The IRS taxes all forms of income, including money that comes from foreign sources. This includes inheritances and bequests made to a U.S. person by a foreign person.

Under IRS law, a U.S. person is a citizen, resident alien, or resident for tax purposes. That a taxpayer isn't a U.S. citizen doesn't eliminate any reporting requirements.

U.S. taxpayers must file Form 3520 when they inherit more than $100,000 from a foreign person. Part IV of Form 3520 covers foreign gifts, which include bequests. This part also covers any gift from an individual who is not considered a U.S. person.

The purpose of Form 3520 is to track money that crosses the U.S. Border. Taxpayers must file Form 3520 when a bequest is greater than $100,000, regardless of whether they owe any tax.

One of the challenges with Form 3520 is that it's separate from the W-2. This means that the two are submitted separately, and requesting an extension for a 1040 doesn't automatically transfer to an extension for Form 3520.

Individuals may also need to submit Form 3520 in situations when multiple, related transactions add up to more than $100,000. For example, a man is slated to receive $200,000 from a great aunt. Rather than a single lump payment, the inheritance is stretched out over four $50,000 payments.

What Happens if I Fail to Report an Inheritance?

Taxpayers must submit Form 3520 by the 15th day of the 4th month following the end of the taxpayer's tax year. For taxpayers based in the U.S., this will be April 15, the same as when their taxes are due. Similarly, taxpayers outside of the U.S. and Puerto Rico must file it by June 15.

If taxpayers fail to report an inheritance on time, they will be assessed 5 percent of the value of the inheritance, up to a total of 25 percent. Individuals may be able to avoid the penalty if they can show a reasonable cause for their failure to report. This penalty for failure to report will be assessed even if the taxpayer did not owe taxes on the inheritance.

If you have questions about reporting foreign inheritance or other foreign income, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.