Foreign Inheritance Definition | International Tax Lawyer & Attorney

Foreign inheritance definition is a topic of crucial importance for both US income and US estate tax compliance, because domestic inheritance and foreign inheritance have vastly different income tax results and reporting requirements. Hence, the topic of foreign inheritance definition directly concerns millions of Americans who reside overseas and tens of millions of Americans who have relatives outside of the United States. In this article, I will explore the foreign inheritance definition and warn against the common tax traps associated with it.

Foreign Inheritance Definition: Confusion Among Taxpayers

There is an enormous confusion right now among many US taxpayers with respect to US tax compliance requirements concerning a foreign inheritance. Some taxpayers firmly believe that a foreign inheritance is never subject to US taxation, some adopt an exactly opposite position while the rest simply do not know what to think.

It appears that the notion that foreign inheritance is non-taxable was acquired by reading various articles on the internet that state exactly this point. The people who believe that foreign inheritance is taxable also draw their conclusion from the internet – the difference arises from the fact that they read different articles. Finally, the third category of taxpayers read both kinds of articles and they simply do not know who to believe.

What is going on? Why is it that the articles on the internet seem to draw mutually-exclusive conclusions? Is one category of articles correct while the other one is one hundred percent wrong?

The answer to these questions lies in identifying the purpose for which an internet article was written, because the source of confusion lies in the foreign inheritance definition. It turns out that there are two definitions with separate applicable US tax compliance requirements!

Foreign Inheritance Definition for Income Tax Purposes

The first foreign inheritance definition exists for income tax purposes only. Under this rule, foreign inheritance is an inheritance received from a decedent who is a non-resident alien.

In this context, “non-resident alien” is defined by the IRS income tax rules. In other words, a non-resident alien is a person who does not fall into any of the tax residency categories. He cannot be a US citizen or US permanent resident; he did not stay long enough to satisfy the Substantial Presence Test; and he never declared himself a US tax resident (for example, by filing a joint US tax return with his US spouse).

Foreign Inheritance Definition for Estate Tax Purposes

A different definition of foreign inheritance applies under the US estate tax rules. Here, a foreign inheritance is defined as an inheritance received from a decedent who is a nonresident noncitizen. A noncitizen is a nonresident if he is domiciled outside of the United States. The term “domicile” here means acquiring a place to live without a present intention of later leaving. There are various factors used to determine a person’s domicile.

It is important to understand that, due to these two different definitions of a foreign inheritance, it is possible that a person could be a tax resident for income tax purposes and a nonresident noncitizen for estate tax purposes. Vice-versa may also be true.

Foreign Inheritance Definition and Tax Consequences

Now that we understand that there is a separate foreign inheritance definition for each tax regime (income and estate), we can clarify the confusion that prevails on the internet and among US taxpayers.

Generally, if the decedent was a non-resident alien, then neither his estate nor his US heirs would be subject to income taxes at the time of inheritance. I wish to emphasize here that this rule applies only “at the time of inheritance”, not before or after the foreign inheritance takes place. Exceptions may be possible with respect to foreign trusts.

On the other hand, if an inheritance was received from a taxpayer who is domiciled in the United States, then it will be subject to US estate tax rules irrespective of the country where the inherited assets are located. Of course, estate tax treaties may provide a certain amount of relief against double-taxation in this case.

If an inheritance was received from a nonresident noncitizen, then all foreign assets, except those considered as “US situs assets”, will avoid US estate taxation. The US situs assets above the exclusion of $60,000, however, may still be taxed in the United States.

Contact Sherayzen Law Office for Professional Tax Help With Your Foreign Inheritance

All of the rules that I have stated here are general, and your international tax attorney needs to apply them to your specific fact pattern in order to determine whether an inheritance fits a foreign inheritance definition for either estate or income tax purposes or both.

Furthermore, one should remember that “non-taxable” does not mean “non-reportable”. There are various income tax information reporting requirements that may apply to you even if your foreign inheritance was not taxable. Additionally, income tax recognition may be required in certain situations with respect to your foreign inheritance, especially before and after the you are deemed to have inherited your foreign assets.

