Do You Owe Tax on a Foreign Inheritance in California?

Do I Have to Pay Taxes on a Foreign Inheritance Received in California?

Foreign inheritance tax in California is less straightforward than most people assume. California imposes no inheritance tax, and the federal government imposes no inheritance tax on recipients. But that framing obscures the real exposure: federal estate tax on the decedent's estate, mandatory IRS reporting with penalties that can reach 25% of the inheritance itself, FBAR and FATCA obligations, and California's 13.3% top income tax rate on everything the inherited assets generate going forward. The compliance picture matters as much as the tax picture.

If you are a California resident who just inherited $2M from a relative in Germany or a portfolio from a parent in Hong Kong, your obligations start the moment the assets transfer, not when you file your return.

What California Actually Does (and Doesn't) Tax on Foreign Inheritances

California has no inheritance tax and no estate tax. The California Franchise Tax Board confirms this directly. The state repealed its estate tax in 1982 and has not reinstated it.

What California does tax, aggressively, is income. The California Franchise Tax Board taxes all income of California residents on a worldwide basis. That means dividends, rental income, interest, and capital gains generated by inherited foreign assets are subject to California's top marginal income tax rate of 13.3%. You do not pay tax on receiving the inheritance. You pay tax on what it earns after you receive it.

The distinction matters enormously for asset mix. Inheriting a €3M apartment in Milan that generates €120,000 in annual rental income means California will treat that rental income as ordinary income. Inheriting a €3M lump-sum cash bequest that sits in a money market account generates interest that California will tax at your marginal rate.

For inherited foreign securities, California's taxation of out-of-state gains applies to any appreciation you realize after the inheritance date. The step-up in basis (discussed below) determines your starting cost basis, and every dollar of gain above that basis is taxable in California when you sell.

One nuance that catches people: California does not fully conform to federal rules on step-up in basis for community property held in certain foreign trust structures. At the federal level, a surviving spouse may receive a full step-up on community property. California's conformity breaks down for foreign assets held in specific trust arrangements, potentially creating a state-level capital gains liability that does not exist federally. On a $5M foreign portfolio, that divergence can represent hundreds of thousands of dollars in California tax when you liquidate.

Federal Estate Tax and the 2026 Exemption Cliff

The federal estate tax applies to the decedent's estate, not to you as the recipient. But it directly affects what you receive.

For 2024, the federal estate tax exemption is $13.61 million per individual, according to the IRS. Estates below that threshold owe no federal estate tax. Married couples can combine exemptions to $27.22 million through portability elections. Estates above the threshold pay a top rate of 40%.

Here is the planning deadline most people are missing: the Tax Cuts and Jobs Act doubled the exemption, and that doubling is scheduled to sunset on January 1, 2026. Absent Congressional action, the exemption reverts to approximately $6 to $7 million per person (inflation-adjusted). For anyone with a taxable estate approaching $7M, the window to lock in the higher exemption through portability elections or irrevocable trust structures is narrow.

If you are the executor or trustee of a foreign estate with US beneficiaries, portability elections must be made on a timely filed estate tax return. Missing that election forfeits the deceased spouse's unused exemption permanently.

For California residents inheriting from foreign nationals, the foreign decedent's estate is generally not subject to US federal estate tax unless the decedent held US-situs assets (US real estate, US securities). The estate of a non-US domiciliary has a federal estate tax exemption of only $60,000 on US-situs assets, a figure that has not been updated in decades. If your foreign relative held US stocks or US real property, that $60,000 threshold is almost certainly breached.

Use our inheritance tax calculator to estimate your estate's tax liability across different asset configurations.

Step-Up in Basis: The Most Valuable Tax Benefit You May Be Underusing

Under IRC Section 1014, inherited property receives a stepped-up cost basis to the fair market value at the date of the decedent's death. This eliminates capital gains tax on all appreciation that occurred during the decedent's lifetime.

Practically: if your parent purchased shares in a Japanese company for $200,000 that were worth $1.8M at death, your cost basis is $1.8M. You owe zero capital gains tax on the $1.6M of appreciation that occurred before you inherited. Sell the shares the day after you inherit them and your taxable gain is essentially zero.

