With the holiday season upon us, we thought it would be a good
idea to review some of the gift tax rules uniquely applicable to
foreign clients. This post examines the rules surrounding one type
of gift in particular - the gift of cash to U.S. persons.
When making gifts of cash to U.S. persons, foreign clients need to be aware of two potential U.S. tax issues: (1) gift tax for the foreign client; and (2) income tax for the U.S. recipient. Although these issues do not always present themselves in a purely domestic setting, the rules in the cross-border setting present traps for the unwary.
Let's start with the first issue - U.S. gift tax exposure for the foreign client. Generally speaking, foreign persons are subject to U.S. gift tax on gifts of U.S. real property and tangible personal property located in the U.S. (things like artwork, jewelry, cars, etc.). Gifts of intangible property (e.g., shares of stock) are not subject to U.S. gift tax in the case of a foreigner. Cash is generally viewed by the IRS as tangible property. Accordingly, depending on how a gift of cash is made, it could be considered a gift of tangible property located in the U.S. and, therefore, a transfer subject to U.S. gift tax. With only the benefit of a $15,000 annual exclusion amount, these transfers could carry a hefty gift tax price tag if foreign clients are not careful. 1
It is not unusual for many foreign clients to have U.S. bank accounts. Since the gift is intended for a U.S. person, it might seem like an obvious choice to make the transfer from a U.S. bank account. The risk, however, is that because the money is situated in the U.S. by reason of being held at a U.S. financial institution, the IRS could view that transfer as a taxable gift of U.S. situs tangible property.2 Instead, a foreign client should consider making the transfer from a foreign financial account titled in the foreign client's personal name. Ideally, the transfer would be made to a foreign financial account owned by the U.S. recipient; however, it may not be practical for a U.S. person to own a foreign bank account. If a foreign-to-foreign account transfer is not possible, the next best approach for making a gift of cash is to transfer funds from the foreign client's personal foreign financial account to the U.S. recipient's personal U.S. financial account.
If a foreign client wishes to remove the uncertainties involved in making cash gifts, he or she could instead consider gifting property that is definitively intangible. For example, a foreign client could purchase short-term U.S. Treasury Bills and transfer those to the U.S. recipient instead. Likewise, a foreign client could consider purchasing publicly traded securities to gift to the intended U.S. recipient.
The second issue concerns potential income tax liability for the U.S. recipient, a concept typically not encountered with gifts made in a purely domestic setting. In the cross-border setting, however, it is not unusual for clients to own financial assets through a foreign holding company. For administrative convenience, a foreign client may simply transfer funds from a bank account owned by that foreign company, rather than first transferring funds out of the company to a personal bank account. The issue is that the IRS views these types of transfers as taxable income to the recipient, even if the intention was to make a gift. Under the so-called "purported gift" rules, transfers received by a U.S. person from a foreign company are generally treated as taxable distributions, subject to the normal income tax rules that apply to distributions from foreign corporations or partnerships (depending on how the company is classified for U.S. tax purposes). 3
The foregoing is a very high-level overview of the U.S. tax issues that can present themselves when foreign clients make gifts of cash to U.S. persons. In addition to these substantive issues, it is worth noting that U.S. recipients must report these gifts on IRS Form 3520 if in excess of $100,000 in any given year, regardless of whether or not they are subject to tax on the gift. Foreign clients and their advisors would be wise to consider the relevant rules in this area to ensure that gifts made this holiday season fall into the nice, rather than the naughty, column.
1 Note, however, that in the case of gifts to
non-U.S. citizen spouses, the amount is increased to $157,000 for
gifts made in 2020 (increasing to $159,000 in 2021). In the case of
gifts made to U.S. citizen spouses, foreign clients still enjoy the
benefit of a full marital deduction.
2 A discussion of the treatment of wire transfers, and whether such transfers should be viewed as tangible or intangible property transfers, is beyond the scope of this post.
3 In the case of a foreign corporation, purported gifts can lead not only to income tax consequences under normal corporate distribution principles, but can also implicate the passive foreign investment company (or "PFIC") rules.
Originally published December 2, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.