The US Treasury has issued long-awaited regulations specifying the domestic taxpayers who have to disclose…
IRS Issues New Proposed Regs on Information Reporting on Foreign Gifts
The reporting of foreign gifts and inheritances is a very complex part of international tax law. Many of our clients have been hit with large penalties for late filing Forms 3520 to report foreign gifts. Although many of these laws were enacted decades ago, the Treasury and the IRS have been slow in issuing formal guidance and regulations. Rather, tax professionals and taxpayers have been required to consult non-binding guidance to determine how to comply with the reporting rules properly. This week, the US Treasury finally issued new proposed regulations to provide more guidance.
The Proposed Regulations (REG-124850-08)are more than 150 pages long and cover various provisions, ranging from foreign trust and gift reporting (secs. 6039F, 6048, and 6677) to transactions with foreign grantor trusts (secs. 643(i) and 679). Although the proposed regulations incorporate some of the informal guidance previously issued by the IRS, they also provide some interesting new rules related to foreign trusts and gifts. The regs will hopefully provide more clarity in this very complex area.
Some of the new proposed regs impacting the receipt and reporting of foreign gifts are discussed below.
Foreign Gift Anti-Avoidance Rule
Section 6039F requires U.S. persons to report the receipt of large gifts from foreign persons. For example, U.S. persons must complete Part IV of Form 3520 to report the receipt of more than $100,000 from a foreign individual. Taxpayers who miss the Form 3520 filing deadline may be subject to civil penalties of up to 25% of the amount of the gift.
In the proposed regulations, the Treasury notes that taxpayers have cleverly attempted to avoid the Form 3520 filing obligation and corresponding penalty by arguing that the transaction should be characterized as a loan and not a gift. To fight against these arguments, Treasury has proposed to include an anti-avoidance rule (Prop. Reg. sec. 1.6039F-1(b)(2)) that would require gift treatment in these instances if all of the following requirements are met: (i) the IRS concludes that the amount received is in substance a gift based on the facts and circumstances; (ii) the recipient does not treat the amount received as a gift; and (iii) the recipient does not treat the amount received as taxable income.
If the anti-avoidance rule makes it into the final regulations, U.S. taxpayers who receive bona-fide debt from foreign persons may want to ensure they can substantiate the debt. For example, they may want to have a written arms-length loan agreement and note, history of principal and interest payments consistent with the loan terms, and other indicia of debt to avoid inclusion under the anti-avoidance rule, particularly if the transaction is a related party (such as a family member, which is most cases).
$100,000 Gift to Adjust for COLA
“Under proposed §1.6039F-1(c)(2)(i)(A), a U.S. person is not required to report foreign gifts from foreign individuals or foreign estates if, during the U.S. person’s taxable year, the aggregate amount of foreign gifts received, directly or indirectly, from any one individual or estate (the transferor) does not exceed $100,000, as modified by cost of living adjustments under proposed §1.6039F-1(c)(2)(v). For purposes of determining whether the $100,000 reporting threshold is met, all foreign gifts (including covered gifts and bequests) from the transferor and from any foreign persons related to the transferor are aggregated. See proposed §1.6039F-1(c)(2)(i)(B).”
Additional Information About the Transferor and Aggregation of Related Parties.
Form 3520 instructions do not require identification of the foreign donor. The new regs state that “Specific identifying information about the transferor is not currently required to be provided on Form 3520. The Treasury Department and the IRS are of the view that the additional identifying information would assist the IRS in its determination of whether these amounts are properly treated as foreign gifts, and the burden imposed on the U.S. person should be minimal because the U.S. person would need to know the transferor’s identity in order to know whether the transferor is foreign and in order to apply the aggregation rule.”
The proposed regulations provide rules and an example for aggregating and reporting foreign gifts from persons related to the transferor.
Itemization of Gifts
A U.S. person is required to report the receipt of gifts from a nonresident alien or foreign estate only if the aggregate amount of gifts from that nonresident alien or foreign estate exceeds $100,000 during the taxable year. If the aggregate amount of foreign gifts from a transferor exceeds the $100,000 reporting threshold, the proposed regulations require the U.S. person to separately identify each foreign gift in excess of $5,000 received from the transferor and each foreign person related to the transferor, and to provide identifying information about the transferor and related foreign persons, including foreign individuals or foreign estates (for example, name and address). Specific identifying information about the transferor is not currently required to be provided on Form 3520.
The Treasury Department and the IRS believe that the additional identifying information would assist the IRS in determining whether these amounts are properly treated as foreign gifts. The burden imposed on the U.S. person should be minimal because the U.S. person would need to know the transferor’s identity to determine whether the transferor is foreign and to apply the aggregation rule.
“Specific identifying information about the transferor is not currently required to be provided on Form 3520. The Treasury Department and the IRS are of the view that the additional identifying information would assist the IRS in its determination of whether these amounts are properly treated as foreign gifts, and the burden imposed on the U.S. person should be minimal because the U.S. person would need to know the transferor’s identity in order to know whether the transferor is foreign and in order to apply the aggregation rule.”
Applicability Dates
The regulations are proposed to apply to transactions with foreign trusts and the receipt of foreign gifts in taxable years beginning after the date on which the final regulations are published in the Federal Register. However, a taxpayer may rely on these proposed regulations for any taxable year ending after May 8, 2024, and beginning on or before the date that final regulations are published in the Federal Register, provided that the taxpayer and all related persons apply the proposed regulations in their entirety and a consistent manner for all taxable years beginning with the first taxable year of reliance until the applicability date of the final regulations.
The proposed regulations, though not yet in final form, represent a good first step to gaining clarity in an already complicated and ambiguous tax area regarding foreign trusts and gifts. Tax professionals and taxpayers should stay tuned to see which rules stay, which are removed, and which are modified in the final regulations.
The new proposed regulation is pasted below.
U.S. recipients of foreign gifts.
(a) Reporting of foreign gifts —(1) In general. Except as provided in paragraph (c) of this section, and subject to paragraph (a)(2) and (3) of this section, each U.S. person (within the meaning of section 7701(a)(30)) who receives a foreign gift (within the meaning of paragraph (b) of this section) during a taxable year must report such gift (including the additional information required under paragraph (c) of this section if, after applying the aggregation rules, the foreign gift exceeds certain reporting thresholds) on Part IV of Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, by the fifteenth day of the fourth month after the close of the U.S. person’s taxable year. In the case of a U.S. person who has been granted an extension of time to file the U.S. person’s income tax return pursuant to section 6081, an extension of time for filing Form 3520 is granted to the fifteenth day of the tenth month following the close of the U.S. person’s taxable year. No further extension of time to file Form 3520 is allowed. For special rules concerning the treatment of dual resident taxpayers (within the meaning of § 301.7701(b)-7(a)(1) of this chapter) and dual status taxpayers (described in § 1.6012-1(b)(2)(ii)) as U.S. persons for purposes of this section, see paragraph (f) of this section.
(2) Reporting by U.S. citizens and residents residing abroad. In the case of a U.S. person who is an individual and who qualifies for an automatic extension to file their income tax return under section 6081 and § 1.6081-5(a)(5) because the U.S. person resides outside of the United States and Puerto Rico and the U.S. person’s main place of business or post of duty is outside of the United States and Puerto Rico, the U.S. person must report the foreign gifts received by the U.S. person during the taxable year on Part IV of Form 3520 by the fifteenth day of the sixth month after the close of the U.S. person’s taxable year. If the U.S. person has been granted an extension of time to file the U.S. person’s income tax return pursuant to section 6081, an extension of time for filing Form 3520 is granted to the fifteenth day of the tenth month following the close of the U.S. person’s taxable year. No additional extension of time to file Form 3520 is allowed.
(3) Reporting for deceased U.S. persons. In the case of a deceased U.S. person, the executor (within the meaning of section 2203) of the U.S. person’s estate must report the foreign gifts received by the U.S. person during the U.S. person’s final taxable year on Part IV of Form 3520 by the fifteenth day of the fourth month following the close of the 12-month period which began with the first day of the U.S. person’s final taxable year. If the executor of the U.S. person’s estate has been granted an extension of time to file the U.S. person’s final income tax return pursuant to section 6081, an extension of time for filing Form 3520 is granted to the fifteenth day of the tenth month following the close of the 12-month period which began with the first day of the U.S. person’s final taxable year. No additional extension of time to file Form 3520 is allowed.
(b) Definition of foreign gift —(1) In general. The term foreign gift means any amount received from a non-U.S. person that the recipient (including a spouse) treats as a gift, bequest, devise, or inheritance for income tax purposes, but does not include any qualified transfer within the meaning of section 2503(e)(2) (relating to certain transfers for educational or medical expenses) or any transfer that is treated as a distribution (within the meaning of § 1.6048-4(b)) from a foreign trust and that is reported on a return under § 1.6048-4. A U.S. person who receives a transfer from a foreign trust must treat that transfer as a distribution from the trust that is reportable under § 1.6048-4, rather than as a foreign gift that is reportable under paragraph (a) of this section, even if the U.S. person treats the transfer as a gift for another purpose (such as computing the person’s Federal income tax liability). For example, although a covered gift or bequest described in section 2801(e) is a foreign gift, a U.S. person who receives a covered gift or bequest from a foreign trust must report the covered gift or bequest as a distribution (within the meaning of § 1.6048-4(b)) under § 1.6048-4.