This is one of the most significant tax benefits in the US code, and it applies to foreign inherited assets just as it does to domestic ones. The key is establishing the fair market value at the date of death with documentation that will hold up to IRS scrutiny: brokerage statements, professional appraisals for real property, certified valuations for closely held businesses.

For foreign real property, capital gains tax implications on foreign property become relevant the moment you sell. The step-up protects pre-inheritance appreciation. Post-inheritance appreciation is fully taxable at federal capital gains rates plus California's 13.3%.

For inherited foreign securities, the inheritance tax on stocks and securities treatment follows the same step-up logic, but currency fluctuations add a layer: if the foreign currency appreciated against the dollar between the inheritance date and the sale date, that currency gain is taxable as ordinary income, not capital gain.

What Is Form 3520 and When Do You Need to File It?

Form 3520 is the IRS's mechanism for tracking large foreign wealth transfers into the United States. According to the IRS, US persons who receive more than $100,000 in aggregate gifts or bequests from foreign persons during a tax year must report these on Form 3520.

The penalty for failure to file is not a slap on the wrist. The IRS imposes an automatic penalty of 25% of the amount received. On a $2M inheritance, that is a $500,000 penalty for a missed filing. The penalty is automatic, meaning the IRS does not need to prove willfulness or intent.

Key distinctions:

• Form 3520 covers gifts and bequests received from foreign individuals and foreign estates. The $100,000 threshold is aggregate across the tax year.
• Form 3520-A covers annual information returns for foreign trusts with US owners. If you are the beneficiary of a foreign trust (as opposed to receiving a direct bequest), different rules and forms apply.
• The $100,000 threshold applies to gifts and inheritances from foreign individuals. Gifts from foreign corporations or partnerships have a much lower reporting threshold of $16,649 (2024, inflation-adjusted).

Form 3520 is due on the same date as your federal income tax return, including extensions. It does not create a tax liability by itself. It is a disclosure requirement. But the penalties for non-disclosure are severe enough that compliance is non-negotiable.

FBAR and FATCA: The Reporting Obligations That Follow the Assets

Inheriting foreign financial accounts triggers reporting obligations that persist as long as you hold those accounts.

FBAR (FinCEN Form 114): US persons who hold foreign financial accounts with an aggregate value exceeding $10,000 at any point during the calendar year must file an FBAR. The IRS is explicit that inherited accounts count from the date of inheritance. If you inherit a €500,000 brokerage account in France on December 1, you have an FBAR obligation for that calendar year even if you held the account for only 31 days.

Willful non-compliance penalties can reach the greater of $100,000 or 50% of the account balance per violation per year. The IRS Offshore Voluntary Disclosure Program has collected over $14 billion from non-compliant taxpayers since 2009, which gives you a sense of how seriously the IRS pursues this.

Form 8938 (FATCA): Under FATCA, US taxpayers with specified foreign financial assets exceeding $50,000 at year-end (or $75,000 at any point during the year) must file Form 8938 with their tax return. For taxpayers living abroad, the threshold rises to $200,000 at year-end. Inherited foreign financial accounts count toward this threshold from the date of inheritance, according to IRS instructions.

FBAR and Form 8938 overlap but are not identical. Both may be required for the same accounts. Filing one does not satisfy the obligation to file the other.

For the full picture on international estate complexities, including how foreign account structures interact with US reporting rules, the specifics vary significantly by country and account type.

How US Tax Treaties Affect Foreign Inheritance Tax Obligations

The United States maintains estate and gift tax treaties with only a limited number of countries, according to the IRS. The list includes Australia, France, Germany, Japan, and the United Kingdom, among others. Most countries do not have estate tax treaties with the US, meaning most foreign inheritances are subject to full US tax obligations with no treaty relief.

Even where treaties exist, they primarily address which country has taxing rights over specific assets, not whether tax is owed. A US-UK estate tax treaty, for example, may allocate taxing rights over UK real property to the UK, reducing the risk of double taxation. But the treaty does not eliminate US reporting obligations.

