Declaring an Inheritance from Canada to the IRS

As a general matter, bequests received from the estate of a foreign person do not have to be reported to the IRS unless you received in 2007 US$100,000 or more in bequests or gifts from foreign persons or foreign estates. However, if the money was distributed out of a foreign trust set up by the deceased foreign person, then you must report receipt of the distribution to the IRS on Form 3520 regardless of the amount received. The first question therefore is whether the inheritance was distibuted from the estate of the person who left the money to you, or was distributed from a trust set up by the person who left the money to you. If the money came directly from the estate (i.e., the check is drawn on an account belonging to the estate, or an account belonging to the administrator/executor that is used to handle the estate's affairs), then you will not have to report the receipt of the gift to the IRS. On the other hand, if the distribution was from the assets of a foreign trust that was set up by the deceased foreign person, then you will have to report receipt of the amount to the IRS on Form 3520. Form 3520 is due on the same date as your Form 1040, with extensions, but is sent to a different address; however, a copy of the Form 3520 must also be included with your Form 1040. With respect to the year in which such receipt must be reported (assuming it was from a trust and not directly from the estate), the issue depends on whether or not you had so-called constructive receipt of that amount in 2006. If you knew about the bequest in 2006 and the amount was set aside or credited to you and was available for you to draw on at your request in 2006, then you should report the receipt of the bequest for 2006. However, since you actually received the amount in 2007, you should attach to your 2007 Form 1040 a Form 8275, Disclosure Statement, briefly explaining receipt of the gift, and that you reported it for

2006 as being constructively received in 2006. Otherwise, if you received the money from a foreign trust, the Form 3520 would be filed with the IRS by the due date of your 2007 Form 1040 (i.e., 4/15/2008). So, you need to answer the following:

1. Was the money distributed to you directly out of the foreign estate, or was it distributed to you out of a foreign trust? If it came directly from the estate, then you most likely do not have to report it. On the other hand, if it came from a foreign trust, then you will have to report it.

1. If it came from a foreign trust, did you know about the bequest in 2006 and was it set aside, credited to your name, and made available for you to draw upon at your request? If you knew about it in 2006 and could have requested in

2006 that part or all of the money be sent to you, then you should most likely report it as being constructively received in 2006. Otherwise, if you did not know about it in 2006, or if you could not have requested in 2006 that the money be sent to you, then you would report it as actually received in 2007.

Thank you for that information. I don't believe it was from an established trust. The cheque is from the trust account of the lawyer handling the probate of the will, which I assume is the normal method in which estate funds are distributed after probate. The letter from the lawyer said he was acting on behalf of the named executors. The word "trustees" was not used. Does that count as a trust or does that mean it was distributed from the estate? The person died in 2006, I was notified by my mom that the decedent left some money to myself and my sister, but I didn't know how much. I knew I would receive this inheritance sometime, but had no idea when. I knew the will was still being probated and the funds issued when it was completed. The money was neither available to me, nor could I request it. So, to clarify, does a distribution from an estate from the trust account of the lawyer handling the probate count as a trust? I"m inclined to think not as it didn't come from the trust of the decedent, but the trust account of the lawyer. Can anyone clear this up for me?

For a decedent in Canada, there is automatically a trust created on death called a testamentary trust. This is the trust of the decedent. (I've had to prepare two of these in the last week.)

Tim

I'm even more confused now. I realize that a trust account is established to handle the decedent's funds. But is that the type of trust to which shyster referred? My understanding is he meant a trust established prior to death.

I believe that shyster may be better to answer than I. All I can deal with here is the Canadian rules for the estate. For Canadian law, the estate is deemed to have been set up prior to death through the will. American law may be different. (And from what I have seen, are generally different. I am a Canadian Tax Practitioner who deals with American taxes but I don't deal with American decedents. That is a stage beyond my knowledge so don't touch that work. Canadian decedents I do know so handle that work. However, as a means to make things easy, what is the workload with reporting the trust? If the work isn't large and the consequences of reporting is not bad while the consequences of not reporting is bad, would it be easier to report and let the government worker make the determination be easier for you? Your choice of course and I can't really give a lot of advise on the US situation - only the Canadian half.

I agree that it is better to err on the side of caution. It's not taxable anyway, so that's the most important thing.

Be careful here. if you report it as a foreign trust distribution rather than as a foreign inheritance, there are a whole new set of rules that apply and you can no longer make the blanket statement that "it's not taxable". Distributions from foreign trusts trigger income tax liability to the beneficiary to the extent that the trust had income. If the foreign trust has been around for more than one year, you could be hit not only with income tax but also with an additional interest charge on the tax. Take a look at Schedules A, B, and C under Part III or Form 3520 to see the foreign trust distribution tax and interest calculations. This is one of the most confusing and most punative provisions in the US tax code. It's probably not an issue in this particular case, but it is possible for the amount of tax and interest payable from a foreign trust distribution to actually exceed the amount of the distribution.

--Chris