Do You Have to Pay US Taxes on Foreign Inheritance?
Though the passing of a loved one is undoubtedly a difficult event, it sometimes happens that a person benefits financially from such an occurrence because they are the recipient of an inheritance. In many cases, especially those involving large amounts of money, there are substantial reporting and withholding requirements that go along with an inheritance, thanks to U.S. tax laws. However, the situation can become more complicated if one or more parties are not American citizens or live outside the United States.
The IRS won’t tax a foreign inheritance that comes from a someone who is not an American resident or citizen. That being said, you might need to report it to the IRS, just for informational purposes. If your foreign inheritance exceeds a certain amount, you will have to file IRS Form 3520, along with other forms, should they apply to your situation.
The certified public accounts at US Tax Help specialize in guiding American expatriates through tax season. Our team can help you understand how to report your foreign inheritance to the IRS. For guidance and helpful tips, visit our website or call the CPAs for American expatriates at US Tax Help today at (541) 362-9127.
How the US Taxes Foreign Inheritances
Generally speaking, the Internal Revenue Service (IRS) imposes steep taxes on estates before they are passed on to the eventual recipient. American expatriates may be able to avoid paying taxes on a foreign inheritance, depending on the situation. The citizenship status of the person you’re inheriting assets from and where you hold those assets can determine whether or not you’ll have to pay taxes on a foreign inheritance. If you recently received or are about to receive an inheritance from someone outside the United States, there are some important factors to keep in mind when determining the tax implications.
One of the most important factors to consider is the nature of the assets being passed to you. If any of the property or other assets is located or based in the United States – sometimes referred to as “U.S. situs” property – those assets will likely be taxed significantly. Similarly, the status of the person who passed away is taken into consideration as well; those who were U.S. expatriates or U.S. residents may have their estates taxed by the IRS.
To figure out the tax liability on the estate of a nonresident foreign citizen, the executor of the estate will use IRS Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return. It’s important to note, however, that the U.S. will only tax assets from within the United States; those that are held outside the country and are unrelated to any U.S.-based companies or property will not be taxed by the IRS.
The good news in all of this is that any U.S. citizen who is inheriting assets that are wholly based outside the U.S. will not be taxed by the IRS on those assets in any way. Keep in mind, however, that certain states may impose an inheritance tax on the money; be sure to check with a qualified international tax specialist, like the CPAs for American expatriates at US Tax Help to learn more. As long as an inheritance is from a non-American resident or citizen and is held outside the United States completely, the IRS will not tax it.
US Reporting Requirements for Foreign Inheritances
Even if the inheritance you are receiving is not going to be taxed, you’ll probably still have to submit one or more forms to relay information about the transfer to the appropriate government agencies; failure to do so could result in substantial penalties. Reporting a foreign inheritance isn’t always a simple process and might require guidance from an experienced accountant. The following are the most common forms that must be filed when receiving a foreign inheritance:
IRS Form 3520
The main form you need to concern yourself with is IRS Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. This form applies in cases where a U.S. taxpayer receives more than $100,000 through a foreign inheritance or is engaged in specific transactions with foreign trusts. However, because this is an information return and not a tax return, no payment needs to be submitted in relation to this form.
Whether you’re an American resident citizen or an expatriate, you may have to report a foreign inheritance with IRS Form 3520. That being said, you won’t be taxed solely on an inheritance if it remains in foreign accounts. However, there is an important distinction to make here. American expatriates will be taxed on their foreign financial assets if those exceed a certain amount. So, adding to your foreign financial assets by way of an inheritance can require you to pay an additional tax.
FinCEN Form 104
The IRS isn’t the only federal agency you should be concerned with when it comes to receiving a foreign inheritance. If you are receiving a foreign inheritance, it’s likely that claiming your money will require transferring funds from a bank account in another country to one in the U.S. If so, you may be required to file Form 104 with the Financial Crimes Enforcement Network, or FinCEN, as part of the government’s effort to fight money laundering. Long-time American expatriates might not have any remaining bank accounts in the United States. If you keep an inheritance in foreign bank accounts, you will not have to file FinCEN Form 104.
FinCEN Form 114
On a related note, those who, at any point in the tax year, have assets in foreign financial accounts with a total value of more than $10,000 are required to submit a Report of Foreign Bank and Financial Accounts (better known as an FBAR) using FinCEN Form 114. This form can be submitted electronically and is generally due by April 15, the standard tax filing deadline.
