A Guide To US Gift and Estate Tax For U.S. Expatriates

Are you worried about paying inheritance/estate/gift tax in the United States and your country of residence? In this guide, we’ll discuss what the inheritance tax is when it’s taxable and what tax obligation you might have in relation to inheriting an estate.

Losing a loved one is often an emotionally charged and complicated process. Things can get even more complicated by different laws and regulations if you’re inheriting property from someone who lives overseas or you reside abroad. It’s important to understand how US inheritance tax laws might impact you.

What Is An Inheritance? What is the Estate Tax?
The term “inheritance” refers to the transfer of wealth from a deceased person to his or her heirs. This includes real estate, stocks, bonds, cash, bank accounts, retirement plans, life insurance policies, etc. The estate tax is a state tax that you pay when you receive money or property from the estate of a deceased person.

What Is an Estate?
In the United States, a deceased person’s estate is a legal entity created after his/her passing. It is usually responsible for collecting the deceased person’s worldwide assets, paying off any outstanding debts, and distributing the rest among the deceased person’s beneficiaries. The estate includes everything the deceased person owned, whether real or personal property, tangible or intangible, anywhere in the world. The Estate tax is a tax on the estate (the property, money, and possessions) of someone who’s died.

How Much Can a U.S. Citizen Inherit Tax-Free?

The lifetime tax exemption on gifts and estates is $12.06 million in 2022. If married, the joint exemption is $24.12 million. The value of the exemption increases each year based on inflation. If the estate value, reduced by the value of gifts made while alive, exceeds the lifetime exemption, progressive federal estate tax rates apply. The tax rates range between 18% and 40%.

Do You Owe US Taxes on a Foreign Inheritance?
The estate tax is usually paid either in the country where the estate is located or where the deceased was living. If you’re an American expat who inherits from someone living or with property overseas, you should seek out a trustworthy accountant in that country for legal advice. If the value of that inheritance is more than $100,000, you would report it on form 3520, which is only an informational requirement. Form 3520 would not cause tax owing, but it is subject to significant penalties for late filing or failure to file it.

Most American Expatriates who inherit property from a foreign person don’t pay any US estate taxes; however, the foreign estate might trigger additional filing requirements to the U.S.

The one exception is for gifts/inheritance received from a covered expatriate. In that case, the recipient would pay a tax of 40% on such inheritance/gift. This is also the only instance in which the estate/gift tax is payable by the recipient as opposed to the donor/estate.

If an American Expat inherits foreign financial assets and the total value of his/hers foreign accounts exceeds $10,000 at any point during the year, they must file an FBAR and report the newly inherited accounts. If the total value of the foreign financial assets is higher than $200,000, it triggers an additional filing requirement of form 8938 (Statement of Specified Foreign Financial Assets).

Moreover, you will need to file IRS Form 3520 together with your US Expat Tax Return if the value of the estate you inherited is over $100,000. Form 3520 is just an informational form; however, failure to file this form can bring hefty penalties. It is used to report foreign gifts, inheritance, and distribution from foreign trusts.

Related: Understanding Form 3520: Reporting Foreign Gifts and Distributions From a Foreign Trust

How to Complete Form 3520 to Report a Foreign Inheritance?
Foreign inheritance recipients must complete Part IV of form 3520, providing the fair market value of the property and/or funds received. It’s important to evaluate the fair market value of any assets you inherit because you may be required to file extra forms. If you’re an American citizen who lives outside the United States and inherits foreign financial accounts, you might need to fill out both form 3520 and form 8938 (Report of Foreign Bank and Financial Accounts).

If you don’t have an experienced accountant by your side, you may incorrectly report your overseas inheritances to the IRS or miss additional reporting requirements you might have. Form 3520 carries hefty penalties, and we’ve seen the IRS often assess these for failure to file form 3520 or an erroneous form 3520.

When do you need to file Form 3520?
You must file form 3520 together with your Federal Tax Return by June 15th if you’re an Expat. If you need more time to gather all the necessary information, your accountant (contact us, and we’ll file an extension for you free of charge) can help you file an extension. The first extension will give you an additional 6 months; if that isn’t enough, you can apply for another 2-month extension to file.

What Happens if You Fail to Report a Foreign Inheritance on Form 3520?
The IRS imposes hefty penalties on taxpayers who fail to file form 3520 when required. Even though foreign inheritances are not taxable, the IRS can assess penalties for errors on Form 3520 or late filing of either $10,000 or 35% of your inheritance.

If the inherited estate triggers additional filing requirements, such as IRS From 8938 or FinCEN 114 aka FBAR, and you fail to file these, additional financial penalties might apply.

Being penalized for failing to file a foreign inheritance tax return is simply unnecessary. If you’re not sure whether you need to file Form 3520 or if you forgot to include any foreign inheritances on your federal tax return, consult an experienced tax professional who can help you figure out which form you need to use. We offer free 20-minutes tax consultations to help you determine your filing obligations. Contact us today!

What Happens When an American Expat inherits an estate from his/her American relatives?
The estate tax is usually collected from the decedents’ estates rather than from beneficiaries. If you inherit someone else’s estate while living abroad, you’ll be required to oversee the estate’s tax matters. If you’re responsible for managing an estate after someone has passed away, and they were living in the United States, you should learn what that entails.

The estate tax is imposed upon the estate transfer. Regardless of whether you live overseas or in the United States, the IRS imposes the same tax laws on both residents and expatriates. If you inherit an estate from a loved one while residing overseas, you will be required to pay any estate tax owed by the estate.

There is a lifetime exemption of $12.06 million in 2022. If you’ve inherited other estates in your lifetime, or if your recently inherited estate is worth more than the lifetime exemption, your estate will be subject to estate tax. The estate tax ranges between 18% and 40%. The estate tax rate depends on the estate’s value.

Although you might not owe any estate tax to Uncle Sam, you still have to notify the IRS of your inheritance. It may be difficult for American Expatriates living abroad to coordinate estate matters if they’re not near their families and friends to provide support. If you live outside of the United States, you can hire an expat tax accountant to assist you with your U.S. estate tax matters.

How Do I Report US Inheritance as a US Expat?
You wouldn’t normally have to report it. The fiduciary of the estate would use IRS Form 706 to report the inherited estate and any taxes due. Of course, this would be your responsibility if you were named to be the fiduciary of the estate. The form is due within nine months of the deceased passing. In some cases, you might be granted an additional extension. It is important to note that you might also have to do a final tax return for the part of the year your loved one was alive. You might need to report the inheritance to the state where the deceased was a resident.

Do US Expats Face Penalties if They Don’t Report Inherited Estates?
It’s important to report an inheritance even if you don’t owe any estate taxes as the penalties for failure to file or erroneous IRS From 3520 start from $10,000 and can reach up to 35% of your inheritance. Additional penalties might apply if you fail to file IRS Form 706.

Note you may also have filing obligations in your country of residence. The foreign country might impose a tax on the estate inheritance and assess penalties if you fail to report or pay the taxes due.

It is best to get professional advice from an accountant who specializes in US taxes for Americans living abroad.

Are foreigners (Non-Resident Aliens) subject to US inheritance tax if they inherit an estate from American relatives?
The estate will take care of the estate tax. The foreigner will not be subject to the tax, just like a US citizen wouldn’t. However, they might still need to file the Final Return for the deceased and Form 706-NA . In most cases, the Non-Resident Alien Spouse will be responsible for filing these forms.

Have a question? Contact Oliver Wagner, 1040 Abroad.