If you have close relatives, like parents, who are citizens and residents of a foreign country, there is a chance you might receive a gift or inheritance from them at some point in your life. You may wonder whether you will have to pay taxes on an inheritance you receive from a foreign relative.
In Utah, those who receive gifts are not required to pay any gift taxes. The burden of paying the gift tax falls on the gift-giver. The same is true for those who receive an inheritance. The fact that the gift is from a foreign person is irrelevant. Therefore, if you receive a monetary gift or an inheritance from relatives abroad, you will not have to pay taxes on it. However, you must report the gift or inheritance to the IRS if the amount you receive exceeds a certain threshold.
Who Needs to Report an Inheritance From a Foreign Relative?
The IRS requires taxpayers to report:
Don’t Try to Fool the IRS
What if your parents abroad want to give you a monetary gift of over $100,000, but you don’t want to be burdened by the reporting requirements? Can you simply get each of them to make a gift less than $100,000 so you don’t have to report?
No. You must combine gifts from related parties. For example, if you receive a gift of $70,000 from your mom and $70,000 from your dad, who are Mexican citizens living in Mexico, you must report the gift because the combined gift totals more than $100,000
How to Report a Gift or Inheritance
If you receive a gift or inheritance that exceeds these $100,000, the tax laws require you to file Form 3520 at the same time as your tax return for the year you received the gift. The form is generally due on April 15 of the year in which you receive your gift. If you do not file Form 3520 accurately or on time, you may be subject to penalties equal to 5% of the gift or bequest for each month during which the failure continues, up to a maximum of 25%.
An inheritance is anything you receive from a person who has passed away. Inheritance may include money, material possessions such as jewelry or furniture, real estate, or shares of stock. An inheritance tax is a tax paid by the person who inherits property after a loved one’s death. In other words, the tax is the responsibility of the heirs of an estate. There is no federal inheritance tax. Inheritance taxes are always on the state level, and many states do not have an inheritance tax at all.
Inheritance taxes are levied after estate taxes are paid, and bequests and inheritances are distributed to a deceased person’s heirs. For example, if you inherited a net amount of two million dollars and you lived in a state that had an inheritance tax, you would be required to pay tax on some or all of the money you inherited. States that have inheritance taxes specify different levels of taxation depending on an heir’s relationship to the deceased person. It’s common for spouses to be exempt from inheritance tax, while siblings may be required to pay an inheritance tax. As a rule, the closer the relationship to the deceased, the lower the amount of taxes an heir will be required to pay.
One common point of confusion regarding inheritances and taxes is a misunderstanding of the differences between the inheritance tax and the estate tax. Since both taxes relate to estates and wills, it can be bewildering to people who aren’t experts in tax law. To clarify, an estate tax is levied against a deceased person’s estate, not against an individual.
The second key difference is the one we have already mentioned. The estate tax is a federal tax that is collected by the Internal Revenue Service. There is no federal inheritance tax. Only a few states have an inheritance tax. The states that have an inheritance tax create the laws governing inheritances and are responsible for collecting the tax money.
Other Necessary Tax Filings
Let’s close with some necessary tax filings you should know about when a loved one dies. The first is the estate tax. Congress has steadily increased the exemptions for the federal estate tax. As of 2021, the IRS requirement says:
A filing is required for estates with combined gross assets and prior taxable gifts exceeding $11,400,000 in 2019, and $11,580,000 in 2021.
If the estate of a deceased person is worth less than the above-stated amounts, there is no federal estate tax return to be filed. For estates where a filing is required, the executor must complete Form 706 to calculate the amount of estate tax that is due, or to show that no estate tax is due.
You should also be aware that depending on what you do with the assets you inherit, you may be liable for capital gains taxes when you sell the assets. As of 2021, capital gains in Utah are taxed at the regular income tax rate of 4.95%. You may also be required to pay a federal capital gains tax.
If you want to lower your estate’s tax burden and maximize the inheritance your beneficiaries receive, you’ll likely need to take steps before you pass away. Beneficiaries might not have much they can do to lower their bills, but they can work with their descendants or relatives on finding the best tax-saving strategy for passing on their wealth.
Give Assets Away Before Dying
If you think you’re going to get hit with sizable inheritance and estate taxes, you might want to give away some of your assets before you die. The IRS generally excludes gifts of up to $15,000 per person each year from taxes.
Move To A Different State Before Dying
You might choose to relocate to a state that charges neither an inheritance tax nor an estate tax to limit how much of your wealth ends up going to the government after you die. When it comes to an inheritance tax, the state where the deceased person lives is what matters, not the beneficiary’s residence.
Utilize A Trust
A trust allows a third party, or a trustee, to hold and direct assets in a trust fund on behalf of a beneficiary. It allows someone to place assets in a trust while they are still alive, while control of the trust is transferred after death to a designated beneficiary. There are two types of trusts: revocable and irrevocable. With an irrevocable trust, there’s no official property transfer upon death, meaning no estate or inheritance taxes.