Under these circumstances, the help of Sherayzen Law Office is of critical importance if you wish to stay in US tax compliance and avoid high IRS tax penalties. We are an international tax law firm highly experienced in US tax compliance concerning a foreign inheritance. We have successfully helped US taxpayers all over the globe with their foreign inheritance issues, and We can help You!

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South Korean Inheritance Leads to Criminal Sentence for FBAR Violations

On January 25, 2018, a South Korean citizen and a US Permanent Resident, Mr. Hyong Kwon Kim, was sentenced to prison for filing false tax returns and willful FBAR violations; additionally, he had to pay over $14 million in FBAR willful civil penalties. I already discussed Mr. Kim’s guilty plea and the main facts of his case in an earlier article last year, but I would like to come back to another aspect of this case: South Korean inheritance. In particular, I would like to trace how a South Korean inheritance led to Mr. Kim’s guilty plea and a criminal sentence for FBAR violations.

From South Korean Inheritance to Swiss Account FBAR Violations

According to the US Department of Justice (“DOJ”), Mr. Kim became a US permanent resident in 1998. The DOJ describes him as a sophisticated business executive who ran family businesses with operations in the United States and internationally.

At some point after he became a US tax resident, Mr. Kim inherited tens of millions of dollars from his family in South Korea. Instead of properly reporting his South Korean inheritance (which would not have been subject to US taxation at that time), he decided to hide it in foreign accounts. You can find the details of his efforts to hide his accounts in this article.

In the end, despite his ingenuous efforts, the IRS was able to identify Mr. Kim as a willfully noncompliant taxpayer who deliberately failed to file FBARs and filed false income tax returns for the years 1999 through 2010. As a result of his willful FBAR and income tax noncompliance and as part of Mr. Kim’s guilty plea, U.S. District Court Judge Brinkema sentenced Mr. Kim to six months to prison, imposed a fine of $100,000 and ordered him to pay $243,542 in restitution to the IRS. Moreover, Mr. Kim already paid $14 million in willful FBAR penalties.

In other words, as a result of his actions, Mr. Kim lost the majority of his South Korean inheritance and all earnings on that inheritance in addition to going to be jail.

Failure to Report South Korean Inheritance Was the First Step that Led to Criminal FBAR Violations

While, undoubtedly, the entire history of willful failures to file FBARs and report foreign income on tax returns is the primary cause of Mr. Kim’s imprisonment in 2018, it is important to understand that his noncompliance was only possible because Mr. Kim did not properly report his South Korean inheritance.

In other words, had Mr. Kim disclosed on Form 3520 that he had received an inheritance from South Korea in the last 1990s, he would not have been tempted to hide his inheritance from the IRS. In fact, the disclosure of his South Korean inheritance, would have made it impossible for him to hide his foreign assets in Swiss banks afterwards.

Primary Lesson from Mr. Kim’s South Korean Inheritance Case

This is an important lesson from this case that many observers and tax attorneys have missed – Mr. Kim’s noncompliance began with failure to report South Korean inheritance, not from the failure to file FBARs and foreign income (even though, he was sentenced and penalized for the latter two activities).

In fact, a very high number of my offshore voluntary disclosure clients came from a similar background – they received an inheritance from a foreign country (and it could be any foreign country: Australia, Canada, China Colombia, France, Germany, Italy, Russia, South Korea, Thailand, et cetera) and they failed to report the foreign inheritance first (usually, due to lack of knowledge about proper reporting of foreign inheritance). This failure to report foreign inheritance later led to significant US tax noncompliance that could have only been corrected through a voluntary disclosure.

Starting in 2013-2014, I have also seen the steady rise in the “reverse discovery” inheritance cases – i.e. clients would receive a foreign inheritance and would come to me to discuss on how to best disclose it. Then, as a result of my due diligence checklist, we would uncover prior FBAR or other tax noncompliance with respect to other foreign assets my clients had prior to their foreign inheritance.

