U.S. Estate and Gift Tax Concerns for Foreign Assets

Most tax practitioners understand that the United States will tax a resident’s worldwide income and will impose estate and gift taxes regardless of whether or not the assets are located within the United States.  The issue, however, is getting clients to accept that worldwide taxation encompasses several reporting duties.  While obvious to an individual income tax return that all interest and dividends earned from foreign accounts and investments must be reported, there may also be a reporting duty to file a Report of Foreign Bank Account (FBAR).  Also, for businesses and partnership investments, there may be reporting required for a controlled foreign corporation (CFC) or controlled foreign partnership (CFP).  Furthermore, reporting may be required to disclose foreign gifts, bequests or trust transfers (Report of Foreign Gift, Bequest or Trust Transfer). All of these reporting requirements apply not just to third party transactions but to transactions involving family members.

Unfortunately, because many clients may be resistant to reporting, a tax practitioner needs to be careful when advising clients as to the law, in strategizing as to options and risks, and in allowing clients to decide what to do.  Clients are all too eager to accept the advice of a friend or “other tax counsel” who recommends no review and no reports on the argument that all reporting is an invitation to trouble.

The reality, however, is that the real trouble may come not from reporting, but from non-reporting.  Furthermore, under IRS Circular 230 rules of practice, a tax advisor deliberately aiding clients in non-disclosure may possibly result in criminal charges against both the advisor and the client under Code Section 7206.

Accordingly, we recommend that tax advisors help their clients to understand that there are several benefits to reporting, if required, and to let them know what they are up against if they decide to not report.  First, because the United States is gaining access to information from other countries allowing discovery of undisclosed transactions, clients who do not report have increasing risk of discovery every year.  Second, if they are discovered, the likelihood of penalties has not only increased but can be quite substantial if they did not make a good faith effort to report.

With respect to this second issue, it may be argued for some clients that “ignorance of the law” is reasonable cause for relief from penalties.  However, tax advisors may not rely on this exception with much confidence.  While it might still be argued that someone living for a short period abroad may claim they did not know of filing requirements, the Service can closely scrutinize the facts to determine reasonableness.  In particular, if a client has a tax preparer or merely uses a tax program to prepare his or her return, the Service may presume that reasonable inquiries should have been made and therefore the client should have known better to report foreign holdings.  Furthermore, the Service can point to the fact that it has not been a new disclosure, as to interest and dividends, because tax returns have for dozens of years asked as to whether there are foreign accounts.  And, the Service’s adoption in 2011 of Form 8938 (Report of Specified Foreign Financial Assets) as an annual reporting makes nondisclosure of foreign investments exceeding $50,000 ($100,000 for married spouses filing jointly) – and higher for U.S. taxpayers living abroad, inexcusable because taxpayers should now know about their annual foreign asset filing requirements.

In summary, in preparing income, gift and estate tax returns, it is important to ask after and determine if there are any applicable foreign asset reporting requirements.  It is not only in preparing returns that tax practitioners need to be extraordinarily careful in advising their clients and facilitating client planning, including covering disclosure requirements, but in many cases, an annual letter may be considered helpful to identify clients who may have issues with respect to foreign asset reporting.


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