Inheriting an estate can be an emotional, complicated process. Unfortunately, there’s more room for confusion when inheritors live abroad. If you’ve recently inherited an estate as a U.S. expat, it’s important to know how estate taxes may affect you.
United States expats who inherit estates from foreign relatives don’t need to pay estate taxes to the IRS. If you live abroad and inherit an estate from an American relative, you must report it to the IRS. You may also be responsible for paying estate taxes if the estate’s value is above a certain amount. Failure to file the proper forms with the IRS and pay an estate tax liability can result in severe consequences. That’s why hiring an experienced tax accountant to guide you through the process is wise, especially if you live abroad.
For help preparing your taxes while living abroad, call the tax CPAs for American expatriates at US Tax Help at this link – get in touch.
Tax and Estate Planning as a US Expat
If you are engaging in estate planning and have set up a trust as an expat living overseas, you might have certain tax reporting obligations to the IRS.
Individuals may set up trusts for any number of reasons, primarily because proper estate planning can allow testators to avoid probate on certain assets. If you set up a living trust to manage your estate, you might have to report the trust’s income to the IRS and comply with Foreign Account Tax Compliance Act (FATCA) reporting requirements, such as filing IRS Form 8938, depending on the value of the estate or trust.
If you do not follow these reporting requirements for reporting a trust, the IRS will likely fine you. The initial penalty for not filing Form 8938 when required is $10,000. There may be an additional penalty imposed of $50,000 for failure to file Form 8938 after IRS notification.
Carefully assessing the tax perks available to you as a U.S. expat can allow you to reduce taxation on your foreign earned income and protect the value of your estate. For example, the U.S. allows expat to exclude up to $126,500 of their foreign earned income from taxation by the IRS. Any additional income earned from a foreign source will be subject to income tax. That said, because the foreign earned income exclusion threshold is so high, many expats can protect their entire income from taxation by the IRS while living abroad.
The foreign tax credit can have a similar effect, enabling expats overseas to avoid double taxation. The foreign tax credit lets you, dollar for dollar, reduce your tax liability to the IRS by taking into account taxes paid to your foreign country of residence. To claim the foreign tax credit, file IRS Form 116 with the IRS by Tax Day. Taking advantage of these exclusions can allow you to lower your taxable income and protect your assets and estate as an expat.
Rules for Inheriting a Foreign Estate as a US Expat
If you live abroad and recently inherited an estate from a foreign loved one or friend, you may be wondering if the United States can impose taxes on the transfer of property. The short answer is no. However, you may be liable for taxes imposed by the foreign relative’s country of residence.
Do I Have to Pay Inheritance Tax to the US?
Generally, the IRS does not impose taxes on inheritances of foreign estates. That means if you live abroad and inherit an estate from a foreign family member, you likely won’t have to pay estate taxes to the IRS. While you may not have to pay estate taxes in the United States if you live abroad and inherit a foreign estate, you may have to report it. Generally, American expats who inherit an estate valued above $100,000 must report it to the IRS using Form 3520. This is simply for informational purposes, not tax reasons. You must do this promptly after inheriting a foreign estate. Submit form 3520 alongside your annual tax return for the year by Tax Day.
Things get a bit more complicated if you become the executor of a foreign estate or receive a foreign inheritance that generates income. In such instances, the income generated by your inheritance may be reportable. Because of the foreign earned income exclusion, you might not be taxed on it by the IRS. However, you will still need to inform the IRS of any income generated from a foreign inheritance, as it might be subject to taxation. This is the case, whether taxpayers live abroad or in the United States.
Foreign inheritances might include any number of assets, from cash to property. If you receive a distribution from a foreign estate and then sell it you should not have to pay capital gains taxes to the IRS, as long as you live abroad.
Do I Have to Pay Inheritance Tax to My Foreign Country of Residence?
All of that said, other countries have their own rules regarding taxing the transfer of property from one person to another, so it’s important to consult our tax CPAs for expatriates for clarification on your tax liability. You may be responsible for paying estate taxes to a foreign government, depending on the rules of your foreign relative’s country of residence.
Rules for Inheriting an American Estate as a US Expat
Just because you moved overseas does not mean that all of your relatives will follow you abroad. Often, American expatriates receive inheritances from loved ones who still reside in the United States. When this happens, the IRS’s rules for reporting domestic inheritances are the same, regardless of where you might live.
Do I Have to Report an Inheritance to the IRS?
