Imagine the following scenario: On February 15, 2012, Jack a U.S. citizen residing in Burlingame, receives a USD $110,000 cash gift from his mother, a nonresident alien residing overseas. Jack’s mother owns a condominium in San Francisco. She does not own any other U.S. situs assets (U.S. sourced assets). Many people assume that any gift from a nonresident alien, regardless of its value, is automatically exempt from U.S. gift tax, and does not need to be reported. Some may also assume that nonresident aliens enjoy the same level of estate tax exemption (for their U.S. situs assets) as U.S. persons. Unfortunately, these assumptions are far from true.
IRS Form 3520 Reporting Obligation. First, the transfer from Jack’s mother, a nonresident alien, is in excess of $100,000. As a result, absent certain limited exceptions, the gift must be reported by Jack, a U.S. person recipient, on a Form 3520 by no later than the due date of Jack’s 2012 income tax return (including any extensions).
The Form 3520 is merely a reporting obligation. However, the penalty for failure to report could be severe – 5% of the gift value for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if Jack can demonstrate his failure to file was due to reasonable cause and not willful neglect. Ignorance of the law is not reasonable cause.
Is the gift a transfer of U.S. tangible property or a transfer of intangible property? In addition to the Form 3520 reporting obligation, Jack’s gift from his mother, depending on the method and form of the transfer, may constitute a taxable gift and result in gift taxes being payable. Gifts of U.S. situs tangible or real property in excess of the annual exclusion gift tax amount are taxable. By contrast, gifts of any intangible property by a nonresident alien, whether or not situated in the U.S. and regardless of its value, would not be taxable.
The Internal Revenue Service and the courts have generally taken the position that cash gifts (for example, in the form of actual bills and coins), constitute tangible personal property. As a result, cash gifts made by a nonresident alien in the U.S. are subject to gift tax. On the other hand, in Private Letter Ruling 8210055, the Service ruled, in part, that a transfer of cash by a check drawn on a foreign bank and payable by a U.S. bank is not subject to gift tax.
Prior rulings by the Service on the issue of whether a cash transfer, in a form other than the physical exchange of bills and coins, have not been entirely consistent. In addition, a private letter ruling binds only the IRS and the requesting taxpayer. Absent clear guidance, the safest approach is to presume that cash is tangible personal property for purposes of the gift tax rules. Therefore, the cautious approach would have been for Jack’s mother to make her cash gift to Jack outside of the United States, or to transfer an entire brokerage account to Jack. (Under the technical tax rules, a brokerage account would be an intangible asset).
If Jack’s gift from his mother is deemed tangible property, the entire value of her gift in excess of the annual exclusion amount would be taxable. Nonresident aliens, just like U.S. persons, may avail themselves to the annual exclusion for gifts of present interests. However, unlike U.S. persons, nonresident aliens are not eligible for any lifetime gift tax exemption amount for gifts in excess of the annual exclusion limit.
Currently, the annual exclusion gift limit per donor is $13,000 to each donee in a calendar year. This threshold increases to $100,000 (indexed for inflation to $139,000 in 2012) for gifts to a non-citizen spouse; there is no limit on the value of a gift to a citizen spouse.
Possible Gift Tax Return (Form 709) Reporting Obligation. If Jack’s gift from his mother is a taxable gift, it would be in excess of the annual exclusion gift tax amount, and must therefore be reported on a Gift Tax Return (Form 709) by April 15, 2013. In addition, Jack’s mother, as the donor, would be responsible for paying any gift tax. If the Service is unable to collect the required gift tax from Jack’s mother, the onus may be transferred to Jack, as the U.S. person recipient of the gift.
U.S. Estate Tax. Now imagine that Jack’s mother dies in October 2012. As a non-resident alien, Jack’s mother is only subject to U.S. estate tax on her U.S. situs assets. Assume that at her death, the only U.S. situs asset owned by Jack’s mother is her San Francisco condominium.
As a non-resident alien, the estate tax exemption amount available to Jack’s mother’s estate would be $60,000, rather than the $5.12 million estate tax exemption amount available to estates of U.S. persons who die in 2012.
Estate taxes on the San Francisco condominium may be delayed if the condominium is transferred to Jack’s father, as his mother’s surviving spouse. If Jack’s father is a U.S. citizen at the time, any outright transfer of the condominium to him would qualify for the unlimited federal estate tax marital deduction and be subject to estate tax at his subsequent death.
If Jack’s father is not a U.S. citizen at the time of his mother’s death, the testamentary gift of the San Francisco condominium would only qualify for the unlimited federal estate tax marital deduction if the condominium is retained in a special type of trust, called a Qualified Domestic Trust (a “QDOT”), in which case estate taxes may be delayed until his subsequent death, or until he withdraws any principal from that trust during his lifetime.
Tax Treaties. Finally, it is important to remember that U.S. tax treaties with individual countries may alter some of the gift tax and estate tax rules described above. For each transaction, one should consider any applicable treaty provisions.
Conclusion. The estate and gift tax rules can be complex for nonresident aliens. Caution is advised when a nonresident alien is contemplating a gift to any loved ones in the U.S. during his or her lifetime, or making any testamentary gifts of U.S. situs assets.