Inheriting Money from Overseas as a US Person: The Form 3520 Trap and How to Avoid It

Inheriting Money from Overseas as a US Person: The Form 3520 Trap and How to Avoid It

If you're a US citizen or resident alien and you've just inherited money, property, or other assets from someone outside the United States, you may owe more than gratitude—you may owe the IRS a specific form it rarely discusses in plain English. The Form 3520 ("Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts") is a compliance requirement that catches many inheritors off-guard, often years after the inheritance is received. Miss this filing, and the IRS can impose penalties of up to 35% of the value of the foreign bequest—a shock that transforms a welcome inheritance into a costly mistake.

This article walks you through the rules, the risks, and the practical steps to stay compliant when you inherit from abroad.

Why Form 3520 Exists and Who Must File It

The IRS treats inheritances from foreign sources differently from domestic ones. While a US citizen inheriting from a US-based estate typically files a straightforward federal income tax return (and pays no federal tax on the inheritance itself, since inherited assets are not income), an inheritance from overseas triggers different reporting rules.

The Form 3520 is the IRS's primary tool to track foreign inheritances and gifts. The official IRS guidance on Form 3520 explains that US persons must report:

• Gifts received from foreign persons (both individuals and entities)
• Inheritances received from foreign estates
• Distributions from foreign trusts
• Certain transactions with foreign trusts

The law assumes that without this transparency, US persons could hide wealth offshore or avoid taxation on income generated by inherited assets. Even though the inheritance itself is not taxable, the reporting is mandatory—and that's where the trap springs shut.

The Critical Distinction: Foreign Person vs. Foreign Trust

Understanding whether your inheritance came through a foreign person (the deceased individual) or a foreign trust changes your filing obligations.

Inheritance from a Foreign Individual

If your relative died and left you money directly—whether by will, intestacy, or through a foreign bank account—and the deceased was a foreign national (or a US person resident abroad), you received a bequest from a "foreign person." This requires Form 3520 reporting.

What you must report:

• The name and address of the foreign person (the decedent)
• The nature and value of each asset inherited
• The date you received it
• Your relationship to the decedent

If the value of gifts and bequests from foreign persons in a single year exceeds the current reporting threshold (typically in the region of USD 100,000–$120,000, but confirm the prevailing threshold each year with IRS Publication 525), Form 3520 must be filed.

Inheritance from a Foreign Trust

If the inheritance flowed to you through a trust established in another country—even if that trust was created by your relative—the rules are stricter and the form is mandatory regardless of amount. Foreign trusts are treated as continuing entities, and the IRS requires detailed reporting of any distribution you receive.

The Penalty Trap: Why Missing This Deadline Is So Costly

Many US inheritors never hear about Form 3520 until a tax professional mentions it—often years after the inheritance. By then, the damage is done.

According to IRS penalty provisions, failure to file Form 3520 or to include required information can result in:

• An accuracy-related penalty of 5% per month (up to a maximum of 25%) of the undisclosed foreign gift or inheritance
• A penalty of 35% of the value of the foreign gift or bequest if the failure is "gross" or willful
• Interest charges on any unpaid tax, compounding over time

Unlike many IRS penalties, the Form 3520 penalty is not waived lightly. The IRS takes a strict approach: the penalty applies even if you didn't know the form existed, and even if you filed all your other tax returns correctly.

For example, if you inherited USD 500,000 and failed to file Form 3520, a 35% penalty would be USD 175,000—in addition to any income tax owed on distributions from the inherited assets or any income they generate.

When Form 3520 Is Actually Due

Form 3520 is due by the normal due date of your federal income tax return for the year in which you received the gift or bequest. For most individuals, this is April 15 (or the next business day if the 15th falls on a weekend or holiday), though extensions can shift this to October 15.

Key timing points:

• The form must be filed for every year you receive a reportable foreign gift or inheritance
• If you receive distributions from a foreign trust in multiple years, you file Form 3520 each year
• If you failed to file in prior years, you can still file—and doing so promptly, before the IRS discovers the omission, may reduce penalties and demonstrate good faith

Income Tax vs. Reporting: Another Key Distinction

A crucial point that confuses many inheritors: the inheritance itself is not subject to federal income tax, but you must report it. This is why many people never think to mention it to their accountant.

