Prologue – Understanding the issue
A young man was born in the United States while his non-U.S. citizen parents were studying. Before the age of two he moved (with his parents) back to France. He had no further connection with the United States. At the age of 25 his parents gifted him (as a graduation present) an apartment in France with a value of approximately $500,000. He did NOT know about IRC 6039F which required him to report to the IRS the fact that he had received this gift from his non-U.S. citizen parents. When he learned of this he filed a late Form 3520 reporting the gift. He was penalized $125,000 (25% of $500,000 as per § 6039F) for his late filing. To understand why, read on.
This post is a “follow up” from the first post I wrote about the August 21, 2024 Treasury public hearing about the proposed Foreign Trust and Foreign Gift regulations. My first post (which includes links to the hearing) is here. That first post focused on whether the pensions and tax favored accounts of Americans abroad should be exempted from the IRC 6048 requirements (meaning whether a Form 3520 should be required).
This post provides commentary on the “Foreign Gift” reporting requirement found in IRC 6039F. Notably, these are two penalty-laden reporting requirements that exist without regard to whether a tax return is required. These reporting requirements (and abuse of them by the IRS) are independent reasons why citizenship must be completely severed from taxation and from reporting requirements. This can be accomplished by legislation (preferred solution), Regulation (an interim step) and by not enforcing the “saving clause” found in U.S. tax treaties.
I have personal knowledge and experience with Americans abroad who have been unjustly penalized by these rules. In every case the penalty was levied because of the late filing (trying to comply with the law) of the form and not because of a failure to file the form at all (not trying to comply with law).
Although the “foreign gift reporting” requirements received less attention at the hearing, they are an important issue and clear example of why citizenship taxation is abusive.
Context
When local school needs funds it runs a "bake sale". The US Gov simply runs an ongoing penalty fundraiser. @YourVoiceAtIRS 2023 report reveals 1.7 billion in penalties assessed against law abiding people who filed their 6039F (report of foreign gift) late. https://t.co/JLTH5jTIy2 pic.twitter.com/D0acGr4sRQ
— John Richardson – Counsellor for US persons abroad (@ExpatriationLaw) September 1, 2024
Facts:
The charts in the above tweet are from a report by the Taxpayer Advocate reporting that from the period of 2018 to 2021, the IRS levied:
– approximately 4000 penalties for the failure to report gifts (in excess of $100,000 USD) from “foreigners”
– the average penalty imposed was approximately $455,000
– the median penalty was approximately $57,000
– the total penalties imposed were approximately 1.7 billion USD.
(Now, that’s a great business!! Think of it. Because nobody could imagine such a ridiculous law exists, all of the filings are going to be late which is certain to generate penalties. Furthermore, all indications are that the penalties are automatically assessed!)
The magic (and comfort) of NOT believing
There are people who really don’t believe that the United States would impose penalties for the failure to report to the IRS, a gift from a person who is not a U.S. citizen or resident. You can’t blame them. After all, gifts received by U.S. citizens are NOT taxable to the recipient. Really, it’s true. The gift is not taxable. Yet the Internal Revenue Code prescribes a penalty for the failure to report the gift. Isn’t the Internal Revenue Code about raising revenue through taxation? Well, not entirely. It’s also a code for the way Americans should live. It’s about raising revenue in the form of “penalites” for the failure to report things that are “Un-American” (usually any association with anything foreign). Having this draconian penalty is bad. But, what’s worse is burying the law in legislation that is supposedly about taxation. If there is no tax consequence to receiving a gift from a foreigner, whey should a penalty for failure to report the gift be buried in tax legislation? Would it make more sense to have a law that was for the sole purpose of reporting interaction with all things foreign? Why not call it the:
“Reporting Interactions With Foreign Persons Or Things Act”?
Yet here it is. Here is the text of 6039F of the Internal Revenue Code:
26 U.S. Code § 6039F – Notice of large gifts received from foreign persons
(a) In general
If the value of the aggregate foreign gifts received by a United States person (other than an organization described in section 501(c) and exempt from tax under section 501(a)) during any taxable year exceeds $10,000, such United States person shall furnish (at such time and in such manner as the Secretary shall prescribe) such information as the Secretary may prescribe regarding each foreign gift received during such year.
(b) Foreign gift
For purposes of this section, the term “foreign gift” means any amount received from a person other than a United States person which the recipient treats as a gift or bequest. Such term shall not include any qualified transfer (within the meaning of section 2503(e)(2)) or any distribution properly disclosed in a return under section 6048(c).
(c) Penalty for failure to file information
(1) In general If a United States person fails to furnish the information required by subsection (a) with respect to any foreign gift within the time prescribed therefor (including extensions)—
(A) the tax consequences of the receipt of such gift shall be determined by the Secretary, and
(B) such United States person shall pay (upon notice and demand by the Secretary and in the same manner as tax) an amount equal to 5 percent of the amount of such foreign gift for each month for which the failure continues (not to exceed 25 percent of such amount in the aggregate).
(2) Reasonable cause exceptionParagraph (1) shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect.
(d) Cost-of-living adjustment
In the case of any taxable year beginning after December 31, 1996, the $10,000 amount under subsection (a) shall be increased by an amount equal to the product of such amount and the cost-of-living adjustment for such taxable year under section 1(f)(3), except that subparagraph (A)(ii) thereof shall be applied by substituting “1995” for “2016”.
(e) Regulations
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.
(Added Pub. L. 104–188, title I, § 1905(a), Aug. 20, 1996, 110 Stat. 1913; amended Pub. L. 115–97, title I, § 11002(d)(13), Dec. 22, 2017, 131 Stat. 2062.)