The foreign tax credit under IRC Section 901 allows US taxpayers to offset US tax liability with estate or inheritance taxes paid to a foreign government. Here is the counterintuitive trap: many countries, including Canada, Australia, and New Zealand, have abolished their inheritance taxes. If the foreign country imposed no inheritance tax, there is no foreign tax credit to claim. US heirs inheriting from estates in these countries have full US tax exposure with no offset.

For estates in countries with no inheritance tax, the absence of foreign tax does not reduce your US obligations. It eliminates your ability to offset them.

FIRPTA: When the Foreign Estate Held US Real Property

If the foreign decedent held US real property, the Foreign Investment in Real Property Tax Act (FIRPTA) creates withholding obligations at the estate level that affect what you ultimately receive.

Under FIRPTA, when a US person inherits US real property from a foreign person, the estate may be subject to a 15% withholding tax on the gross sales price upon disposition, according to IRS Publication 515. This withholding applies to the sale proceeds, not the gain, which means it can significantly exceed the actual tax owed. The estate can apply for a withholding certificate to reduce or eliminate the withholding if the actual tax liability is lower.

FIRPTA also applies to US Real Property Holding Corporations (USRPHCs), which are foreign corporations that hold primarily US real estate. If the foreign estate held shares in such a structure, the FIRPTA rules extend to those shares.

For non-resident capital gains tax rules on US-situs property, the interaction between FIRPTA withholding and the estate's actual tax liability requires careful coordination between US and foreign counsel.

Federal vs. California Reporting Requirements: A Side-by-Side View

Practical Action Items for Foreign Inheritance Recipients

The sequence matters as much as the substance. Here is what to do, in order:

Before you receive the inheritance:

• Identify the asset types and their fair market values at the date of death. This establishes your step-up basis and determines which forms you will need to file.
• Determine whether the foreign estate is subject to US estate tax (US-situs assets held by a non-US domiciliary) or FIRPTA withholding.
• Review whether the decedent's country has a US estate tax treaty and whether that treaty affects the allocation of taxing rights.

Within 90 days of the tax year:

• File Form 3520 if you received more than $100,000 in aggregate from foreign persons. The form is due with your tax return (typically April 15, extended to October 15). Do not confuse this with a 90-day deadline; the 90-day window applies to certain foreign trust transactions, not direct bequests.
• Open a separate account for inherited assets to maintain clean records of basis, income, and distributions.

By April 15 of the following year:

• File FBAR (FinCEN 114) if inherited foreign accounts exceeded $10,000 at any point during the year.
• File Form 8938 if specified foreign financial assets exceeded $50,000 at year-end.
• Report all income generated by inherited foreign assets on your California and federal returns.

Ongoing:

• Track currency fluctuations if inherited assets are denominated in foreign currency. Currency gains on sale are taxable as ordinary income.
• Monitor recent changes to California property inheritance law if the inherited assets include California real property, particularly under California's Prop 19 rules, which significantly altered property tax reassessment treatment for inherited real estate.
• Reassess your overall estate plan in light of the 2026 exemption sunset. If your combined estate (including inherited assets) approaches $7M, the window to act is closing.

The professionals you need are not interchangeable. A CPA handles return preparation and Form 3520. A tax attorney handles treaty analysis, FIRPTA certificates, and voluntary disclosure if you have prior non-compliance. An international estate planning attorney handles trust structures and cross-border coordination. For US inheritance tax obligations for non-residents on the decedent's side, foreign counsel familiar with US tax obligations is often essential.

References

• Internal Revenue Service -- "Instructions for Form 3520: Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts" (2024)
• Internal Revenue Service -- "Estate Tax: Frequently Asked Questions" (2024)
• Internal Revenue Service -- "Publication 515: Withholding of Tax on Nonresident Aliens and Foreign Entities" (2024)
• Internal Revenue Service -- "IRC Section 1014: Basis of Property Acquired from a Decedent"
• Internal Revenue Service -- "FinCEN Form 114: Report of Foreign Bank and Financial Accounts (FBAR)" (2024)
• Internal Revenue Service -- "United States Income Tax Treaties -- A to Z" (2024)
• California Franchise Tax Board -- "California Nonresident or Part-Year Resident Income Tax Return (Form 540NR) Instructions" (2024)
• Internal Revenue Service -- "Instructions for Form 8938: Statement of Specified Foreign Financial Assets" (2024)