Work With A Tax Expert
An expert can help you identify the best course of action for limiting your tax bill to ensure that you maximize the inheritance that you pass on to your beneficiaries
For tax purposes, an inheritance isn’t normally considered taxable income unless it’s generating frequent returns, such as a rental property or an asset that provides interest or dividend payments. It also applies to withdrawals you’re taking from an inherited 401(k) or IRA. You also want to watch out for capital gains taxes. If you sell any stocks, bonds, or other property that you received as part of an inheritance, capital gains taxes may apply to the profit you made.
Foreign Law Controls
When a Utah person inherits property of a deceased person living abroad, the laws of the country of domicile of the deceased person, and not Utah laws, will generally control and govern how to claim the inheritance. Thus, for example, if a Utah person is the heir of a deceased resident of Germany, the laws of Germany will define how the Utah person should claim the inheritance.
Each foreign country will have its own rules and requirements regarding how a Utah person can claim the inheritance of a deceased resident of such foreign country. There are certain basic questions that will need to be answered, but each foreign country may provide a different answer. What paperwork must be prepared and filed to claim the inheritance? Must this paperwork be filed within a certain time? Is this paperwork filed as part of litigation or just with a government official? Does the beneficiary of an inherited asset have to also personally assume any liabilities appurtenant to the inherited asset? What tax liability is payable in the foreign country with respect to the inheritance? In certain countries, there may be the issue that foreign ownership of property is not allowed.
Besides the different foreign laws, there may be practical issues that the Utah heir of a deceased person living abroad must address. If the inherited property is real estate or an operating business, it may difficult for a person to manage such inherited property from far away in the Utah. If the inherited property is in the form of foreign currency, it may be difficult for a person to efficiently convert such currency into dollars.
While foreign law will be controlling, the Utah beneficiary of a deceased person living abroad still must be aware of certain Utah law requirements. If the inheritance is more than $100,000, the Utah beneficiary will be required to file an information return, Form 3520, with the Internal Revenue Service. While there is no Federal inheritance tax liability in Utah, it is possible that the state of residence of the Utah beneficiary may assess state inheritance tax liability. There may also be applicable banking and OFAC requirements.
Some people think that only the very wealthy or those with complicated assets need wills. However, there are many good reasons to have a will.
A Written, Witnessed Will Is Best
To maximize the likelihood that your wishes will be carried out, create what’s known as a testamentary will. This is the most familiar type of will; you prepare the document and then sign it in the presence of witnesses. It’s arguably the best insurance against successful challenges to your wishes by family members or business associates after you die. You can write one yourself but having it prepared by a trusts and estates attorney tends to ensure it’ll be worded precisely, correctly, and in keeping with your state’s laws.
Other Types of Inheritance Wills
While a testamentary will is likely your best bet, several other types of wills get varying degrees of recognition.
Wills written and signed by the testator but not witnessed are known as holographic wills—from the less common secondary meaning of the word holograph, meaning a document hand-written by its author. Such wills are often used when time is short and witnesses are unavailable, for example, when the testator is trapped in a life-threatening accident. Holographic wills are not recognized in some states, however. In states that permit the documents, the will must meet minimal requirements, such as proof that the testator wrote it and had the mental capacity to do so. Even then, the absence of witnesses often leads to challenges to the will’s validity.
Least widely recognized are oral wills, in which the testator speaks their wishes before witnesses. Lacking a written record, or at least one prepared by the testator, courts do not widely recognize oral wills.
Another type of will, a pour-over will, is used in conjunction with creating a trust into which your assets flow.
A married or committed couple usually executes this type of will. After one party dies, the remaining party is bound by the terms of the mutual will. Mutual wills can be used to ensure that property passes to the deceased’s children rather than to a new spouse. Because of state differences in contract law, a mutual will should be established with a legal professional’s help. Though the terms sound similar, a mutual will should not be confused with a joint will.
A will allows you to direct how your belongings—such as bank balances, property, or prized possessions—should be distributed. If you have a business or investments, your will can specify who will receive those assets and when. A will also allow you to direct assets to a charity (or charities) of your choice. Similarly, if you wish to leave assets to an institution or an organization, a will can assure that your wishes are carried out. While wills generally address the bulk of your assets, some aren’t covered by their instructions. Those omissions include payouts from the testator’s life insurance policy. Since the policy has specified beneficiaries, those individuals will receive the proceeds. The same will likely apply for any investment accounts that are designated as “transfer on death.”
There’s a key exception: If the beneficiaries of those assets predeceased the testator, the policy or account then reverts to the estate and is distributed according to the terms of a will or, failing that, by a probate court—a part of the judicial system that primarily handles wills, estates, and related matters. Most states have elective-share or community property laws that prevent people from disinheriting their spouses. If a will assigns a smaller proportion of such assets to the surviving spouse than state law specifies, which is typically between 30% and 50%, a court may override the will. In addition to directing your assets, a will states your preferences for who should take over as guardian for your minor children in the event of your death.