Unreported Foreign Gifts and Divorce

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In a recently released Chief Counsel Advisory (CCA) the IRS addressed the statute of limitations on assessment of penalties for failure to report gifts from foreign persons. The CCA states:

“Under section 6501(c)(3), the statute of limitations has not begun to run in the case where a U.S. taxpayer has not filed a Form 3520 reporting the receipt of a large gift from a foreign person, and pursuant to section 6039F(c)(1)(B), the Service may assess a 5% penalty (up to 25%) on the amount of the unreported gift.”
The penalty for unreported foreign gifts when put into context of a divorce proceeding presents some interesting issues.

Among the issued presented are:
(1) was the gift separate or community property?
(2) if the gift was separate property were the proceeds used for community purposes (commingled)?
(3) which of the spouses is responsible for the penalties?
(4) is the innocent spouse defense or other defenses to penalties available.

In divorce, particularly in cases involving dual nationals, asset tracing can be complex. Adding to the complexity are claims that a spouse is receiving “gifts” from family and friends offshore. Evidence of whether a true gift was made or not can be based upon whether a Form 3520 was filed timely or not. The failure to file Form 3520 ay be probative in the divorce proceeding that the gift was really income from the spouses offshore holdings and that the spouses income statement should include those items.

The claim of offshore gifts may also merit an investigation into whether the spouse has an offshore financial account (s) which are unreported. Offshore financial accounts are reported under the Bank Secrecy Act on a Report of Foreign Bank Account (FBAR). The penalty for “willful” failure to file an FBAR (as would be the case in a disguised gift claim) is the greater of $100,000 or 50% of the highest annual account balance for six (6) years.

The tax compliance issues in divorce proceedings where offshore gifts are concerned is complex and requires skilled professional advice.