Do I Need to Pay Tax on Inheritance From Abroad?

U.S. Tax Treatment of Inherited Assets

For U.S. citizens or residents, receiving an inheritance from abroad does not create a U.S. income tax liability. The U.S. tax system does not consider inheritances as taxable income, regardless of whether the assets are cash, real estate, or other property.

While the recipient does not pay income tax, an estate tax might apply to the decedent’s estate, which is a tax on the transfer of wealth from the deceased. This is usually the responsibility of the estate or its executor, not the beneficiary. A gift tax is levied on the donor, not the recipient, further differentiating inheritances from taxable gifts.

An important aspect of inheriting assets is the “stepped-up basis” rule. This rule adjusts the cost basis of inherited property to its fair market value on the date of the decedent’s death. This adjustment benefits heirs by reducing potential capital gains tax if they sell the asset. For example, if an asset appreciated significantly, the heir’s tax basis becomes the higher fair market value at inheritance, minimizing future taxable gain.

Reporting Large Foreign Inheritances

Even though inheritances are not subject to U.S. income tax for the recipient, U.S. persons must report large foreign inheritances to the Internal Revenue Service (IRS). This reporting is for informational purposes, allowing the IRS to track significant transfers from abroad. The primary form used is IRS Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.”

A U.S. person must file Form 3520 if they receive more than $100,000 from a nonresident alien individual or a foreign estate during a tax year. This threshold is cumulative, meaning if multiple smaller inheritances from related foreign persons or estates collectively exceed $100,000 in a year, reporting is required. Additionally, inheritances from foreign corporations or partnerships exceeding a specific threshold, which is adjusted annually for inflation (e.g., $19,570 for 2024), also trigger a reporting requirement on Form 3520.

Form 3520 requires specific details about the inherited assets, including a description of the property, the date of receipt, and its fair market value. The form does not generally require the identity of the foreign person who bequeathed the assets. The filing deadline for Form 3520 generally aligns with the individual’s income tax return due date, including extensions.

Foreign Country Tax Considerations

Inheritances received from abroad may be subject to taxes in the foreign country where the assets originate. Many foreign countries impose their own inheritance taxes, typically levied on the beneficiary, or estate taxes, paid by the deceased’s estate. These foreign tax obligations are governed by the laws of that specific country.

Foreign inheritance or estate taxes are usually handled by the foreign estate or executor before distribution to the beneficiary. In some cases, the beneficiary may be directly responsible for paying these taxes, depending on the foreign country’s tax laws. The payment of foreign inheritance or estate taxes does not typically qualify for a foreign tax credit against U.S. income tax for the recipient.

The U.S. foreign tax credit is generally applicable to foreign income taxes paid, not inheritance or estate taxes, because the inheritance itself is not considered U.S. taxable income. Individuals facing foreign tax obligations should consult with a tax professional in the foreign country to navigate their specific requirements and ensure compliance with local laws.

Penalties for Non-Compliance

Failing to file IRS Form 3520 when required can lead to penalties, even if no U.S. tax is owed on the inheritance itself. The IRS views Form 3520 as an informational return, and non-compliance indicates a failure to provide necessary financial transparency. The initial penalty for not timely filing Form 3520 can be high.

For the receipt of a foreign gift or bequest, the penalty is generally 5% of the gross value of the inheritance for each month the failure continues, up to a maximum of 25% of the amount received. For transactions with foreign trusts, penalties can be even higher, with an initial penalty generally equal to the greater of $10,000 or 35% of the gross value of the distributions received. Additional penalties may apply for continued non-compliance after notification from the IRS.

Penalties can be imposed even if the failure to file was not intentional. While the IRS has indicated a shift towards reviewing reasonable cause statements before automatically assessing penalties for late-filed Forms 3520 related to foreign gifts or inheritances, the reporting requirement remains mandatory. Individuals who believe they have a reporting requirement or who have previously failed to report a foreign inheritance should consult a qualified U.S. tax professional to address their situation.