Large Gifts From Foreign Citizens May Result in Unexpected Tax Consequences

The Procession of the Trojan Horse into Troy by Giovanni Tiepolo circa 1760.

For most people, the receipt of a gift, particularly a large cash gift, is cause for celebration. But over the millennia gifts have spawned a lot of wise advice from various wary pundits. Beware of strangers bearing gifts was an admonition coined by Virgil in a less-than-politically-correct reference to the Trojan Horse immortalized by Homer in The Illiad, and as envisioned by Giovanni Tiepolo in the stunning portrait pasted above. And don’t look a gift horse in the mouth is a suggestion from St. Jerome that one show proper appreciation for a gift.  And to these wise admonishments, let’s add the recommendation that one consult their tax advisor upon the receipt of a large gift, particularly if the gift exceeds $10,000 and the donor is a citizen of a foreign country.

Tax Ramifications for Overseas Gifts

This brings us to the point of this post. A professional colleague recently asked me to help him with a case pending in the United States Tax Court. One of the primary legal issues was the tax ramifications caused by our client’s receipt of a series of large cash gifts from overseas. Before discussing the exact issue and resolution of that case, a quick primer of the general rules of taxation applicable to gifts between US citizens is in order. Assuming a gift is really a gift,[1] then the receipt is not subject to income tax, and any applicable gift tax is imposed on the donor, not the recipient. Additionally, with the availability of spousal gift splitting and the unified credit, it is the rare gift that will result in the imposition of a gift tax liability, although a gift tax return might be required.

But gifts from citizens of foreign countries are treated differently. Even though the receipt does not give rise to an income tax for the recipient, and the IRS does not have the ability to impose a gift tax on a donor who is a citizen of a foreign country, the recipient is required to file with the IRS a form 3520 reporting the receipt of a gift in excess of $10,000. And if the recipient fails to file that return, the IRS will impose a penalty of up to 25.0% of the gift.[2]

Getting back to case that is the subject of this post, my client received nearly Ten Million Dollars in gifts over a period of several years, and even though his income tax returns had been prepared by a CPA, the checklist that the CPA used for preparing the returns did not ask about foreign gifts in excess of $10,000. Consequently, the preparer did not advise the client to file forms 3520, which resulted in the proposed assessment of a penalty of nearly Two Million Dollars.

Happily, the Tax Court case eventually settled for a small fraction of the proposed assessment, because of a technical defect in the way the penalty had been approved by IRS management.[3] But the key takeaway is anytime you receive or contemplate giving a large gift, you consult your tax advisor.

The information provided in this post is for general informational purposes only. It is not intended to be legal or accounting advice and should not be relied on for that purpose. The Kauffman Group has extensive experience representing clients in complex civil and criminal tax matters. One of our tax professionals will be happy to discuss the unique facts of your case.    

[1] Just because the parties call a transfer of value a gift is not dispositive for tax purposes, and the IRS is always free to challenge the taxpayer’s characterization of a transaction. In Duberstein v. Commissioner, 363 U.S. 278,  285 (1960),  the  Supreme Court  explained that  a gift proceeds  from  a  “detached  and disinterested generosity”  and is  made  “out of affection, respect,  admiration, charity  or  like impulses”  not  because  of  “any  moral  or legal”  duty  to make  a payment. In Olk v. U.S, 536 F. 2d 876 (9^th Cir.) a casino dealer argued that tokes (i.e. amounts gamblers pay to dealers when they win) are gifts. The Court rejected this argument, and held that “receipts by taxpayers engaged in rendering services contributed by those with whom the taxpayers have some personal or functional contact in the course of the performance of the services are  taxable  income when in conformity with the practices of the area and easily valued. Tokes like tips meet these conditions.”

[2] §6039F of the Internal Revenue Code of 1986, as amended (the “Code”), requires the recipient to file form 3520 with the IRS if the applicable gift threshold is exceeded for any tax year. The threshold if the donor is a nonresident alien or an estate is $100,000, while the threshold if the donor is a corporation or a partnership is $10,000, adjusted for inflation.

[3] See IRC §6751(b) of the Code.