Our second article in a series on U.S. Gifting Considerations for Global Families discusses how foreign individuals can unwittingly incur tax on cash gifts withdrawn from their U.S. bank accounts, and offers some workarounds to consider.

How the U.S. gift tax applies to foreign individuals who aren’t domiciled in the U.S. is anything but straightforward.

Foreign nationals with no U.S. domicile can incur gift tax on transfers of cash from their U.S. bank accounts, even if the cash is gifted to a non-U.S. person, like a child going to college in the U.S. That’s because the IRS generally looks to the gift-giver – the foreign national with the U.S. bank account in this respect – to pay gift taxes. 

As we explained in our first article in this series, a non-U.S. domiciliary can incur U.S. gift tax¹ on gifts of U.S. situs assets. Other than a small annual gift tax exemption,² an annual exemption for transfers to non-citizen spouses,³ or the exemption for direct payment of qualified medical and educational expenses,⁴ no other gift tax exclusion applies to foreign nationals.⁵

For foreign individuals, the U.S. gift tax applies to real and tangible assets physically located in the U.S.⁶ – such as homes, cars and art. However, their gifts of intangible assets, like stock of U.S. companies and other securities, are exempt.  

Cash located in a U.S. safe deposit box is a clear example of a U.S. situs tangible asset. But the tax treatment of cash sitting in a foreign national’s U.S. bank account isn’t as clear-cut. 

Although there is a rule that specifically exempts bank deposits from the U.S. estate tax,⁷ it doesn’t necessarily apply to transfers of bank deposits during a foreign national’s life, whether by wire or check.⁸

Non-U.S. parents can unwittingly incur U.S. gift tax when transfers are made to children living in the U.S. to pay for tuition,⁹ for living expenses, to buy a car or apartment, or as a graduation gift of cash. To the extent these cash transfers exceed the annual exclusion amount and don’t fall under one of the gift tax exclusions, they will be subject to U.S. gift tax.

Keep in mind that even when transfers are made to someone who doesn’t live in the U.S., the gift tax can still be triggered if the cash comes out of a foreign individual’s U.S. bank account.

Gifting securities 

Although the U.S. transfer tax can be quite tricky for those unfamiliar with it, there are some workarounds. Since intangible assets are not considered to be U.S. situs, one technique is to convert the tangible asset – cash in a U.S. bank account for example – into an intangible asset, like securities. A common technique is to purchase U.S. Treasury bills with the cash and gift those instead.

Yet be aware that donees can receive a carry-over basis¹⁰ in received gifts. That means any built-in capital gains in gifted equities will later be taxable to the recipient when the stock is sold. Also keep in mind that the “step transaction”¹¹ doctrine could apply if the cash is converted to a tax-exempt gift for purposes of avoiding the gift tax,¹² or gifted securities are immediately converted to purchase real estate or a car, for example. Using the “step transaction” principle, the IRS may interpret these gifts as direct gifts of cash, real estate or a car – all tangible assets subject to gift tax if physically located in the U.S.

Ensuring Treasury bills are held for an appropriate length of time before gifting them, and leaving a sufficient amount of time between the gift and any subsequent sale and new purchase, should mitigate this issue. Ultimately, the IRS should not be able to find a pre-existing plan to achieve a tax-free gift by virtue of converting the cash.

Transferring cash offshore

Another workaround is to only transfer cash from a non-US bank account¹³ to someone in the U.S., as this cash will likely not be treated as a U.S. situs asset. The most fool-proof way to ensure non-taxable treatment is to keep the transaction completely offshore, by transferring cash from a non-U.S. account to a donee’s own offsore account. However, this isn’t always a practical option, as the donor or donee might not have a bank account outside of the U.S., and setting one up – in particular for U.S. donees – is not always an easy thing to do.¹⁴

Any gifts over $100,000 received by a U.S. person from a foreign individual donor will need to be reported on the IRS's Form 3520. This applies regardless of whether the gifted assets are considered U.S. situs or not. Unlike the triggering of U.S gift tax, the mere fact that a U.S. person received assets from a non-U.S. person or entity is sufficient to require filing Form 3520.