As the Taxpayer Advocate points out:
Gifts From Foreign Persons Are Traps for the Unwary
The approach taken to reporting foreign gifts and bequests well illustrates the inherent unfairness of the IIR penalty regime. IRC § 6039F requires U.S. persons who receive foreign gifts or bequests worth more than $10,00026 to submit information returns to the IRS. For each month that the taxpayer fails to report the gift or bequest, the IRS can assess a penalty of five percent of the total amount of the gift, up to a maximum of 25 percent. For gifts and bequests from foreign individuals or estates, the IRS provides administrative guidance raising the reporting threshold to $100,000,27 but the penalties themselves remain the same.28 The code’s explicit requirement impacts gifts from foreign corporations and partnerships, whereas the IRS’s administrative guidance impacts those from foreign individuals and estates.
These penalties can be unexpected and severe for unsophisticated taxpayers. Imagine a lower- or middle- income U.S. taxpayer receiving a $500,000 inheritance from a foreign relative. Because this bequest is excludable from income,29 the taxpayer may not realize that there was an information reporting requirement until after the fact. In this scenario, the recipient of the tax-free inheritance could suddenly end up with an IIR penalty of up to $125,000, depending on how many months have elapsed since the receipt of the inheritance. As with several other IIR penalties, these penalties are potentially subject to an abatement for reasonable cause.30 Nevertheless, the taxpayer cannot be certain that the IRS will grant this relief and, in the meantime, is exposed to the delay, cost, and stress inherent in seeking relief from the IRS.
The available data shows that the IRC § 6039F penalty can be severe. Between 2018 and 2021, there were over 4,000 penalties assessed against individuals and businesses, totaling $1.7 billion.31 During this period, the average penalty was approximately $426,000 while the median penalty was approximately $58,000,32 as shown in Figure 2.8.1.
The IRC § 6039F penalties have an especially heavy impact on individual taxpayers: 92 percent were assessed against individuals.34 Figure 2.8.2 shows penalty data by year for individual taxpayers.
See the full report at:
These are primarily gifts from family members (often spouses)
It’s fairly obvious that the main victims of this insanity are Americans abroad. This is because the gift must be received from an individual who is neither a U.S. citizen nor U.S. resident. (Non-citizen spouses of resident Americans are likely U.S. residents.)
Incidentally, it’s fairly clear that these rules can be interpreted to include basic support received by U.S. citizens from their “foreign spouses”. To the extent that the support exceeds any minimal level of support required by law, the excess could be construed to be a gift. Spouses of U.S. citizens abroad, with lavish (or even middle class lifestyles), who are supported by their spouse, should be careful. As I pointed out in the August 21, 2024 hearing:
“… I simply reiterate every single thing that has been said in relation to the foreign gift rules, well said. I think I would add to that. There’s only one thing I would add to that, and that is that if these rules are really applied strictly, then presumably they would apply to cost-of-living expenses that are given — that are received from a foreign spouse that exceed, you know, what would be reasonable. So this is a big problem. But let’s go back to the beginning.”
(No, I am not suggesting that financial support from a “foreign spouse” should be reported.I am only pointing out that the rule is broad enough to include this!)
Submissions to the IRS about the “Foreign Gift” reporting provisions
To their credit many commentators expressed their view that the unfairness could/should be alleviated by increasing the reporting threshold ($1,000,000 was proposed as the threshold) and/or by exempting gifts from spouses.
I have a better idea to solve the problem.
The solution to solving the problem of “foreign gifts” is to:
End U.S. citizenship taxation by severing U.S. citizenship from U.S. tax residency once and for all!! Citizenship taxation cannot be reformed. IT cannot be improved. It must be ended once and for all!
John Richardson – Follow me on X.com @ExpatriationLaw
Appendix – Excerpt From SEAT Submission
IRC 6039F
Interestingly the Regulatory proposal provides no information with respect to the reason(s) for the 6039F requirement to report foreign gifts. The absence of a justification is consistent with California lawyer Michael Karlin’s comments that:
Given that a gift or bequest from any person, foreign or U.S., is not subject to tax in the hands of the recipient, [footnote omitted] what purpose is served by asking for this information? The legislative history of section 6039F gives no explanation! For example, the Joint Committee on Taxation’s General Explanation of the 1996 Act states that there was no requirement to report gifts or bequests from foreign sources under prior law; it also explains the new provision. But it gives no reason for the change. The Conference Report is the same. [footnote omitted] In other words, Congress never stated why this addition to the law was needed.
IRC 6039F was introduced as section 1905 of Public Law 104-88 of the 96th U.S. Congress – “The Small Business Job Protection Act of 1996”. Interestingly it appears as part of “Subtitle I – Foreign Trust Tax Compliance”. It is NOT apparent how a requirement to report “foreign gifts” is related to “foreign trusts”. Perhaps the legislative concern was that distributions from “foreign trusts” were subject to improper characterization as gifts?
https://www.congress.gov/104/plaws/publ188/PLAW-104publ188.pdf
SEAT’s comments take place within this context and specifically address the reality and concerns of U.S. citizens living outside the United States. It is clear that the legislative purpose motivating the 1996 “Foreign Trust” reporting rules (of which IRC 6039F is a part) has nothing to do with the lives and realities of U.S. citizens living outside the United States. SEAT submits that Treasury has a duty and moral imperative to protect U.S. citizens
abroad from legislation and regulations that were and are unrelated to their lives.
http://seatnow.org/wp-content/uploads/2024/06/Foreign-Trust-Regulations-SEAT-Comments.pdf
