When is Gift or Bequest Received by a USA Person Tax Free & When not ?

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The rules of taxation of gifts or bequests received by a US citizen or tax resident of the USA owing to passing the substantial presence test is straightforward. Under section 102 of the 26 US Code, any gift, bequests or inheritance in form of a property receipt of the gift by a US Citizen or US tax resident is generally tax-free . The relevant extract is given below:

26 U.S. Code § 102 – Gifts and inheritances

(a)General rule
Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.
(b) Income
Subsection (a) shall not exclude from gross income
(1) the income from any property referred to in subsection (a); or
(2) where the gift, bequest, devise, or inheritance is of income from property, the amount of such income.

What type of Gifts Not Tax Free ?

While the general rule as given in section 102(a) of IRC is not to charge any tax on the value of property received by a tax resident of the USA ( includes a US citizen whether or not he/she is residing in the USA) . However, sub-clause (b) of section 102 of 26 US Code says that the income from gifted property or gift of income of a property is not to be excluded from gross income tax-free. The provision of sub-section 2 of section 102 is extracted below:

Examples

Example 1 : Mr Jayant is from India. He is working in a USA company for the last seven years and therefore is a tax resident of the USA.His father gifted a house property to him which has a market value of $1 Million. Is the value of the gifted house taxable in the hand of Mr Jayant?

The answer is No because of the general exemption provided by section 102 of IRC.

Example 2 : Mr SriHari is also from India. He is working in a USA company for the last seven years and therefore is a tax resident of the USA.His father created a trust under which the rental income from an ancestral property earned by trust (say $10,000 ) would be transferred Sri Hari as gift every year.Is $10,000 received as a gift taxable in the hand of Mr Sri Hari?

Answer is Yes. The money received by Mr Sri Hari will be taxable in USA as section 102(b) of 26US Code clearly states that income of a property or periodical distribution of income of a property can not be excluded from gross income. So such a gift is not tax exempt.

Is there any reporting requirements in case of receipt of gifts from foreign person or entities ?

Yes, there is statutory reporting requirements in case a US person receives gifts or inheritance or bequests from non-residents persons above a threshold value which is explained below :

  1. The aggregate amount received from that nonresident alien or foreign estate exceeds $100,000 during the taxable year.  If the gifts or bequests exceed $100,000, you must separately identify each gift in excess of $5,000. 
     
  2. If you received gifts from foreign companies or partnerships, you are required to report the receipt of such gifts only if the aggregate amount received from all entities exceeds $16,649 for 2020 .  You must separately identify each gift and the identity of the donor.

In both the aforesaid cases, you need to file Part IV of Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, by April 15th -basically the due date from filing of tax return. So that date may be changing if you have applied from any extension of time to file tax return.

What happens if Form 3520 is not filed or filed late?

Section 6677 of 26 US Code provides law for imposing failure to file penalty if Form 3520 is not filed in time or or if the information is incomplete or incorrect. Generally, the initial penalty is equal to the greater of

  • $10,000 or
  • the 35% of the gross value of the distributions received from a foreign trust

Please note that penalty may not be imposed if you convince IRS that there were reasonable cause for delay in filing the form 3520.

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