Foreign Nationals & Expats
Houston Tax Attorney
IRS Form 3520 – What are the Reporting Requirements and Tax Consequences of Receiving a Gift from a Foreign Person?
It is a common scenario where a U.S. person receives a gift from a parent or relative who lives abroad. Such transactions usually trigger a Form 3520 filing requirement. There are two steps to determining the tax and reporting consequences of such transactions.
Is the Transfer Actually a Gift and not Disguised Compensation?
A true gift that is not compensation for past services is not taxable to the recipient. Any income generated from the gift is taxable. For instance, if you receive real estate from a parent and subsequently rent the property, the rental income as well as any gain from the sale of the property is taxable income.
Quick note about tax basis: a gift has the same tax basis for the recipient as it did in the hands of the donor. This is opposed to a transfer through inheritance, where the recipient’s basis in the property is the fair market value at the decedent’s death (AKA “stepped up” basis). For instance, Ann has 2,000 shares of Company A that were transferred from her father, Bob. The cost basis (the amount Bob purchased it for) is $100,000 and the fair market value at the time Bob passes away is $900,000. Assume that Ann wants to sell the stock which are now worth $1,000,000. If Bob had gifted the stock to Ann, the gain (taxable amount) would be $900,000 ($1,000,000 sale price – $100,000 cost basis). On the other hand, if the stocks had been transferred through inheritance, the gain would be $100,000 ($1,000,000 sale price – $900,000 stepped up basis).
There are situations where a “gift” is really disguised compensation for past services. Courts have defined a gift as “a detached and disinterested generosity out of affection, respect, admiration charity or like impulses.” For example, Bob works for Joe for several months and in exchange he receives a new car worth $20,000 as a “gift.” The IRS would scrutinize such a transaction – was this really a gift or is it compensation for past services? If the IRS determines it is compensation for services, the $20,000 would be taxable income to Bob. The relationship between the parties is an important factor. Gifts between family members would likely face less scrutiny. For example, a father gifting stocks to his daughter for having graduated from college is a gift.
What is the Residency of the Donor?
Donor is not a U.S. Tax Resident
If the donor is not a U.S. tax resident (i.e., is not a U.S. Citizen or permanent resident and does not meet the substantial presence test), then the donor has no reporting requirement. However, the recipient of the gift as a U.S. tax resident must report the gift from any foreign person or entity if:
(a) The value of the gifts and bequests received from a nonresident alien individual or foreign estate, which must also include gifts or bequests received from foreign persons related to the nonresident alien individual or foreign estate, exceeds $100,000, or
(b) The value of the gifts received from foreign corporations or foreign partnerships, which must also include gifts received from foreign persons related to the foreign corporations or partnerships, exceeds $15,358 in 2014, or $15,601 in 2015, or $15,671 in 2016 (this value is adjusted annually for inflation).
The recipient must file Form 3520 which is due on the date of the income tax return, including extensions.
Donor is a U.S. Tax Resident
However, if the donor is a U.S. tax resident, they may have a gift tax return filing requirement if the total value of all gifts made to the same person within the same calendar year exceeds $14,000 (or $28,000 for married individuals).
If a gift tax return is required, the donor must file Form 709 on or before April 15th of the year following the calendar year in which the gift(s) were made. Although there is a reporting requirement for gifts above $14,000 (or $28,000), the donor will not pay taxes on the gift unless it exceeds the maximum lifetime exclusion amount of $5.45 million (as of 2016).
Penalties for Failing to File Form 3520
Under IRC 6677, a penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable):
- 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust.
- 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution.
- 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679) for failure by the U.S. person to report the U.S. owner information. Such U.S. person is subject to an additional separate 5% penalty (or $10,000 if greater), if the foreign trust (a) fails to file a timely Form 3520-A or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(a) through (c) and the Instructions for Form 3520-A.
Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. For more information, see section 6677.
Reasonable cause. No penalties will be imposed for failing to file a Form 3520 if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect.