What happens when a U.S. family inherits foreign assets
Key takeaway
The value of an inheritance is generally excluded from gross income, but a U.S. recipient may have separate reporting duties and owe tax on income from inherited foreign assets.
Separate the inheritance from its earnings
The inheritance exclusion does not cover income generated by inherited property or an inheritance of income from property. Beneficiary income included under trust income tax rules is treated as an inheritance of income for this purpose.
The exclusion also does not apply to transfers by or for an employer to an employee.
U.S. citizens, wherever resident, and resident alien individuals generally face federal income tax on income from both U.S. and foreign sources. Subject to other income tax provisions, gross income includes property gains, interest, rents, royalties and dividends.
Taxable income reflects allowable deductions from gross income.
Reporting a foreign bequest on Form 3520
A U.S. person generally meets the foreign bequest reporting test after receiving more than $100,000 during the tax year in gifts or bequests from a nonresident alien individual or foreign estate.
Aggregate receipts from related donors or estates when you know or have reason to know they are related, or one acts as a nominee or intermediary for another.
Qualified tuition and medical payments are excluded. The recipient rule excludes organizations described in section 501(c) that are exempt under section 501(a).
Foreign trust distributions belong in Part III rather than as gifts in Part IV. Purported gifts from foreign corporations or partnerships have a separate annually adjusted threshold and aggregation rules.
After meeting the individual or estate reporting test, complete Form 3520 line 54, columns (a) through (c).
If no individual gift or bequest exceeds $5,000, leave those columns incomplete and enter “No gifts or bequests exceed $5,000.” in column (b) of the first line.
The $5,000 amount concerns itemization, not a separate filing threshold.
Foreign accounts: check both reporting systems
A U.S. person generally must file an FBAR when foreign financial accounts in which they have a financial interest or signature authority exceed $10,000 in aggregate at any time during the calendar year.
Review account location and authority alongside value. Separate exceptions can apply, so inheritance alone does not settle the filing question.
Form 8938 covers foreign financial institution accounts and specified investment assets held outside financial accounts. These include foreign issued stock or securities, foreign entity interests and financial instruments or contracts with a non U.S. issuer or counterparty.
Filing Form 8938 does not replace an otherwise required FBAR.
For individuals, the following Form 8938 thresholds concern the total value of specified foreign financial assets. No Form 8938 is required if no income tax return is required.
| Location and filing status | More than at tax year end | Or more than at any time during the tax year |
|---|---|---|
| United States, unmarried or married filing separately | $50,000 | $75,000 |
| United States, married filing jointly | $100,000 | $150,000 |
| Qualifying abroad, unmarried or married filing separately | $200,000 | $300,000 |
| Qualifying abroad, married filing jointly | $400,000 | $600,000 |
The abroad thresholds require a foreign tax home, a qualifying presence test and no applicable exception. A U.S. citizen can qualify through uninterrupted bona fide foreign residence that includes an entire tax year.
Alternatively, a U.S. citizen or resident can qualify through at least 330 full foreign days during 12 consecutive months ending in the tax year being reported.
Direct property ownership and ownership through an entity
Directly owned foreign real estate, including a residence or rental property, is not itself reportable on Form 8938 or FBAR.
An interest in a foreign entity holding that property is a specified foreign financial asset for Form 8938, subject to applicable filing requirements and thresholds.
Its value takes the real estate into account, but the property is not separately reported on Form 8938. Review associated accounts separately under the account rules above.
Inherited foreign investment funds
A foreign corporation is a passive foreign investment company, or PFIC, if it meets either the income test or the asset test. The income test requires at least 75% of gross income to be passive income under section 1297(b).
The asset test requires at least 50% of its average asset percentage, determined under section 1297(e), to consist of assets producing or held to produce passive income.
Classification also requires the applicable measurement and look through rules. Publicly traded corporations use fair market value for the asset test.
Nonpublic controlled foreign corporations use adjusted basis, while eligible nonpublic corporations that are not controlled foreign corporations may elect adjusted basis.
A corporation owning at least 25% of another corporation by value takes its proportionate assets and income into account. Controlled foreign corporation overlap qualifications also require review.
Form 8621 filing circumstances
A U.S. direct or indirect PFIC shareholder generally files Form 8621 in five circumstances.
- Specified direct or indirect distributions from a PFIC
- Recognized gains on a direct or indirect disposition of PFIC stock
- Qualified electing fund or section 1296 mark to market reporting
- Reportable elections
- Annual reporting under section 1298(f)
A separate form is required for each PFIC, subject to applicable exceptions. Holding a fund without purchases or sales does not alone resolve annual reporting.
A limited Part I exception
One limited exception removes Part I for a specific section 1291 fund. Aggregate qualifying PFIC stock must be $25,000 or less on the tax year's last day, or $50,000 for a joint return.