If you’re an established American expat, you may already be familiar with FBAR. That’s because you have to report if your aggregate assets across all bank accounts exceed $10,000. However, if you’ve just moved overseas, this might be new to you. If all of a sudden, receiving a foreign inheritance causes your accounts to exceed $10,000, you may not be aware that you’re also required to file FinCEN Form 114. After all, you may not have even heard of the Financial Crimes Enforcement Network before. That’s why seeking guidance from a trusted accountant, like the CPAs for American expatriates at US Tax Help, is a good idea. You can properly report a foreign inheritance and avoid unnecessary fines and penalties.
IRS Form 8938
Like the FBAR, this form applies to those who have foreign financial assets over a certain value at any point in the tax year. The Foreign Account Tax Compliance Act (FATCA) mandates that anyone who meets one of the following thresholds file IRS Form 8938, Statement of Specified Foreign Financial Assets:
Taxpayers living in another country
Single taxpayers living outside the U.S. or married taxpayers filing alone must file Form 8938 if their foreign financial assets are worth more than $200,000 at the end of the tax year or more than $300,000 at any point during the year; these values are doubled for married taxpayers filing this form jointly.
Taxpayers in the U.S.
Single taxpayers or married taxpayers filing separate returns have to file Form 8938 if their foreign assets are valued at more than $50,000 at the end of the year or more than $75,000 at some point during the year; again, these values are doubled for married taxpayers jointly filing this form.
Filing Form 8938 might be completely foreign to new American expatriates living overseas. While resident Americans might be aware of the need to file Form 8938 if they have foreign financial assets, not every resident citizen is. After moving overseas and adjusting to your new lifestyle, figuring out how the U.S. Tax Code now applies to you might be the furthest thing from your mind. Even if you’ve learned about Form 8938, you might not know that receiving a foreign inheritance adds to your aggregate foreign financial assets. That’s why it’s beneficial to work with an experienced professional, like the CPAs for American expatriates at US Tax Help. Having guidance when it comes to new filing requirements can help expats get through tax season without stress.
Abiding by the United States rules for reporting a foreign inheritance is important. That being said, not all Americans are aware that by receiving a foreign inheritance, you’re required to complete certain forms. Sure, most citizens know about the IRS and that they have to pay taxes. Many even know about the protocol for receiving an inheritance. But, things get more complicated when citizens, including expatriates, receive a foreign inheritance. When the funds remain overseas, you might have to report to other agencies you never heard of before, like the Financial Crimes Enforcement Network.
Why Don’t You Have to Pay US Taxes on Foreign Inheritance?
Although you probably won’t have to pay United States taxes on your foreign inheritance as an expatriate, reporting it to the IRS is still necessary. In order to keep tabs on American money overseas, the IRS requires you to report a foreign inheritance over a certain amount. It’s for informational purposes, not tax purposes.
If you receive a foreign inheritance while living overseas and keep those funds in a foreign account, the IRS won’t tax them. However, as long as you’re an American citizen, the IRS retains the right to have information about your finances. Receiving a foreign inheritance can substantially add to your foreign financial assets, which are taxable by the IRS. That being said, you don’t have to report an inheritance separately if it is beneath the $100,000 threshold.
When an inheritance comes from a foreign person or trust, it doesn’t concern the IRS. Because of that, the IRS won’t tax it, especially if the funds remain overseas. That being said, failure to report a foreign inheritance correctly can result in substantial fines that are otherwise avoidable with the help of an experienced professional, like the CPAs for American expatriates at US Tax Help.
Understanding why and how to report your foreign inheritance to the IRS can protect you from incurring high fines. For each month that you fail to file Form 3520, you can be fined 5% of the total inheritance amount. You can face penalties for failure to file IRS Form 8938 and FinCEN Forms 114 and 104 as well. These penalties can result in a massive financial headache. Because there are so many intricacies in the U.S. Tax Code, it can be difficult for American residents to understand. It only becomes more confusing when you move abroad, as additional requirements now pertain to you as an expatriate. Knowing how to report your foreign inheritance to the IRS can save you time and money.
Experienced International Tax Accountants Available for Help with Foreign Inheritances
When it comes time to file all the forms related to a foreign inheritance, it’s important that no mistakes be made, because the IRS can impose steep penalties on those who fail to comply with their rules. If you or someone you know has recently received a foreign inheritance or is likely to receive one soon, know that international tax accountant Ted Kleinman, CPA, has more than 30 years of experience handling issues like yours for U.S. taxpayers and American expats living abroad. To learn more about how the CPAs for American expatriates at US Tax Help can assist you, visit us online or call (541) 362-9127 today.