes on the beneficiary or the deceased’s estate. An exception arises if the inherited assets fall under the category of “US Situs.”

Deciphering “US Situs”

“US Situs” refers to assets that hold a physical presence within the United States, typically tangible properties such as real estate. For instance, inheriting a New York real estate property from a non-US individual would qualify as a US situs asset, subjecting it to a tax that typically amounts to 40% of its value.

Beyond US Situs

Assets not conforming to the US situs criteria usually escape federal inheritance tax. However, depending on personal circumstances, state taxes might apply to inheritances from foreign sources.

Foreign Bank Accounts and Offshore Assets

Holding inherited funds in foreign bank accounts exceeding $10,000 triggers the obligation to file a Report of Foreign Bank and Financial Accounts (FBAR) using FinCEN Form 114. This is a separate informational filing that doesn’t influence your income tax return.

For offshore assets crossing specified thresholds, Form 8938 (Statement of Specified Foreign Financial Assets) must be filed. This form’s threshold varies based on filing status. Married US individuals residing abroad, for instance, should file Form 8938 if offshore assets exceed $400,000 at tax year-end or $600,000 at any other point within the year. Timely and accurate Form 8938 filing is crucial; failure could result in fines ranging from $10,000 upwards.

Unveiling Other IRS Reporting Obligations

Even when foreign inheritance taxes seem unlikely, reporting the inheritance to the IRS might be mandatory. Below, we delve into common reporting scenarios for foreign inheritances.

1. Foreign Gifts: Crossing the $100,000 Threshold

If the cumulative value of gifts or inheritances from non-US sources surpasses $100,000, filing IRS Form 3520 is crucial. This form—known as the “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts”—should accompany your individual income tax return. The filing deadline is usually aligned with the income tax return deadline, often around April 15th. Taxpayers do have the option to file an extension with their personal income tax return, which automatically grants an extension to Form 3520.

This figure encompasses multiple sums received within a single year. Imagine receiving a $50,000 gift and a $70,000 inheritance from different non-US individuals in the same year; due to the combined value exceeding $100,000, both amounts necessitate reporting via Form 3520.

Penalties of up to 35% of the gross value of the gift or inheritance might be levied for inaccurate or belated Form 3520 submissions.

2. Foreign Trusts: Navigating Regulations

In cases where a foreign inheritance finds its way into a trust, filing Form 3520-A—an “Annual Information Return of Foreign Trust With a U.S. Owner”—is required if any segment of the trust involves a U.S. individual as an owner. The trust must file this form by March 15, with the US owner taking responsibility for ensuring accurate submission. Taxpayers also have the option to file an automatic 6-month extension using Form 7004 by March 15.

Form 3520-A and Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) might need to be submitted jointly by the US owner in cases where the foreign trust misses the filing deadline. Form 3520-A, like Form 3520, serves as an informational disclosure. Noncompliance could incur penalties of $10,000 or 5% of the inheritance’s gross value, whichever is higher.

The Expat Perspective: Foreign Inheritance and Taxes

Expats typically don’t face US tax liabilities for foreign inheritances. The IRS’s stance on foreign inheritances remains consistent whether the individual resides abroad or within the US. While expats might need to file informational forms, actual expat tax liability due to foreign inheritances is unlikely. However, tax obligations might arise from any income generated via the inherited assets.

Contact Us Today

Navigating foreign inheritance tax intricacies can be daunting. Dimov Tax stands ready to offer assistance, not just for foreign inheritance tax queries but also for expat tax matters and US citizens engaged in foreign business ventures. Contact our team for guidance or a personalized consultation with our expat tax experts tailored to your unique financial situation.