Reporting domestic inheritances can be difficult for Americans living overseas. Generally, expat inheritors need to use IRS Form 706 to report an inherited estate and any necessary taxes. This form is often due within nine months of a loved one’s passing, although inheritors can file for an extension in some cases. After filing Form 706, expats who inherit an estate from an American family member must file IRS Form 1041 annually.
It’s also important to note that you may have to report your inheritance to the state in which your deceased loved one resided. This calls for more paperwork, so reach out to our tax CPAs for American expatriates to guide you. Furthermore, if you inherit a domestic estate as an expat, and that estate generates income, you will have to report that income to the IRS and pay taxes on it, even if you live in another country.
Do I Have to Pay Inheritance Tax to the IRS?
Generally, estate taxes are paid by the decedent’s estate, not the beneficiary. However, if you’ve inherited a loved one’s estate while living overseas, it’s your responsibility to oversee estate taxes. If your newfound responsibility is to manage a loved one’s estate after their passing, and they lived in the United States while you live abroad, you should learn what that will entail.
In the United States, estate taxes are imposed upon property transfers to inheritors. It doesn’t matter if you live abroad or domestically, as the IRS imposes similar rules on residents and expats alike. If you inherited an estate from a deceased loved one as an expat, you’ll be liable for paying the imposed taxes through the estate. However, there is an exemption. In 2024, the lifetime gift and estate tax exemption has increased to $13.61 million. If you’ve inherited other estates in your life, or your recently inherited estate is valued above the exemption threshold, you’ll likely have to pay estate taxes. Generally, the estate tax ranges from 18% to 40%, depending on the estate’s value.
While you may not have to pay estate taxes upon a property transfer, you may still have to notify the IRS of your inheritance. This can get complicated for U.S. expats who are far from family and friends who can help. Because of that, Americans living abroad can benefit from hiring our tax CPAs for American expatriates to help them understand their potential estate tax liability and the necessary steps to take.
Lifetime Gift Tax Exclusion Amount and Estate Planning for Expats
Suppose you live abroad and have accumulated many assets, whether they are located overseas or abroad. In that case, it will be important to understand how the lifetime gift tax exclusion might impact your estate in the future.
For 2024, the lifetime gift tax exclusion for single expats and domestic citizens alike is $13.61 million. For married couples, the threshold is doubled. This means that you can send millions of dollars in gifts over your lifetime without being taxed. Of course, expats must also keep the annual gift tax exclusion in mind, which is $18,000 in 2024.
The lifetime gift tax exclusion directly impacts an estate and its distributions. For example, if an estate is not larger than $13.61, it will not be taxed on its distributions, provided they remain under the necessary limits. However, if an estate’s distributions are greater than the lifetime and annual gift tax exemption limits, the estate will have to pay taxes on the gifts. Again, the estate will pay taxes, not the recipients of the distributions.
If an estate is ultimately deemed a foreign estate, even if the creator was an American expat, the IRS will not be concerned with the matters of that foreign estate. Instead, the expat’s foreign country of residence will handle assessing gift taxes to the estate if necessary.
Fines and Penalties for Not Reporting an Inheritance as a US Expat
Reporting a recently inherited estate, even if you don’t have to pay estate taxes, is crucial. If U.S. expats don’t properly report and pay taxes on an inherited estate, they can face steep financial penalties from the IRS.
Most forms associated with reporting foreign inheritances or domestic inheritances are due by Tax Day. If you are an expat, you will get an automatic two-month filing extension for your taxes, pushing your due date back to mid-June.
U.S. expats who inherit an estate from a foreign loved one and fail to report it to the IRS can face financial penalties as well. This is the case even though expat inheritors of foreign estates don’t have a tax liability to the IRS. The minimum financial penalty for failure to file IRS Form 3520 is $10,000. There are also serious financial penalties for expats who fail to file IRS Form 706.
Furthermore, if your recent inheritance of a foreign estate put you over the reporting threshold for filing a Report of Foreign Bank and Financial Accounts (FBAR), you must do so with the Financial Crimes Enforcement Network by Tax Day. This report is required for any U.S. taxpayers with upwards of $10,000 across all foreign bank accounts. Failure to file an FBAR when required can result in fines of up to $100,000 or half the amount held in foreign accounts.
Remember, you may also face financial penalties if you’re required to report an estate inheritance to a foreign country and fail to. Because of the risk of incurring financial penalties, and the complications surrounding reporting a recently inherited estate, it’s wise to consult our tax CPAs for American expatriates to better understand your responsibilities.
Call Our Tax Accountants to Learn More About Estate Taxes for Expats
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