(2) Anti-avoidance rule. The term foreign gift includes any amount received by a U.S. person from a non-U.S. person that meets all of the following requirements—
(i) Based on all the facts and circumstances, the Commissioner determines that the amount received is in substance a gift;
(ii) The recipient does not treat the amount received as a gift, bequest, devise, or inheritance; and
(iii) The recipient does not treat the amount received as taxable income (such as a purported loan).
(c) Exceptions —(1) Section 501(c) recipient. Paragraph (a) of this section does not apply if the recipient of the foreign gift is an organization described in section 501(c) and exempt from tax under section 501(a).
(2) Reporting threshold rules —(i) Foreign gifts from foreign individuals or foreign estates —(A) Reporting threshold. Except as provided in paragraph (c)(2)(ii) of this section, paragraph (a) of this section does not apply to a foreign gift received by a U.S. person from a non-U.S. person who is an individual (a foreign individual) or a foreign estate (within the meaning of section 7701(a)(31)(A)) if, during the U.S. person’s taxable year, the aggregate amount of foreign gifts received, directly or indirectly, from that foreign individual or foreign estate (the transferor) does not exceed $100,000, as modified by cost-of-living adjustments pursuant to paragraph (c)(2)(v) of this section.
(B) Aggregation rule. To determine whether paragraph (c)(2)(i)(A) of this section applies to foreign gifts received from a transferor, each U.S. person must aggregate foreign gifts, including covered gifts and bequests described in section 2801(e), received from all foreign individuals, foreign estates, and any other foreign person (such as corporations or partnerships) that the U.S. person knows or has reason to know are related to the transferor within the meaning of § 1.643(i)-1(d)(9). If the aggregate amount of all these foreign gifts exceeds the $100,000 reporting threshold, the U.S. person must separately identify each foreign gift in excess of $5,000 received from the transferor and from each foreign person related to the transferor and must provide identifying information (for example, name and address) about the transferor and each such foreign person, including a foreign individual or a foreign estate.
(ii) Covered gifts and bequests. Subject to paragraph (h)(2) of this section, paragraph (a) of this section does not apply to a foreign gift that is a covered gift or bequest described in section 2801(e) if the aggregate amount of covered gifts and bequests received by the U.S. person during the calendar year does not exceed the section 2801(c) amount, which is the dollar amount of the per-donee exclusion in effect under section 2503(b). For purposes of this paragraph (c)(2)(ii), the aggregate amount of covered gifts and bequests received by the U.S. person during the calendar year does not include transfers from a foreign trust (as described in paragraph (b)(1) of this section), as such transfers are reportable as distributions (within the meaning of § 1.6048-4(b)) under § 1.6048-4.
(iii) Other foreign gifts —(A) Reporting threshold. Paragraph (a) of this section does not apply to a foreign gift received by a U.S. person from a foreign corporation or a foreign partnership if, during the U.S. person’s taxable year, the aggregate amount of foreign gifts from that corporation or partnership (the transferor), when aggregated with foreign gifts received from other foreign persons that the U.S. person knows or has reason to know are related to the transferor as described in paragraph (c)(2)(iii)(B) of this section, does not exceed $10,000, as modified by cost-of-living adjustments pursuant to paragraph (c)(2)(v) of this section.
(B) Aggregation rule. To determine whether paragraph (c)(2)(iii)(A) of this section applies to foreign gifts from a transferor, the U.S. person must aggregate foreign gifts received from all foreign corporations, foreign partnerships, and any other foreign person that the U.S. person knows or has reason to know are related to the transferor within the meaning of § 1.643(i)-1(d)(9). If the aggregate amount of these foreign gifts exceeds the reporting threshold, the U.S. person must separately identify each foreign gift from the transferor and from each foreign person related to the transferor and provide identifying information (for example, name and address) about the transferor and each such foreign person, including a foreign individual or foreign estate.
(iv) Joint returns. In the case of married U.S. persons who file joint income tax returns under section 6013 for a tax year, the reporting threshold under paragraph (c)(2)(i)(A) of this section applies separately to each spouse. Thus, married U.S. persons who file a joint income tax return will not be subject to paragraph (a) of this section if the aggregate amount of foreign gifts received by each spouse, directly or indirectly from any one foreign individual or foreign estate, taking into account the aggregation rule of paragraph (c)(2)(i)(B) of this section, does not exceed $100,000 during the taxable year.
