Inheriting Assets Gained Through Tax Evasion: Now What?
Contents
- 1 Inheriting Assets Gained Through Tax Evasion: Now What?
- 1.1 Come Clean Through Voluntary Disclosure
- 1.2 Try Quiet Disclosure
- 1.3 Plead Ignorance
- 1.4 Claim the Audit Lottery
- 1.5 Renounce the Inheritance
- 1.6 File Form 3520 for Foreign Gifts and Inheritances
- 1.7 State Tax Compliance
- 1.8 Warning Signs You Inherited Evaded Assets
- 1.9 Get Professional Help
- 1.10 The Bottom Line
Inheriting Assets Gained Through Tax Evasion: Now What?
So your parents were involved in some shady tax stuff, and now you’ve inherited a bunch of assets that were never properly reported to the IRS. What do you do? This situation is way more common than you’d think! Lots of people have found themselves with money or property that was obtained through tax evasion. It puts you in a tricky spot when tax time comes around.
The first thing to understand is that you are not automatically guilty of tax evasion just because you inherited questionable assets. The sins of the parents don’t pass on to the children in the eyes of the law. But you do need to take steps to get right with the IRS now that these hidden assets are coming to light.
This article will walk you through your options, explain the risks, and give some practical tips for dealing with inheriting assets gained through tax evasion. Let’s dig in!
Come Clean Through Voluntary Disclosure
The best thing you can do in this situation is come clean by filing amended tax returns through the IRS’s Voluntary Disclosure Program. This allows you to avoid criminal prosecution and minimize penalties by disclosing unreported income and assets. The Voluntary Disclosure Process is outlined in Internal Revenue Manual 9.5.11.1. Basically you file amended returns and pay back taxes and interest on any unreported income. The penalties are usually around 20-25% of the previously unpaid tax, much lower than if the IRS discovers the evasion on their own.
You’ll need to file returns going back 6 years, which is the statute of limitations on civil tax fraud. The IRS won’t prosecute you criminally as long as you come forward voluntarily before you’re on their radar. This route allows you to become compliant with minimal penalties. Just be sure to consult with a tax attorney first to make sure you do everything by the book. The Voluntary Disclosure Process is your best bet for inheriting questionable assets.
Try Quiet Disclosure
Some people attempt to fix past misreporting through a “quiet disclosure.” This just means you start filing accurate tax returns without actually informing the IRS about the previous evasion. You don’t amend the old returns, but you properly report the inherited assets moving forward. This can work out fine, or the IRS can still come after you for penalties and interest if they decide you didn’t come clean soon enough. It’s a gamble.
If the statute of limitations has passed and the IRS has no idea about the previous evasion, quiet disclosure is probably fine. But it’s impossible to know if the IRS is already suspicious, in which case quiet disclosure could be seen as continued evasion. Consult with a tax attorney to assess whether quiet disclosure is a smart option or too risky in your specific situation. The Voluntary Disclosure Program is the more cautious route.
Plead Ignorance
Can you convince the IRS you had no idea the inherited assets were obtained illegally? This defense is pretty hard to pull off. As the beneficiary, you have a responsibility to inquire about the source of large gifts or inheritances. Just playing dumb is unlikely to work. However, if you truly had no knowledge of the evasion and acted in good faith, you may be able to avoid civil tax fraud penalties.
If the assets were held in a foreign account that you were unaware of, and you immediately reported the inheritance once discovered, you have a better case for pleading ignorance. The IRS might believe you were an unwitting beneficiary. But for domestic assets, it’s hard to claim you didn’t know about the tax evasion. This defense only goes so far.
Claim the Audit Lottery
Some people are tempted to just inherit the questionable assets and hope they don’t get audited. After all, the IRS only audits around 0.5% of individual tax returns each year. Why amend old returns and potentially raise red flags? Maybe you’ll win the audit lottery and the IRS will never know.
But this is very risky. Tax evasion related to offshore accounts is one of the IRS’s priorities, so inherited foreign assets are likely to get scrutiny. And if you get caught, you’ll face much higher penalties and interest than if you came clean voluntarily. It’s usually not worth the gamble to hide inherited tax evasion and hope you don’t get caught.
Renounce the Inheritance
If you want to avoid the headache altogether, you can legally renounce your claim to the inheritance. This must be done within 9 months of the death through filing a Disclaimer of Interest form. Any assets you disclaim will pass on to the next beneficiary as if you were not alive. This gets you off the hook, but also means losing your inheritance.
Renouncing an inheritance may be an option if you feel the risk of coming clean to the IRS outweighs the value of the assets. But you can’t engage in “selective renunciation” – you have to refuse the entire inheritance, not just the problematic parts. And any benefits you already received would still need to be reported. Tread carefully if going this route.
File Form 3520 for Foreign Gifts and Inheritances
If the inheritance involves foreign assets or trusts, you need to report it to the IRS within 90 days using Form 3520. This form discloses foreign gifts over $100,000 and inheritances over $16,812 (2022 limits). Failing to file Form 3520 can lead to huge penalties, on top of any taxes and penalties due on related unreported income. Don’t mess around with foreign inheritances – file Form 3520 right away.
State Tax Compliance
In addition to federal tax issues, you need to consider state compliance. Many states have their own voluntary disclosure programs that mirror the IRS’s program. States don’t always follow federal statutes of limitations, so their lookback periods for amending returns may be longer. Get advice on your specific state tax requirements when inheriting questionable assets.
Warning Signs You Inherited Evaded Assets
How do you know if assets you inherited were obtained through shady tax dealings? Here are some red flags:
- Inheritance is paid in cash or physical assets like gold, suggesting an attempt to avoid paper trails
- Assets are held by foreign shell companies or trusts
- You inherit a business but are unable to verify its financial records
- The will or trust instrument seems designed to obscure ownership
- Family members refuse to discuss the history or origin of the assets
- The nature, size, or location of the inheritance doesn’t match what you know about the deceased’s wealth
If you see signs like these, it’s best to do some investigating before accepting the inheritance. An experienced tax attorney can help you evaluate any red flags.
Get Professional Help
Dealing with an inheritance from unreported income or assets is messy at best, and potentially criminal at worst. Don’t go it alone. Get help from a tax controversy attorney to understand your options and create a strategy. An attorney can negotiate with the IRS on your behalf and try to reduce penalties through voluntary disclosure. They can also advise you on whether to accept the inheritance at all.
A tax attorney is expensive, but the cost pales compared to the penalties you’ll face if things go sideways with an illegal inheritance. Plus a good attorney may get penalties waived or reduced. It’s worth the investment for expert guidance on inheriting questionable assets.
The Bottom Line
If you find yourself inheriting assets gained through tax evasion, take a deep breath. You have options. The best approach is usually coming clean voluntarily through the IRS disclosure programs. This allows you to minimize penalties and become compliant. An experienced tax attorney can guide you through the process.
While the situation is stressful, don’t panic. People inherit shady assets more often than you think. Get professional help to make things right, and you can put this chapter behind you! Just file those amended returns and try to move forward.