Contact Sherayzen Law Office for Proper Reporting of Your Foreign Inheritance

If you received a foreign inheritance, you should contact Sherayzen Law Office for professional help. Sherayzen Law Office is an international tax law firm that specializes in US tax reporting of a foreign inheritance. We can Help You!

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Foreign Inheritance and Stepped-Up Basis | US International Tax Lawyer

If you received a property as part of your foreign inheritance, one of the key questions that you are facing is whether this inherited property is entitled to a stepped-up basis in the United States. This issue was resolved some time ago by the IRS in Revenue Ruling 84-139, 1984-2 C.B. 168.

What is a Stepped-Up Basis?

First, let’s understand the concept of “stepped-up basis”. From the outset, it is important to understand that this is a purely tax concept – the property that existed right before and right after the step-up in the basis is exactly the same property.

There are two terms that we need to understand here: “basis” and “step-up”. Basis is basically the amount of capital investment in a property – i.e. the amount of capital a taxpayer invested in a property, including the purchase price, the construction costs, subsequent improvements of the property, et cetera. Not all expenses are allowed to be “capitalized” or added to the basis (also referred to as “cost-basis”) under US tax law; sometimes, expenses are just deducted in the year they were incurred. Furthermore, the cost-basis may also be reduced by certain usage of a property through appreciation, amortization, depreciation, et cetera.

The “step-up” in the basis means the adjustment of the basis for tax purposes to the fair market value of the asset at the time the “step-up” event occurs. One of the most common step-up events is inheritance.

Of course, this is a simplified explanation of a stepped-up basis and many complexities are simply omitted here (such as step-up in a community property state, et cetera), but, for educational purposes, it is sufficient to provide the general idea.

Is an Inherited Foreign Property Subject to Stepped-Up Basis?

Despite the fact that the foreign inherited property was not subject to an estate tax in the United States, the IRS has clearly ruled that such a property is entitled to a step-up in its basis. The logic is not complex. IRC (Internal Revenue Code) Section 1014(a)(1) states that the basis of a property acquired from a decedent shall be the fair market value of the property at the date of the decedent’s death. IRC Section 1014(b)(1) adds that an inherited property is considered to be acquired under IRC Section 1014(a)(1). Treasury Regulations Section 1.1014-2(b)(2) in essence provides that the stepped-basis applies to a foreign property (because the requirement that such property is includible in the value of a decedent’s gross estate does not apply).

Contact Sherayzen Law Office for Help with US Tax Issues Concerning a Foreign Inheritance

If you received a foreign inheritance, contact Sherayzen Law Office for professional help with your US tax compliance. Sherayzen Law Office is an international tax law firm that has helped its clients around the world with planning for a foreign inheritance, identification of the relevant US tax requirements and the preparation of the necessary tax forms (including Forms 3520). Our legal team has also helped our clients with the issues concerning late reporting of a foreign inheritance, including as part of an offshore voluntary disclosure.

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Foreign Inheritance Form 8938 Reporting | Form 8938 Lawyers

Foreign Inheritance Form 8938 reporting has quickly turned into one of the most important tax reporting requirements despite being one of the newest tax forms that debuted barely four years ago in 2012 (for the tax year 2011). In this article, I will discuss when Form 8938 needs to be filed with respect to inherited assets. For the purposes of this article, I will only discuss Form 8938 with respect to the assets actually received, not the assets which are still in the estate. I will also avoid the discussion of Form 3520; it is important to note, though, that Form 3520 is likely to be one of the most relevant reporting requirements with respect to foreign inheritance.

Foreign Inheritance Form 8938 Reporting: Form 8938 Basics

IRS Form 8938 was created by the infamous Foreign Account Tax Compliance Act (FATCA) and, generally, it requires individual U.S. taxpayers to report what are known as “specified foreign financial assets” if the value of those assets exceeds the applicable reporting threshold.

It is beyond the scope of this article to explore Form 8938 filing requirements in detail, but, in essence, IRS Form 8938 requires the reporting of three types of assets. The first category consists of financial accounts maintained at foreign financial institutions. This category closely follows the FBAR reporting requirements (with important exceptions, such as signatory authority accounts) but requires U.S. taxpayers to disclose more information with respect to these accounts.

