General Rule
Generally, when a U.S. person receives a gift from a foreign person the done is simply required to report the gift on Form 3520. The Form is not a tax return, but simply an informational return. While significant penalties are assessed for failing to file the Form, foreign gifts are generally not subject to income tax.
The Internal Revenue Code (IRC.) defines a “foreign gift” as assets received by a U.S. Person from a foreign person. A “foreign person” is a nonresident alien individual or foreign corporation, partnership or estate. If these conditions are satisfied the gift is excluded from gross income. Form 3520 is required for gifts valued at more than $100,000 (which must be aggregated for multiple gifts) and must be filed separately from the U.S. Person’s income tax return.
Gifts from Covered Expatriates
For those U.S. Persons receiving gifts from former U.S. citizens and/or residents, the regulations and tax consequences increase significantly. Under IRC Sections 877A and 2801, gifts from individuals ceasing to be U.S. citizens or permanent residents (e.g. green card holders) on or after June 17, 2008 are subject to additional reporting requirements and taxation. The IRC characterizes such individuals as “covered expatriates.” Specifically, the IRC defines a covered expatriate as a U.S. citizen or permanent resident who relinquishes their citizenship on or after June 17, 2008 and who has a net worth of over $2million. Further, those who fail to properly relinquish their residency and/or citizenship are included as are those who fail to properly certify compliance with their U.S. tax obligations. As discussed in our previous article, relinquishing residency can prove to be more complicated than anticipated thereby resulting in many individuals who thought they relinquished residency prior to June 17, 2008 being covered by the new regulations.
Receiving gifts from a covered expatriate has significant consequences. While tax credits are available for foreign estate and gift taxes, the tax rate applicable to such gifts is 40%. Further, tax is assessed whether or not the assets were acquired by the covered expatriate after they they relinquished citizenship/residency. Finally, gifts received from covered expatriates are not subject to the lifetime exemption available to U.S. domiciliaries who receive a current exemption of $5.45 million.
Summary
Receiving a foreign gift is relatively straight forward and simply requires compliance with basic reporting requirements. Whereas, receiving gifts from covered expatriates requires donors and donees to evaluate proposed gifts prior to execution as a failure to do so could result in taxation of 40%. While gifts can be structured to minimize tax exposure by engaging in strategies such as utilizing the lifetime exemption prior to relinquishing citizenship/residency, a failure to consider such strategies could result in significant tax exposure.
