Foreign Clients: Watch out for U.S. Gift Tax Traps this Holiday Season

With the holiday season upon us, the time for gift-giving is here. For foreign clients or foreign persons (meaning someone who is neither a citizen of the U.S. nor domiciled in the U.S. for U.S. federal transfer tax (i.e., estate and gift tax) purposes) who are making gifts, there are potential U.S. tax traps at every turn. Accordingly, there are relevant U.S. federal tax considerations that foreign clients should keep in mind when making gifts, especially when making gifts of cash.

In a very typical fact pattern, a foreign client may wish to make a gift of cash to a U.S. recipient. When making gifts of cash to U.S. persons, foreign clients need to be aware of two potential U.S. federal tax issues: (1) gift tax exposure for the foreign client; and (2) income tax exposure for the U.S. recipient. These issues do not always present themselves in a purely domestic setting; however, the rules in the cross-border setting present traps for the unwary.

Starting with the U.S. federal gift tax exposure for the foreign client, generally speaking, foreign persons are subject to U.S. federal gift tax on gifts of U.S. real property and tangible personal property located in the U.S. (things like jewelry, furniture, artwork, cars, etc.). Gifts of intangible property (e.g., shares of stock) are not subject to U.S. federal gift tax in the case of a foreign person. Cash is generally viewed by the Internal Revenue Service 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. federal gift tax. With only the benefit of a $15,000 annual exclusion amount (for gifts of present interests), these transfers could carry a hefty gift tax price tag if foreign clients are not careful. Note, however, that in the case of gifts to non-U.S. citizen spouses, the annual exclusion 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.

Given that foreign clients may already have U.S. investments or family members living in the U.S., it is not uncommon for a foreign client to have a U.S. bank account. Because the gift is intended for a U.S. person (meaning a U.S. citizen, U.S. green card holder or resident alien), it might seem obvious 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 Internal Revenue Service could view that transfer as a taxable gift of U.S. situs tangible property. 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 wire 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.

Moving on to the potential U.S. federal income tax liability for the U.S. recipient, here again we encounter a concept not typically present with gifts made in a purely domestic setting. In the cross-border setting, however, it is not unusual for foreign clients to own financial assets through a foreign holding company (which the client may own personally or through a non-U.S. trust established by the foreign client). For administrative convenience, a foreign client may 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 Internal Revenue Service 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. federal tax purposes). In the case of a foreign corporation, purported gifts can lead not only to U.S. federal income tax consequences under normal corporate distribution principles, but can also implicate the passive foreign investment company (or PFIC) rules.

Making cash gifts can also present U.S. tax traps in other ways. For example, a foreign client may want to purchase a particular item located in the U.S. for a child. Assume a foreign client would like to purchase a car for his or her child going to school in the U.S. Foreign client buys the car from a U.S. dealership with funds provided by foreign client, but titles the car directly in the child’s name. Such a transaction is tantamount to a gift of the car itself and, therefore, a taxable gift of U.S. situs property. Purchases of U.S. real estate must also be carefully planned. For example, if a foreign client makes a gift of money with the intention that such money is to be used to purchase U.S. real estate, then such gift could be treated as a gift of U.S. real property rather than a gift of money, especially if the foreign client already owns the real estate in question. Thus, if a foreign client is contemplating buying a house or an apartment for a child living in the U.S., it is critical that the client do planning well in advance to minimize the U.S. federal gift tax exposure.

For some final gift tax thoughts, consider the treatment of transfers of money via check and transfers of money via wire transfer. The IRS has ruled that a gift made by a foreign person by a check drawn on his or her personal financial account located outside the U.S. is not treated as property located in the U.S. for U.S. federal gift tax purposes, even if such check is deposited in a U.S. financial account owned by the recipient. Based upon this logic, it is also reasonable to conclude that a gift by a check drawn on a foreign client’s personal financial account located in the U.S. may be problematic while a check drawn on a foreign client’s personal financial account located outside the U.S. would not be. Likewise, a foreign client may have U.S. federal gift tax exposure by allowing someone to use a debit or credit card which is linked to a U.S. financial account owned or controlled by the foreign client.

As for wire transfers, there is no clear answer on whether cash transferred via a wire should be viewed as a tangible or intangible property transfer. Utilizing the logic which applies to gifts made by a check, a wire transfer sent from a foreign client’s personal foreign financial account to the recipient’s U.S. financial account should not trigger U.S. federal gift tax exposure for the foreign client. On the other hand, a wire transfer sent from a foreign client’s personal U.S. financial account generates potential U.S. federal gift tax exposure.

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. It is also worth noting that a foreign client, rather than making a gift from a personal financial account, may instead direct that a distribution be made to a U.S. person from an account owned by a foreign trust created by the client and of which the U.S. person is a beneficiary. Such distributions carry their own U.S. federal tax implications and will be the subject of another discussion.

Foreign clients and their advisors would be wise to consider the relevant U.S. federal gift tax implications discussed herein and plan carefully before making any gifts this holiday season.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Paul D’Alessandro is an attorney with Bilzin Sumberg.