October 4, 2012

Foreign Inheritance Tax?


The United States, as famously stated, is a nation of immigrants. Naturally then, many U.S. persons have close relatives that reside abroad. For example, I have many close relatives living in Iran, namely Tehran and Shahmirzad, from my father's side of the family. Invariably, relatives residing abroad will unfortunately reach a demise at some point in time. It might then be possible for a U.S. person to be the beneficiary of that foreign relative's estate. A common question that is raised when a person inherits money from a foreign estate is, "do I have to pay taxes for inherited assets from a foreign source?"

The answer to this question is no, a U.S. person does not have tax liability in regards to assets inherited from a foreign estate. However, there are reporting requirements when certain thresholds are met. 

For example, assume John Quimby is a U.S. citizen residing in Los Altos, CA, my hometown. John has a wealthy aunt that lives in Australia and maintains citizenship there. The aunt does not have a green card or any association with the U.S. The aunt pens a will and names John the sole beneficiary of her estate, which consists solely of $101,000 in a bank account. John's aunt later passes away when she is ambushed by an angry flock of seagulls at Bell's Beach. The aunt's executor eventually wires to John the $101,000 when the estate is closed. John will not have to pay the U.S. government taxes for this inherited amount. However, John will have to file with the IRS Form 3520 because the amount received from the foreign estate exceeds $100,000.

One rationale for imposing no tax on inherited assets is that the decedent presumably already paid taxes on their estate. If the U.S. government imposed a tax on a foreign inheritance, this would arguably constitute double taxation which some find objectionable.

Another rationale for imposing no tax is that this policy facilitates the in-flow of capital to the U.S. By not imposing a tax, this encourages foreigners to name a U.S. person the beneficiary of their estate because the foreigner knows that a portion of the inheritance will not end up in the government's coffers but rather will entirely end up in the beneficiary's hands.

What is important to remember is that Form 3520 relates to an inheritance. If a U.S. person receives money as a result of investment or services, this would not be considered a gift. Rather it would be considered foreign taxable income. Regardless, it should not be difficult to distinguish between inheritance and income.

There is no California equivalent to IRS Form 3520. Thus, all that is required of a foreign estate beneficiary is to file with the IRS.

Finally, if you receive an email from a supposed Nigerian prince informing you that you are the beneficiary of an astronomical amount of money, it might just be a scam. Call me crazy.