The second category is the requirement to disclose the ownership of a whole new set of classes of assets grouped together under the vague definition of “other foreign financial assets”. Basically, other foreign financial assets include classes of assets which are held for investment but not held in an account maintained by a financial institution. Such assets include stocks or securities issued by anyone who is not a U.S. person, any interest in a foreign entity, and any financial instrument or contract that has an issuer or counterparty that is other than a U.S. person.

Finally, Form 8938 requires the taxpayer to report whether he disclosed any assets on Forms 5471, 8865, 8621, 3520 and 3520-A.

It should be remembered that Form 8938 has its own set of independent penalties associated with Form 8938 noncompliance. These penalties are imposed in addition to penalties associated with FBARs, Form 3520 and other U.S. information returns.

Foreign Inheritance Form 8938 Reporting: Foreign Financial Accounts

If you received foreign bank and financial accounts as part of your foreign inheritance, you will need to disclose these accounts on Forms 8938 if the relevant filing threshold requirement is satisfied. In a foreign inheritance context, an issue often arises if you are an executor of a foreign estate and have signatory authority over the estate’s financial accounts. Whether Form 8938 would need to be filed for the accounts in this situation is a fact-dependent question and needs to be explored by an international tax attorney (though, in the great majority of cases, an FBAR would need to be filed in this context as long as the relevant reporting threshold is satisfied).

Foreign Inheritance Form 8938 Reporting: Other Investment Instruments

If you received other investment instructions as part of your foreign inheritance, your international tax attorney should explore whether these instruments satisfy the second category of reportable Form 8938 assets. Examples of other foreign financial assets include: a note, bond, debenture, or other form of indebtedness issued by a foreign person; an interest rate swap, currency swap; basis swap; interest rate cap, interest rate floor, commodity swap; equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty; an option or other derivative instrument with respect to any currency or commodity that is entered into with a foreign counterparty or issuer; and other assets held for investment.

Foreign Inheritance Form 8938 Reporting: Foreign Business Ownership

The detailed exploration of the reporting of an ownership interest in a foreign business is beyond the scope of this article. Therefore, I want to briefly mention that, if you inherited an ownership interest in a foreign corporation, partnership or a disregarded entity, this interest may need to be reported on Form 8938. However, it is possible that this interest may also have to be reported on Forms 5471, 8865, 8858 and other U.S. information reports related to business entities. In this case, it is possible that you will only need to report on Form 8938 that the information regarding an ownership interest in a foreign entity was reported on Form 5471, 8865 and/or 8621.

The final decision on how a foreign business ownership needs to be reported to the IRS should rest with your international tax lawyer.

Foreign Inheritance Form 8938 Reporting: Foreign Trust Beneficiary Interest

The detailed exploration of the reporting of a beneficiary interest in a foreign trust is beyond the scope of this article. For the purposes of this article, let me just provide this brief and over-simplified summary – if you inherited a beneficiary interest in a foreign trust, you should report it on Form 8938 unless it is already reported on Forms 3520 and/or 3520-A (if the latter is the case, you just need to check the box on Form 8938 for the appropriate form on which the beneficiary interest was reported). Again, the decision on how to report your foreign trust beneficiary interest should rest with your international tax lawyer.

Contact Sherayzen Law Office for Professional Help with Your Foreign Inheritance Form 8938 Reporting

The U.S. tax requirements related to reporting of your foreign inheritance may be highly complex and it is very easy to run into trouble. Contact Sherayzen Law Office for professional help. Our legal team is highly experienced in foreign inheritance reporting, including Forms 8938, 3520 (all parts of Form 3520: foreign trusts, foreign gifts and foreign inheritance), 3520-A, 5471, 8621, 8865 and other relevant forms. We have also helped U.S. taxpayers around the globe with their offshore voluntary disclosures with respect to late reporting of their foreign inheritance.

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