(v) Cost-of-living adjustments. The reporting thresholds under paragraph (c)(2)(i)(A) and under paragraph (c)(2)(iii)(A) of this section are increased by an amount equal to the product of the amounts specified in such paragraphs and the cost-of-living adjustment for the taxable year of the gift under section 1(f)(3), except that paragraph (A)(ii) thereof is applied by substituting “1995” for “2016.”
(d) Valuation principles. The amount of a foreign gift is the value of the property at the time of its transfer. The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. Accordingly, the value of the property is determined in accordance with the Federal gift tax valuation principles of section 2512 and sections 2701 through 2704 (chapter 14 of the Internal Revenue Code) and the regulations under section 2512 and sections 2701 through 2704 in this part.
(e) Penalty for failure to file information —(1) In general. If a U.S. person fails to furnish information required under paragraph (a) of this section with respect to any foreign gift by the due date provided under paragraph (a)—
(i) The tax consequences of the receipt of such foreign gift may be determined by the Commissioner based on all the facts and circumstances, and
(ii) Notwithstanding the tax consequences under paragraph (e)(1)(i) of this section, such U.S. person must pay (upon notice and demand by the Commissioner and in the same manner as tax) an amount equal to 5 percent of the amount of such foreign gift for each month (or portion thereof) for which the failure to report the foreign gift as a gift on Form 3520 continues (not to exceed 25 percent of such amount in the aggregate).
(2) Reasonable cause exception. Paragraph (e)(1) of this section will not apply to any failure to report a foreign gift if the U.S. person submits a reasonable cause statement to the Commissioner under penalties of perjury and demonstrates to the satisfaction of the Commissioner that the failure is due to reasonable cause and not due to willful neglect. The determination of whether a taxpayer acted with reasonable cause and not with willful neglect is made under the principles set out in § 1.6664-4 and § 301.6651-1(c). This determination is made on a case-by-case basis, taking into account all pertinent facts and circumstances.
(f) Special rules —(1) Dual resident taxpayers. If a dual resident taxpayer (within the meaning of § 301.7701(b)-7(a)(1) of this chapter) computes U.S. income tax liability as a nonresident alien on the last day of the taxable year and complies with the filing requirements of § 301.7701(b)-7(b) and (c) of this chapter, the dual resident taxpayer will not be treated as a U.S. person for purposes of section 6039F with respect to the portion of the taxable year the dual resident taxpayer was treated as a nonresident alien for purposes of computing U.S. income tax liability.
(2) Dual status taxpayers. If a taxpayer abandons U.S. citizenship or residence during the taxable year or acquires U.S. citizenship or residence during the taxable year as provided in § 1.6012-1(b)(2)(ii), the taxpayer will not be treated as a U.S. person with respect to the portion of the taxable year the taxpayer is treated as a nonresident alien for purposes of computing U.S. income tax liability.
(g) Examples. The following examples illustrate the rules of this section. In these examples and unless otherwise stated, assume that the reporting threshold under paragraph (c)(2)(i)(A) of this section is $100,000:
(1) Example 1: Qualified transfer exception. X, a U.S. person, attends Private University, an accredited college in the United States. X’s grandparents, who are not U.S. persons, pay X’s tuition directly to Private University. The tuition payment is a qualified transfer within the meaning of section 2503(e)(2). Under paragraph (b)(1) of this section, X is not treated as receiving a foreign gift from X’s grandparents. Accordingly, X is not required to report the tuition payment under paragraph (a) of this section.
(2) Example 2: Charitable donee. XYZ, a U.S. person, is an organization described in section 501(c) and is exempt from tax under section 501(a). XYZ receives a bequest of $200,000 from a foreign estate. Because XYZ meets the exception under paragraph (c)(1) of this section for organizations described in section 501(c) and exempt from tax under section 501(a), XYZ is not required to report the bequest under paragraph (a) of this section.
(3) Example 3: Gift from dual resident taxpayer. X is a lawful permanent resident of the United States within the meaning of § 301.7701(b)-1(b) of this chapter and is a resident of Country F under the domestic law of Country F. X is a resident of Country F under the residence article of the U.S.-Country F income tax treaty and notifies the United States by taking such a position on Form 1040NR and Form 8833 for Year 1. Pursuant to § 301.7701(b)-7 of this chapter, X is treated as a nonresident alien for purposes of computing X’s U.S. income tax liability for Year 1. During Year 1, X makes a gift of $150,000 to Y, a U.S. citizen. Under paragraph (f)(1) of this section, X is not treated as a U.S. person for purposes of this section. Because X is not treated as a U.S. person for Year 1, the gift is a foreign gift within the meaning of paragraph (b) of this section. Y must report the foreign gift on Part IV of Form 3520 under paragraph (a) of this section.
