U.S. taxpayers who inherit foreign assets must handle the tax consequences of their inheritances with great care. In addition to taxing all worldwide income, the U.S. also includes foreign assets in the gift and estate tax calculation, which determines whether estate tax will be assessed. Heirs who receive foreign assets also have to consider their Foreign Bank Account Report (FBAR) and other foreign account reporting requirements, or risk facing significant penalties.
What Happens When You Inherit a Foreign Account?
If you are a “United States person”—including citizens, permanent residents,(individuals who hold green cards) or must file taxes due to their substantial presence in the United States—you may suddenly have an FBAR filing requirement if you inherit a foreign financial account. If the aggregate of all of your foreign financial accounts exceeds $10,000 at any point during the year, you must file an FBAR.
This is true even if you would not owe any U.S. tax on any income earned on the accounts. If you pay tax in another country, you may receive a tax credit which eliminates U.S. tax liability on the income. However, you still have an FBAR filing requirement, and you still face penalties of $12,459 per violation for non-willful violations, with much harsher penalties for willful violations.
What If the Inherited Account Has Not Been in Compliance?
The more complicated situation arises when you inherit a foreign account and the previous account holder has failed to meet their FBAR obligations. The IRS still has the ability to audit the previous year tax returns—FBAR penalties can be assessed for the previous six tax years—and penalties can be assessed against the estate.
The heir will be faced with the problem of not only reporting the accounts moving forward, but also going back and amending the previous year tax returns. If only the current year returns are filed, the IRS may look further into the accounts and determine that there have been several FBAR violations, and it’s possible that penalties for willful FBAR violations will be assessed.
To avoid this problem, the heir should consult with an offshore disclosure attorney to see if any of the amnesty programs can be used to manage the risk of excessive penalties. The Offshore Voluntary Disclosure Program will often be an option because it is available even for willful FBAR violations. The Streamlined Compliance Procedures may also be used in cases where there is a strong argument that the FBAR non-compliance was not willful.
For more information, download our free special report, Nine Questions You Should Be Asking About the IRS Streamlined Filing Compliance Procedure for Unreported Foreign Accounts.