However, income generated by inherited assets is taxable. If you inherit a foreign bank account that earns interest, you owe tax on that interest. If you inherit rental property abroad and collect rent, that's taxable income. If you inherit shares in a foreign company and receive dividends, those are taxable.

Form 3520 is the gateway: it tells the IRS what you inherited so they can cross-reference it with subsequent income filings. If you inherit USD 200,000 in a foreign account but don't report it on Form 3520, and then the IRS sees interest income from that account in later years, they'll investigate.

What If You're Already Behind?

If you inherited foreign assets months or years ago and didn't file Form 3520, you're not alone—and it's not yet too late to fix the problem.

Here's what to do:

1. Stop worrying and start acting. The IRS gives credit for voluntary disclosure if you come forward before they audit you.

2. File an amended return. Use Form 1040-X to amend the tax year in which you should have reported the inheritance, and attach Form 3520.

3. Include a statement of reasonable cause. Explain why the form was missed (e.g., you didn't know it was required, your accountant didn't mention it). Most taxpayers successfully argue reasonable cause for a first omission.

4. Act sooner rather than later. If the IRS initiates an audit before you file, penalties are harder to reduce.

If your situation is complex—if you're an expat, if multiple inheritances are involved, or if you've also missed other filings—this is exactly when you need professional guidance. Many US business owners and expats who inherit overseas assets have missed prior US tax returns and filings) and are unsure how to unwind the situation. That's a more urgent issue to address than Form 3520 alone.

Form 3520-A: The Secondary Form for Foreign Trusts

If you received a distribution from a foreign trust (meaning the trust existed before you inherited), the trust itself (or its administrator) must also file Form 3520-A. You'll need to obtain a copy of that form from the trust administrator to complete your own Form 3520 correctly.

This is another common source of confusion and delay. If you're coordinating with an estate executor or trust administrator abroad, make sure they understand the US reporting requirement and that they send you the Form 3520-A data you need.

FATCA and Additional Layers of Compliance

If your inheritance includes a foreign financial account, you may also be subject to FATCA (Foreign Account Tax Compliance Act) reporting. Any US person with foreign financial accounts exceeding USD 10,000 in the aggregate must file Form 114 (FBAR) by April 15 (with automatic extension to October 15).

Form 3520 and Form 114 are separate filings with separate deadlines and penalties, but they often apply to the same inheritance. Inheriting a foreign bank account requires both.

A Practical Example

Let's say you live in New York and your aunt in London died in June 2023, leaving you £250,000 (approximately USD 315,000 at the time) in a UK bank account. You're a US citizen.

Your obligations:

• By April 15, 2024, you must file Form 3520 reporting the bequest from your foreign (UK-resident) aunt
• By April 15, 2024, you must file Form 114 (FBAR) if the UK account balance exceeded USD 10,000 at any point during 2023
• For tax year 2024, if the account earns interest, you report that interest income on your Form 1040
• If you withdraw the funds and bring them to the US, there's no additional income tax, but the Form 3520 must still have been filed in 2024

If you missed the April 2024 deadline, you should file both forms now, with a letter explaining the delay. Doing so voluntarily significantly reduces penalty risk.

Working with a Cross-Border Tax Specialist

Inheriting money from overseas is both a legal and emotional matter. The tax side should not add stress—it should clarify your path forward.

A licensed tax professional with cross-border expertise will:

• Determine whether Form 3520 applies to your specific inheritance
• Identify any other reporting forms (FBAR, FATCA, state-level disclosures) you may need
• Calculate the proper reporting value and date
• Draft any required explanatory statements to reduce penalty risk
• Advise on ongoing compliance for income generated by inherited assets

At Next Tax Source, every US and UK filing is reviewed and signed by an IRS Enrolled Agent who is also ACCA-qualified, ensuring that cross-border inheritances are handled with both jurisdictions' rules in mind.

Next Steps: Confirm Your Compliance Status

If you've recently inherited money from abroad, or if you inherited years ago and never heard about Form 3520, now is the time to clarify your position. The sooner you act, the better your options.

Don't assume the inheritance "doesn't count" because it's not income. The IRS doesn't see it that way. And if you've missed previous US tax returns and filings), the inheritance issue is just one part of a larger picture that needs to be addressed comprehensively.

Ready to ensure you're compliant? Book a consultation with our team) to review your inheritance, confirm your filing requirements, and chart the right path forward. We'll give you clarity, peace of mind, and a clear action plan—all before any IRS surprise finds you.