For many foreign individuals, the revelation that they could be subject to U.S. gift tax through seemingly innocuous family transactions is a startling discovery. The simple act of sending money to an adult child attending college in America so he can pay tuition, wiring cash for a wedding gift, or gifting an apartment in America for an elderly relative can unexpectedly trigger U.S. gift tax obligations. Understanding the fundamentals is crucial.
What exactly is the gift tax? Who bears the responsibility to pay it? How can foreign individuals avoid gift tax when making gifts to U.S. persons? Today’s article answers these questions and more.
Basic “Must Know” Rules
Unlike income tax, the U.S. gift tax is a transfer tax. It is imposed on the donor making the gift transfer, not the recipient of the gift. With one exception, gifts are not taxed to the recipient under the U.S. tax rules regardless of the citizenship of the gift giver or the amount or value of the gift. Even though not taxed, the U.S. recipient may have very specific tax information reporting requirements for the foreign gift. Failing to file can result in a 25% penalty on its value.
The gift tax applies differently to U.S. citizens or residents and to non-U.S. citizen/non-resident individuals (for simplicity, “non-U.S. persons”). U.S. citizens and residents are taxed on the transfer of global assets, irrespective of the asset’s location when the gift is made. Non-U.S. persons are subject to U.S. gift tax only on tangible assets located within the U.S. at the time of the gift transfer. For the non-U.S. person, making gifts of intangibles (for example, stock in a U.S. company) are exempt from the tax.
Both U.S. and non-U.S. donors are entitled to gift $18,000 per recipient per calendar year, without triggering gift tax. The number of recipients can be unlimited. Significantly, non-U.S. persons are not entitled to the large gift and estate tax exemption amount (currently $13.61 million) available to U.S. citizens and residents.
When a non-U.S. citizen makes a gift, the question of whether he or she will be treated as a U.S. “resident” for purposes of the tax is very important. The rules regarding residency for transfer taxes are different from those for income tax purposes. While a green card holder is automatically treated as a “resident” for U.S. income tax purposes, the same is not true for the gift tax. For non-U.S. citizens, determining residency status for gift tax purposes focuses on the concept of “domicile” requiring both physical presence and intent to remain in the U.S. indefinitely. It is a complex analysis based on numerous factors.
Gifts of Cash, Checks, Wire Transfers
The classification of gifts such as cash, checks, or wire transfers as tangible or intangible assets further complicates matters. The Internal Revenue Service (IRS) has treated cash, checks and wire transfers as tangible personal property. This characterization potentially subjects non-U.S. person donors to gift tax liabilities if the gift is considered made within the U.S. Thus, even seemingly benign gestures, like providing financial support to stateside family members, can inadvertently trigger gift tax obligations to the generous foreigner.
Awareness of the potential pitfalls is essential to avoid complications down the line.
Exploring Strategies To Avoid U.S. Gift Tax
When it comes to gifting, foreign non-residents must tread carefully to avoid U.S. gift tax. The IRS might pursue the U.S. recipient for these taxes if they cannot be collected from the foreign donor.
Here are some strategies to navigate the rules and avoid unexpected problems:
- Transfers from U.S. Bank Account or Foreign Bank Account: While it may seem convenient to transfer funds from a foreigner’s U.S. bank account to a U.S. recipient, this could be problematic. Such transfers can trigger gift tax if they exceed the current annual exclusion of $18,000 per recipient. The most prudent method would be to transfer the funds from a personal foreign financial account directly to the U.S. recipient’s foreign financial account (if the recipient has one). In this way, the gift transfer occurs strictly outside of the U.S. If the recipient does not have a foreign account, the next best method is to make the transfer from the donor’s foreign personal account to the recipient’s U.S. account.
- Never Transfer from Foreign Entity Accounts: Direct or indirect gift transfers from the account of a foreign corporation or partnership can lead to tax complications for the U.S. recipient, potentially resulting in re-characterization of the gift as income subject to U.S. taxation. It’s crucial for foreign donors to make gifts from personal foreign accounts to mitigate this risk.
- Gift Intangibles Instead of Cash: Instead of transferring cash, foreign donors can consider purchasing intangible assets like U.S. stocks or bonds. Gifting these intangible assets does not trigger gift tax liabilities for the donor. However, careful planning is essential to prevent IRS challenges and advice should be taken to avoid missteps.
- Direct Payments to Educational Institutions or Healthcare Providers: Certain gifts are exempt from gift tax, including payments made directly to educational institutions for tuition or to healthcare service providers for medical payments. These exemptions can also include related travel and lodging expenses if done properly.
These strategies can help the foreign gift-giver navigate the complexities of the U.S. gift tax rules while providing love and support to cherished ones in America. In many instances, professional guidance is advised to avoid possible errors or potential issues in the future.
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