6 Things You Should Know About IRS Foreign Trusts

6 Things You Should Know About IRS Foreign Trusts

6 Things You Should Know About IRS Foreign Trusts

When it comes to international tax law, one of the most complicated aspects of reporting to the Internal Revenue Service involves foreign trust disclosures. That is because there are so many different flavors of foreign trusts, depending on which country the foreign trust was formed — and if it is operating as a trust or other type of entity. For example, possibly you created a foreign grantor trust because you own a foreign rental property that you placed in a trust. Or, you may own foreign assets in a country that does not allow non-citizens of that country to own such assets unless they are owned in an entity. Alternatively, maybe you are trying to ‘protect’ your foreign assets, so you placed them in an Offshore Asset Protection Trust. Whatever the case might be, you may now have a Form 3520/3520-A reporting requirement to deal with. Let’s look at six (6) important facts about foreign trusts.

Multiple IRS Forms May Be Required 

For Taxpayers who own and/or are deemed beneficiaries of a foreign trust, there are many different international information reporting forms that a U.S. taxpayer may have to file each year depending on the specific type of foreign accounts, assets, and investments that they maintain overseas. Some of the more common forms include:

The IRS can Re-Categorize for U.S. Purposes (Corp vs Trust)

When it comes to reporting foreign trusts, it is important to try to get it right when it comes to reporting for U.S. tax purposes. For example, if the IRS determines that the Taxpayer filed the wrong form (For example, filing Form 5471 instead of Form 3520/3520-A) the IRS can issue fines and penalties for non-compliance with trust reporting – even when the Taxpayer believed they did everything correctly as in the recent Tax Court case, Fairbank.

Foreign Grantor Trust vs Non-Grantor Trust

The Grantor and Non-Grantor Trusts are taxed differently for U.S. taxes. With a grantor trust, the owner of the trust is taxed on the income (even if distributed to beneficiaries). With a non-grantor trust, the beneficiaries are taxed on their income.

Throwback Rule

When a foreign trust issues distributions of income that were accumulated in prior years, there may be additional taxes and interest that are due. In this type of situation, where the income is UNI (not currently year DNI),  the throwback rule may be applicable.

Foreign Trust Penalties

The IRS may issue extensive fines and penalties for failing to accurately report the foreign trust. Penalties can reach upwards of 35% value of the trust. As provided by the IRS:

Section 6677.

    • “A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable).

        • 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust in Part I.

        • 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution in Part III.

        • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679), if the foreign trust (a) fails to file a timely Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. If a foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for the Form 3520-A, which is otherwise due by the 15th day of the 3rd month after the end of the trust’s tax year) in order to avoid being subject to the penalty for the foreign trust’s failure to timely file Form 3520-A.

          • For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for U.S. owners who are individuals), is considered to be timely filed. See section 6677(a) through (c) and the instructions for Part II of this form and Form 3520-A.”

Beware of Anti-Abuse Rules

The IRS has been actively pursuing foreign trusts that they deem to be illegal or fraudulent (aka IRS Abusive Trust Arrangements). Taxpayers should be very wary of tax promoters who are trying to sell them tax strategies that do not seem kosher. Getting entwined with abusive tax promoters can lead Taxpayers to have to pay extensive fines and penalties for taking certain tax positions.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file the necessary international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.