When a U.S. person receives a gift from a foreign person in excess of $100,000, the transaction triggers a Form 3520 filing requirement. There are two steps to determining the tax and reporting consequences of such transactions.
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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. For example, a father gifting cash to his daughter for having graduated from college is a gift, absent some implied or express tax avoidance agreement.
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 6039F(c)(1)(B), the penalty of failing to file a Form 3520 is 5% of the amount of the foreign gift for each month for which the failure continues, not to exceed 25%.
Reasonable cause. Section 6039F(c)(2) states that the penalty shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.
What should non-compliant taxpayers do?
If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:
- Voluntary disclosure program
- Streamlined domestic offshore program
- Streamlined foreign offshore program
- Delinquent international information return submission procedures
- Delinquent FBAR Submission Procedures
We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.