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.
Footnotes
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.
