Am I Required to Pay U.S. Taxes on My Foreign Inheritance?

Foreign Inheritance Tax

Foreign Inheritance Tax 

When a U.S. Person receives an inheritance from a Foreign Person, it is referred to as a Foreign Inheritance — and this ignites the foreign reporting requirements under the Internal Revenue Code, specifically 26 USC 6039F. The concept of Foreign Inheritance Tax has many nuances to it.  One of the important distinctions that must be made is between the tax rules and the reporting requirements. When a receives a foreign inheritance from an overseas estate, one of the first questions they have is whether the inheritance is taxed by the IRS. Generally, a foreign inheritance, from a foreign person — that does not include U.S. situs — is not subject to U.S. Estate Tax (subject to the expatriate gift tax regulations still in flux).

Foreign inheritance taxation will depend on various different factors and has several moving parts to it, including:

• • U.S. situs

  • Foreign situs

  • U.S. inheritance tax laws

  • Foreign country tax laws

Whether or not a person has to pay U.S. tax on money or assets they receive from a foreign inheritance is a very common question.   We will review the basics of foreign inheritance tax and reporting. Even if the inheritance is not taxed, the U.S. person will still have a Form 3520 requirement when the threshold for filing the form is met.

Let’s review the basics of the foreign inheritance tax:

Is There a Foreign Inheritance Tax?

Usually, there’s a very simple answer, which is that you do not pay tax on the receipt of a foreign inheritance.  In general, the U.S. does not tax an inheritance solely because it is foreign. If a Foreign Person has U.S. property, there may be an inheritance tax on the U.S. assets (situs). If a Foreign Person has U.S. property, there is no inheritance tax BUT, the U.S. person recipient may have to file a Form 3520 (reporting requirement)

Why Is There No U.S. Tax on Foreign Inheritance?

The United States follows an estate tax model. That means, that it is the estate that is being taxed and not the inheritance.  Stated another way, it is the money of the person who passed away that is being taxed and not the actual recipient’s portion of the money that is being taxed. Therefore, if a non-US person (let’s say a citizen of Taiwan) who has no U.S. status and no U.S. situs passes away and leaves a U.S. person $40 million worth of foreign assets, investments, etc… then the IRS has no right to tax the assets, etc. of the foreign person because the foreign person has no relation to the United States. Likewise, the recipient is not taxed directly on the inheritance. The federal government does not have an inheritance tax, (although some states still do have an inheritance tax), so you’ll want to check with your particular state’s estate tax rules.

All pretty good news, unless the person who passed away also had a U.S. situs —

U.S. Situs Changes the Foreign Inheritance Tax Rules

In the prior example above, the person who passed away (a.k.a. the decedent) did not have any U.S. situs, such as land. But let’s say that person also had $3 million worth of US real estate. Let’s also presume that the person did not properly place the land into a trust or other asset protection entity and that the person presumably owned property directly. When a foreign person (non-U.S. Citizen or Resident) owns U.S. property, the default rule when he or she passes away is that only the first $60,000 is exempted from estate tax. This is a far cry from the exemption amount for US persons, which is roughly $11.2 million. In this situation, if the foreign person decedent also had $3 million of U.S. situs, then any amount over $60,000 may be taxed at 40%.

Therefore, while the foreign assets would pass tax-free, the U.S. situs would be taxed at 40% — which is nearly $1.2 million.

Inheriting Foreign Assets

If you have inherited foreign assets or accounts, it is important that you remain in IRS tax compliance. As you may or may not be aware, the IRS has made international tax enforcement a key priority. And, as a result of the inheritance, you may now have an International Informational Return filing requirement. Moreover, the penalties associated with failing to remain in compliance are brutal, and can often reach 100% value in a multi-year audit situation in which the IRS believes you are willful.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their Form 3520 and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.