When Does a Beneficiary of a Foreign Usufruct Need to Report the Gift on a Form 3520

Under Section 6039F of the Internal Revenue Code, U.S. persons are required to file Form 3520 with the Internal Revenue Service (“IRS”) to report “receipts of large gifts or bequests from certain foreign persons.” The current requirement of the IRS is that U.S. persons file a Form 3520 reporting only those large gifts or bequests from foreign individuals or estates which exceed the threshold amount of $100,000. See IRS Notice 97-34, 1997-1 CB 442. The IRS may penalize a U.S. person 5% of the value of the foreign gift for every 30 days the gift is not reported on Form 3520, up to 25% of the value of the gift.

Reporting a foreign gift of a Form 3520 is not typically a difficult exercise. Foreign gifts that exceed $100,000 in the aggregate are reported on a Form 3520 for the tax year received. Sometimes however, it is difficult to determine when a reported foreign gift is received for reporting purposes. This is particularly true when a U.S. person has received a foreign usufruct interest. With the exception of Louisiana, the concept of a usufruct is not well known in the United States. A usufruct is often used in foreign estate planning. A typical usufruct estate plan involves a foreign donor retaining a usufruct interest and giving bare ownership interest to the next generation, typically a U.S. person. The benefits of a usufruct for foreign tax purposes is that typically the value of the gift on which the foreign gift tax will be paid is reduced based on the age of the donor. At the donor’s subsequent death, the usufruct interest terminates by operation of law and is automatically recovered by the bare ownership holder who then owns the property in full. As a result, nothing is included in the usufructuary’s estate to be taxed at death for foreign tax purposes and the appreciated value all passes entirely to the bare ownership holder, sometimes a U.S. person. The usufructuary has the right to use the property and is entitled to income from the property during his or her lifetime.

For U.S. tax purposes, a usufruct may be treated as a life estate because there is no separate title owner or trustee. The question many U.S. usufructory beneficiaries have is when are they required to report the usufruct gift on a Form 3520 (assuming the value of the gift exceeds $100,000). Fortunately, the Internal Revenue Service (“IRS”) has issued a private letter that provides guidance on this unique reporting situation. Although a private letter ruling has no legal precedent, a private letter ruling provides an insight as to how the IRS will treat such a reporting position for purposes of the Form 3520.

In Private Letter Ruling (PLR 201825003), the IRS found that a donor’s gift of art in which the donor retained a life interest through the use of a usufruct to two museums was gift tax purposes. This was the case even though the donor reserved the option to terminate the gift under certain circumstances. In PLR 201825003, the IRS cited Treasury Regulations Section 25.2511-2(b). Under this Treasury Regulation a gift is considered complete where the donor has parted with all dominion and control of the property such that the donor has no power to change its disposition.

According to PLR 201825003, the donor at issue retained the option to revoke the gifts when particular conditions were met. In this particular case, the IRS did not consider the particular conditions as amounting to retained dominion and control by the donor. This is because the conditions set in the deed for the art gifted as being dependent on any act of the donor and was thus beyond the control of the donor. Consequently, the donor’s ability to revoke the gift did not amount to a retained interest in the art that would make the gifts incomplete. Based on the above discussed rationale, the IRS concluded that the donor’s grant to the museums of the remainder interest in the artworks would be completed for federal gift tax purposes notwithstanding her intent and conditional option to revoke the gift.

Applying the reasoning of PLR 201825003 and Treasury Regulation Section 25.2511-2(b), when a U.S. person is granted bare title in a foreign usufruct, the date the usufruct interest or bare title is gifted to the U.S. person is when a 3520 reporting requirement vests. A usufruct reporting requirement does not vest on the date on date of the foreign donor’s death for Form 3520 reporting purposes. It should be noted that as of this date, there are no Treasury Regulation, Revenue Rulings, or case law on point. The conclusion in this article is purely based on PLR 201825003 and is subject to change.

Conclusion

The foregoing discussion is intended to provide the reader with a basic overview of the Form 3520 reporting requirement of a U.S. beneficiary of a foreign usufruct.It is important to note that this area is constantly subject to new development and changes.
If you are a beneficiary of a foreign usufruct, you should contact a competent international tax attorney to discuss your potential U.S. reporting requirements.

Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi & Liu, LLP. As a domestic and international tax attorney, Anthony Diosdi advises both U.S. and international individuals in relation to a broad range of personal taxation and estate planning matters. He has extensive experience of advising on complex cross-border estate planning matters. Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi is admitted to the California and Florida bars.

Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.