You know that the IRS pays especial attention to
foreign transactions of U.S. citizens. We are to report foreign bank accounts,
for example, should they exceed a certain balance.
Did you know that you may also have to report gifts
made to you by individuals (and entities) overseas and exceeding certain
threshold amounts?
That may come as a surprise, as we anticipate gifts to
be tax free (and unreported) by the recipient. To the extent we pay attention
to this area of tax, it is the donor - not the donee - who reports a gift. It
is even possible to have a tax (the gift tax) if one cumulatively gifts “too
much” over a lifetime.
Let’s be candid here: this is not a risk you or I have
to sweat.
What got me thinking about it is a recent case coming
out of California. Ms. Huang litigated over IRS penalties for her failure to
timely report gifts from her overseas parents. She used TurboTax to prepare her
taxes, and TurboTax advised her incorrectly about the gifts. She believes she
has reasonable cause for abatement of those penalties.
I agree with her.
I also think this area of tax law is a mess.
Let’s go over this – briefly.
First, there are two considerations with foreign
gifts:
· Disclosure
· Taxation
It is unlikely that there will be a tax, but it is likely that you must report the gift. There is even a specialized form for this – Form 3520:
Trust me, one can have a long career in public
accounting and never see this form.
The filing threshold varies depending on the donor:
Gifts From Foreign Individuals
· The
threshold is $100,000. Not surprisingly, multiple gifts from the same person
(say mom) must be added together.
o
BTW, if mom gets creative and arranges to
transfer more than $100 grand via various family members, there is a related
party rule that will combine all those donors into one person – and put you over
the $100,000 threshold.
o
Once required to file, each gift of $5
thousand or more is to be separately identified and described.
o
There may be excellent reasons for the multiple
gifts. There are numerous countries which impose restrictions on outbound currency
transfers. South Korea, for example, places a limit of $50,000 (USD).
Gifts From Foreign Corporations or Partnerships
· The
reporting threshold is greatly reduced if a business entity is involved – to
$19,570.
· In
addition to the usual gift information, one is also to provide the name, address,
and tax identification number (if such exists) for the entity.
Inheritances
The IRS takes the
position that an inheritance is comparable to a gift. If one inherits from a
nonresident, the inheritance might be reportable on Form 3520.
EXAMPLE: Carlos is a
lawful permanent resident of the U.S. His uncle – a nonresident alien - passes
away, leaving Carlos a house in a foreign country. While the residence is
outside the U.S., Carlos is a U.S. permanent resident and should file a Form
3520.
Let’s change the example
a little bit:
EXAMPLE: Carlos’ uncle
was also a lawful permanent resident of the United States, even though he lived
for substantial periods outside the U.S. The inheritance now is from one “US
person for tax purposes” to another, and there is no need to file Form 3520.
The penalties
for not filing a 3520 can be onerous.
· 5%
of the gift amount for each month a failure to file exists. In the spirit of
not bayoneting the dead, the IRS will (fortunately) stop counting once you get
to 25%.
· If
the IRS contacts you before you contact them, the penalty changes. It then
becomes $10,000 for each month you fail to file Form 3520 after request.
· Penalties
will apply even if you filed a 3520, if the IRS believes that the return is
incomplete or incorrect.
· BTW
this penalty can chase you unto death – and beyond. There are cases where the
IRS has demanded penalties from the estates of deceased individuals.
So, what happened to Ms. Huang?
Her name is Jiaxing Huang, and in 2015 and 2016 her
parents gifted substantial sums to help her relocate to the U.S. and purchase a
home. Ms. Huang, like millions of others, used TurboTax to prepare her taxes
for those years. She asked - and TurboTax informed her - that donors, not
donees, are required to report gifts. Based on that feedback, she did not file
Form 3520 for those years.
COMMENT: TurboTax was correct, IF one was talking about gifts from a U.S citizen or lawful permanent resident to another. It was not correct in specialized circumstances – such as that of Ms. Huang’s.
A couple of years later she learned of her filing
obligations. Trying to play by the rules, she immediately filed Form 3520 for
2015 and 2016. She was late, of course, but she filed before the IRS ever
contacted her – or had any reason to suspect that she was even required to file.
The IRS responded – here is a (too) common reason
people hate the IRS – with penalties exceeding $91 grand.
COMMENT: The IRS churns these letters automatically. They do not go by human eyes. I propose – as a small improvement – that the someone at the IRS review these letters and related files before sending out such onerous penalties. I understand workforce limitations, but let’s be blunt: HOW MANY NOTICES CAN THERE BE?
Ms. Huang submitted an abatement request based on
reasonable cause.
The IRS denied the request. They then withheld her
2019 ($280) and 2022 ($7,859) tax refunds.
Of course.
She appealed the denial of abatement within the IRS itself.
COMMENT: She was trying.
She instead learned that her penalty had jumped to
over $153 grand. With interest she was topping $190 grand.
This was so egregious that even the IRS backed down.
Appeals reduced the penalty to slightly over $36 grand.
Ms. Huang paid it.
COMMENT: No!!!!!
Two weeks later she filed a Claim for Refund.
COMMENT: Yes!!!!!
Her grounds? Abatement of the penalties – as well as
the 2019 and 2022 tax refunds the IRS intercepted.
Let’s take a moment to explain why Ms. Huang paid the
penalty.
In many if not most areas of tax law, one can bring
suit without paying the tax (or penalty or whatever). That is one of the attractions
of the Tax Court: you can get a hearing before sending the IRS a nickel. Not
all areas of tax law are like this, however. An area that is not? You guessed
it: Form 3520 penalties.
COMMENT: If you think about it, this is one way to keep people from bringing suit. How many can afford to pay the tax (or penalty or whatever) AND pay a tax attorney to litigate? It’s a nice scam you have there, Agent Smith.
The government did its usual: an immediate motion to
dismiss the complaint. They even offered four reasons why the Court should
dismiss.
The Court agreed with the government on three of the reasons.
It did not agree with the fourth: whether Ms. Huang’s
reliance on tax software such as TurboTax under these circumstances could
constitute reasonable cause.
Ms. Huang will have her day in Court.
But at what cost to her.
And why – when the IRS is hemorrhaging employees and
losing budget allocations it likely should not have received in the first place
– are they wasting their time here? The facts are unattractive. Ms. Huang is
not a protestor or scofflaw. She tried. She got it wrong, but she tried. There
is no win condition here for the government.
Our case this time was Jiaxing Huang v United States,
Case No 24-cv-06298-RS, No District California.
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