(4) Example 4: Gifts from related foreign individuals. X, a U.S. citizen, is married to Y, a nonresident alien. Y has three brothers, A, B, and C, who also are nonresident aliens. In Year 1, Y makes a gift of $90,000 to X, A makes a gift of $40,000 to X, B makes two gifts to X (one of $4,000 and one of $3,000), and C makes a gift of $4,000 to X. X knows or has reason to know that A, B, and C are related to Y within the meaning of § 1.643(i)-1(d)(9). X treats all five transfers as gifts. Under paragraphs (c)(2)(i)(A) and (B) of this section, to calculate the $100,000 reporting threshold, X must aggregate foreign gifts from Y, A, B, and C. For Year 1, X must report the receipt of $141,000 in foreign gifts. In addition, under paragraphs (a) and (c)(2)(i)(B) of this section, X must separately identify and report information regarding the $90,000 foreign gift from Y, the $40,000 foreign gift from A, and the aggregated $7,000 foreign gifts from B because each person’s foreign gift for Year 1 exceeds $5,000. X is not required to identify the $4,000 gift from C separately because it does not exceed $5,000.
(5) Example 5: Covered gift within meaning of section 2801(e). Z is a resident of Country F and relinquishes U.S. citizenship on July 1, Year 1, becoming a covered expatriate within the meaning of section 877A(g)(1). On December 31, Year 10, a date after the date final regulations under section 2801 are published in the Federal Register , Z gives $50,000 to Z’s son, X, who is a U.S. person. The transfer is a covered gift within the meaning of section 2801(e) and a foreign gift within the meaning of paragraph (b) of this section. Because the value of the foreign gift exceeds the threshold specified in paragraph (c)(2)(ii) of this section (assuming that for Year 10 this amount is under $50,000), X must report receipt of the foreign gift on Part IV of Form 3520 under paragraph (a) of this section. X also is subject to tax and separate reporting requirements under section 2801.
(6) Example 6: Gifts from foreign individual and related corporation. X, a U.S. citizen, is married to Y, a nonresident alien. Y is the sole shareholder of FC, a foreign corporation. During Year 1, Y makes a gift of $11,000 to X, and FC makes a gift of $9,000 to X. Because X knows or has reason to know that Y and FC are related, X must aggregate the gifts from Y and FC ($20,000). Although the $20,000 aggregate amount deemed received from Y does not exceed the $100,000 reporting threshold with respect to foreign gifts from foreign individuals, the $20,000 aggregate amount received from FC exceeds the applicable reporting threshold for foreign gifts from foreign corporations under paragraph (c)(2)(iii) of this section for Year 1 (assume that for Year 1 this amount is $18,000). Accordingly, X must report receipt of the foreign gift on Part IV of Form 3520 under paragraph (a) of this section. In addition, X must separately identify each foreign gift from Y and FC and must provide identifying information about Y and FC.
(7) Example 7: Penalties for failure to report information. The facts are the same as in paragraph (g)(6) of this section ( Example 6). X fails to report the amounts received from Y and FC on Form 3520 and does not demonstrate to the satisfaction of the Commissioner that such failure is due to reasonable cause and not due to willful neglect. Under paragraph (e)(1)(i) of this section and § 1.672(f)-4(a)(2), the Commissioner may determine that, based on all the facts and circumstances, the gift of $9,000 from FC to X should be treated as a dividend from FC to X and included in X’s gross income. Under paragraph (e)(1)(i) of this section, the Commissioner also may determine that there are no tax consequences to X upon receiving the gift of $11,000 from Y. Without regard to the tax consequences determined under paragraph (e)(1)(i) of this section, under paragraph (e)(1)(ii) of this section, X must pay (upon notice and demand by the Commissioner and in the same manner as tax) $1,000, an amount equal to 5 percent of the aggregate amount of $20,000 for each month for which the failure to disclose the foreign gifts on Form 3520 continues (not to exceed $5,000, an amount equal to 25 percent of the aggregate amount of $20,000).
(h) Applicability date —(1) In general. Except as provided in paragraph (h)(2) of this section, the rules of this section apply to amounts received after the [date of publication of the final regulations in the Federal Register ].
(2) Covered gifts and bequests. Paragraph (c)(2)(ii) of this section is effective on the date final regulations under section 2801 are published in the Federal Register and applies to covered gifts or bequests received on or after that date.
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