The shareholder must receive no excess distribution from that fund and recognize no gain on its sale or disposition.
Count qualified electing funds, section 1291 funds and stock subject to a section 1296 election. Exclude stock held through another U.S. person or another PFIC.
This exception concerns Part I, not every filing trigger. Other exceptions need separate review.
Two related terms
Domicile: For federal estate tax, domicile means living in a place with no definite present intention of leaving. Residence alone does not establish it, and an intended change requires actual removal.
Income in respect of a decedent: This is decedent income not properly includible in the taxable period of death or an earlier period. Section 1014 does not provide a new basis for the right to receive that income under section 691.
Four resources to open next
- Cross border estate information to gather. Use this checklist to organize account locations, ownership records and fund statements before reviewing an overseas inheritance with advisers.
- Basis and trust tax records and questions checklist. Gather the records for a separate discussion about inherited property basis and any income rights included in the inheritance.
- How estate tax treaties and foreign tax credits work. Open this guide if foreign death taxes are part of your inheritance questions. It covers the separate treaty and credit topic.
- How wills and inheritance laws work across borders. Continue here for questions about wills and property spanning countries alongside the income and reporting questions covered on this page.
An Investor Advantage perspective
A talk participant describes an advisory business focused on a particular international community.
"Another example is a family office in New York that only serves German families, and many people's reactions like what? How does that exist?"
Common questions
Does an income tax exclusion settle the reporting question?
No. Review the foreign bequest, account and investment reporting tests above separately from the inheritance income exclusion.
What can happen if foreign gift reporting is late?
The IRS may determine the receipt's tax consequences and impose a penalty when required foreign gift information is not furnished by the prescribed deadline, including extensions.
The penalty is 5% of the foreign gift amount for each month the failure continues, capped at 25% in total. The exception requires reasonable cause and absence of willful neglect.
Where should I look for filing deadlines?
Start with the filing instructions for each required form. The source notes below collect filing routes and timing so you can build a separate calendar.
Sources
- 26 U.S.C. §102: Inheritance exclusion and its limits for property income, inherited income, trust beneficiary income and employer transfers.
- 26 C.F.R. §1.1-1 and 26 U.S.C. §61: Worldwide income and gross income categories.
- IRS Instructions for Form 3520: Foreign bequest reporting, aggregation, exclusions, line 54 itemization and individual filing instructions.
- 26 U.S.C. §6039F: Recipient exclusions and foreign gift information reporting penalties.
- FinCEN FBAR filing information and instructions: Foreign financial accounts, financial interest, signature authority, aggregation and exceptions.
- IRS Instructions for Form 8938: Individual reporting thresholds, qualifying presence abroad, asset categories and overlapping reporting.
- IRS Basic Questions and Answers on Form 8938: Directly owned foreign real estate and interests in entities holding real estate.
- IRS Comparison of Form 8938 and FBAR Requirements: Real estate treatment, filing routes and deadlines.
- IRS Instructions for Form 8621: PFIC classification, reporting circumstances, filing instructions and the limited Part I exception.
- 26 U.S.C. §691 and 26 U.S.C. §1014: Income in respect of a decedent and the exclusion of those income rights from section 1014 basis treatment.
- 26 C.F.R. §20.0-1: Federal estate tax domicile.
Individual Form 3520 filing notes
An individual recipient generally files Form 3520 by the 15th day of the fourth month after the income tax year ends. A granted income tax return extension moves that deadline no later than the 15th day of the tenth month.
A U.S. citizen or resident satisfying either overseas condition on the income tax return due date receives the sixth month deadline instead of the fourth month deadline.
- The individual lives outside the United States and Puerto Rico, and their place of business or post of duty is outside the United States and Puerto Rico.
- The individual is in military or naval service on duty outside the United States and Puerto Rico.
The individual must attach a statement showing that one of these conditions is met. If the deadline falls on a Saturday, Sunday or legal holiday, file by the next day that is none of those.
Send the complete form to Internal Revenue Service Center, P.O. Box 409101, Ogden, UT 84409. Only a complete form, including every required attachment, is considered timely filed.
Form 8938 and FBAR filing notes
When required, Form 8938 accompanies the annual return and follows that return's deadline, including applicable extensions.
FBAR is due April 15, with an automatic six month extension to October 15. File it electronically through FinCEN's BSA E-Filing System, separately from the federal tax return.
Form 8621 filing notes
Attach a required Form 8621 to the shareholder's applicable tax return, partnership return or exempt organization return. File both by the return's due date, including extensions, at the service center where that return is required to be filed.
If no income tax or other return is required, file Form 8621 directly with Internal Revenue Service Center, Ogden, UT 84201-0201.